Bristol Myers Squibb Company (BMY) sells at a low valuation due to worries over patent expirations for Revlimid (starting in 2022) and Opdivo and Eliquis (starting in 2026), observes Bruce Kaser, editor of Cabot Undervalued Stocks Advisor.

However, the company is working to replace the eventual revenue losses by developing its robust product pipeline while also acquiring new treatments (notably with its acquisitions of Celgene and MyoKardia), and by signing agreements with generics competitors to forestall their competitive entry.

The likely worst-case scenario is flat revenues over the next 3-5 years. Bristol should continue to generate vast free cash flow, helped by a $2.5 billion cost-cutting program, and has a relatively modest debt level.

On July 28, Bristol reported encouraging second-quarter results, with revenues growing 13% from the pandemic-weakened quarter a year ago. Revenues were 4% above the consensus estimate. One of the major debates on Bristol is its ability to grow revenues, so the “beat” is an indicator that we are on the right track.

Earnings rose 18% from a year ago and were slightly higher than the $1.90 consensus estimate. The company reiterated its full-year 2021 revenue and earnings guidance. Net debt was trimmed about 7% from the year end — an important metric that we are watching.

In its September 14 presentation at Morgan Stanley’s Global Healthcare Conference, CEO Giovanni Caforio said the dividend (and growing it) remains a high priority, and that Bristol is being more aggressive and opportunistic with its share repurchases given the strong free cash flow and balance sheet.

Bristol will continue to focus on acquisitions and pointed to the recent MyoKardia deal as a successful example. Caforio also spoke highly of Opdivo’s ability (and other immune-oncology treatments) to sustain revenue growth longer than investors believe.

BMY shares have slipped about 10% from their recent high; the most likely weight on the shares is the legislative proposal for more drug price controls. The exact scope and depth of the pressure won’t be known until at least after the bill is passed.

Many investors simply avoid pharma stocks during such a period. We are a bit more optimistic that Congress won’t gut the industry, and remain patient with BMY shares with strong conviction in the company’s underlying fundamentals.

The stock trades at a low 7.7x estimated 2022 earnings of $8.06 (up a cent in the past week) and 7.2x estimates of $8.61 (down 3 cents) for 2023. Either we are completely wrong about the company’s fundamental strength, or the market must eventually recognize Bristol’s earnings stability and power.

We believe the earning power, low valuation and 3.2% dividend yield that is well-covered by enormous free cash flow make a compelling story.

Subscribe to Cabot Undervalued Stocks Advisor here…