A Healthy Pipeline

09/16/2008 12:00 am EST

Focus: GLOBAL

Allan Nichols

Equities Strategist & Editor, Morningstar InternationalInvestor

Allan Nichols, editor of Morningstar InternationalInvestor, sees big potential in a European drug company.

Sanofi-Aventis (NYSE: SNY) develops and markets pharmaceuticals with a concentration in oncology, cardiovascular disease, central nervous system disorders, diabetes, and vaccines. Its highest revenue generator, antithrombotic treatment Lovenox, represents about 9% of total sales. About 33% of total revenue comes from the US and 43% from Europe.

Sanofi-Aventis’s wide lineup of branded drugs and a robust pipeline create strong cash flows and a wide economic moat and should offset patent losses on allergy drug Allegra and cancer treatment Eloxatin. Further, Sanofi dodged a bullet in mid-2007 by holding on to patent exclusivity of blockbuster Plavix, removing a major risk hanging over the company.

Sales of Sanofi’s industry-leading products, including Lovenox, anticlotting agent Plavix, and diabetes drug Lantus, grew 11%, to more than 7 billion Euros in 2007, and 8% average annual growth is projected during the next four years. None represented more than 9% of the company’s total sales. The patents on these drugs will not expire until 2011–2015, providing the company with ample time to launch new products.

We expect its development strength in the neurological class, including multiple sclerosis and depression, to add several blockbuster drugs. It is working on a diabetes drug similar to Amylin’s AMLN Byetta that, despite arriving second to market, has plenty of growth potential. The company has just under 60 compounds in Phase II or III development and approximately 60 in Phase I development.

The company also harnesses its research and development to increase product potential through life cycle management techniques. Sanofi introduced Ambien CR, an extended-release version of Ambien. The new drug not only offers patients more options, but extends the patent life on the Ambien franchise. The company is also performing multiple late-stage trials on marketed drugs for additional indications.

Our fair value estimate is $50 per share. (It closed at $34.98 Monday—Editor.) We maintain a cost of equity of 9.5%, in line with the company’s large pharmaceutical peer group. We project a ten-year average annual revenue growth rate of 2%, largely driven by new products offsetting [those that are] losing patents. Also, we project operating margins to increase by 900 basis points during the next five years, largely because of the reduction of amortization costs related to the Aventis acquisition and the realization of related synergies.

We assume the patent on Lovenox fends off generic competitors until its expiration in 2012. However, if generic challengers are successful in entering the market as early as 2008, we would lower our fair value estimate by a dollar per share to $49.

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