- Bristol-Myers Squibb recently reported Q4 earnings, narrowly beating expected EPS
- The shares have been volatile over the past 12 months
- Wall Street consensus outlook for the next 12 months is mixed
- The market-implied outlook (calculated using options prices) is slightly bullish to the middle of 2022, but slightly bearish for the full year
On Feb. 4, pharmaceuticals giant Bristol-Myers Squibb (NYSE:BMY) reported Q4 earnings. While the results from the New York City-based healthcare company were solid, with this quarter's gains driven by its immuno-oncology drug Eliquis, as well as usage increases for its melanoma drug Opdivo, the outlook for longer-term growth is a concern.
The consensus for EPS growth over the next three to five years is 4.05% per year. Potential growth is limited by the expected impacts of expiring patent protection on several high-earning drugs.
The large difference between the TTM P/E (20.8) and the estimated P/E based on earnings expectations (8.3) shows how sensitive the current valuation is to the earnings outlook.
BMY has been volatile over the past year, closing just above $69 twice in August and going as low as $53.60 at the end of November.
Source: Investing.com
BMY’s recent share price surge, with a total return of 10.6% over the past three months, is notable, the share performance over the past 1-, 3-, 5-, and 10-year periods lags the industry averages.
Source: Morningstar
BMY has delivered consistent earnings growth, beating the analyst expectations in every quarter over the past four years except for Q1 of 2021. The stability of the earnings growth is a notable contrast to the substantial swings in the share price, indicating that the volatility is driven by instability in the long-term outlook.
Green (red) values are amount by which EPS exceeded (missed) expected value. Source: E-Trade.
BMY has raised the dividend for 15 years in a row, and the current payout ratio is a modest 26.8%. The trailing three- and five-year dividend growth rates are 7.7% and 5.6%, respectively. Along with the current dividend yield of 3.47%, BMY is likely to get some attention from income investors. The Gordon Growth Model predicts total return of 9%-11% on the basis of current yield and dividend growth, although the applicability of this model to a company with such potentially volatile earnings is debatable. Expected returns in this range seem reasonable in light of past performance, however.
I last wrote about BMY on Sept. 16, at which time I assigned a neutral/hold rating. Over the (almost) five months since, BMY has rallied and returned a total return of 11% as compared to 1.1% for the S&P 500 over the same period.
BMY’s valuation looked reasonable in September and the Wall Street consensus rating was bullish, with a 12-month price target that was about 24.5% above the share price at that time. I maintained my neutral rating on BMY because the consensus outlook from the options market was signalling a less bullish view.
The price of an option on a stock reflects the market’s consensus estimate of the probability that the stock price will rise above (call option) or fall below (put option) a specific level (the option strike price) between now and when the option expires. By analyzing the prices of call and put options at a range of strike prices, all with the same expiration date, it is possible to calculate a probable price forecast that reconciles the options prices. This is called the market-implied outlook and represents the consensus outlook among buyers and sellers of options.
With almost five months since my last post on BMY, along with the recent strong earnings, I am revisiting my analysis.
Wall Street Consensus Outlook for BMY
E-Trade calculates the Wall Street consensus outlook for BMY by combining the views of eight ranked analysts who have published ratings and price targets over the past 90 days. While the consensus rating is bullish, the consensus 12-month price target is only 2.8% above the current share price.
Source: E-Trade
Investing.com calculates the Wall Street consensus from the views of 21 analysts. The consensus rating is bullish and the consensus 12-month price target is 9.2% above the current share price.
Source: Investing.com
While the Wall Street consensus calculated by both E-Trade and Investing.com are bullish, the differences in the individual 12-month price targets and even between the two consensus calculations demonstrate that there is a fairly wide range of opinions among the individual analysts. Averaging the two consensus price targets gives an expected 12-month price return of 6% and expected total return of 9.5%, very close to the trailing 10-year annualized total return for BMY.
Market Implied Outlook For BMY
I have calculated the market-implied outlooks for BMY to the middle of 2022 (using options that expire on June 17, 2022) and to early 2023 (using options that expire on Jan. 20, 2023). I selected these two option expiration dates because the options that expire in June and January tend to be especially liquid. The amount of open interest for options on BMY is high for these two expiration dates.
The standard presentation of the market-implied outlook is in the form of a probability distribution of price return, with probability on the vertical axis and return on the horizontal.
Source: Author’s calculations using options quotes from E-Trade.
The market-implied outlook to June 17, 2022, is generally symmetric, with comparable probabilities of positive and negative returns of the same magnitude. The distribution is centered near zero return. The annualized volatility calculated from this distribution is 23%, quite low for an individual stock.
To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).
The negative return side of the distribution has been rotated about the vertical axis. Source: Author’s calculations using options quotes from E-Trade.
This view shows that the probabilities of positive and negative returns of the same size are very similar (the solid blue line and the dashed red line are right on top of one another). Theory suggests that the market-implied outlook is expected to be negatively biased because investors, in aggregate, are risk averse and tend to pay more than fair value for downside protection. As such, this market-implied outlook is interpreted as being slightly bullish.
The market-implied outlook for the next 11.4 months, from now until Jan. 20, 2023, favors negative price returns. The probabilities of negative returns are consistently higher than for positive returns of the same magnitude (the red dashed line is consistently above the solid blue line). I interpret this outlook as slightly bearish. The annualized volatility calculated from this outlook is 26%.
The negative return side of the distribution has been rotated about the vertical axis. Source: Author’s calculations using options quotes from E-Trade.
BMY has some positive momentum, reinforced by recent strong earnings. The market-implied outlook to June 17 is consistent with the continuation of the positive trend for the time being. The market-implied outlook for the full year is slightly bearish, however, reflecting the longer-term concerns with earnings growth. The outlook for volatility is slightly higher for the full year than for the first half.
Summary
While BMY has rallied in recent months, these gains mainly represent a recovery from the substantial decline in late 2021. Even with the 10.6% gain in the past three months, BMY substantially lags the drug manufacturing industry average over the past year.
The Wall Street analyst consensus rating is bullish, but there is considerable difference between individual analyst outlooks and even between estimates of the Wall Street consensus. The average of the consensus 12-month price targets from E-Trade and Investing.com implies a 12-month total return of 9.5%.
As a rule of thumb for a buy rating, I want to see an expected 12-month return that is at least half the expected (annualized) volatility. Using the volatilities from the market-implied outlooks, BMY does not reach this threshold. The market-implied outlook to the middle of 2022 is slightly bullish, but the outlook for the full year is slightly bearish.
I am maintaining my overall neutral rating on BMY.