Nicholas Ward

With so many of my favorite names falling towards levels where I’d like to buy them, it’s important for me to have cash on hand to do so. Unfortunately, my wife isn’t working because she’s in graduate school, which really puts a hamper on our ability to save money at the moment. Money doesn’t grow on the trees in my front yard, which means that I have to raise cash from elsewhere in my portfolio.

It’s never fun to sell into a downdraft like this. It’s common knowledge that its best to buy into weakness and sell into strength (buy low, sell high). Because of this, I’m looking at relative out performers in the last week or so, trying to find companies with high valuations still trading near all-time highs. I’m looking for companies that I hold that don’t play into my long-term, dividend growth oriented thesis. In other words, I’m looking to sell companies that aren’t core DGI holdings trading at high prices that mean I haven’t left a lot of profits on the table by selling/trimming into major market weakness.

Lately I’ve been selling/trimming my exposure to the consumer staples space because of my valuation concerns in the face of rising rates combined with my belief that their slowing sales/market share loss will result in slower dividend growth. However, I’ve sold most of my low hanging fruit there and all I have left are some of my absolute favorite names in the space: Coca-Cola (KO), Pepsico (PEP), and Unilever (UL). My reluctance to cut ties with any of those names lead me to another one of my holdings with sub-par dividend growth prospects: Bristol-Myers Squibb (BMY).

Bristol-Myers has held up extraordinarily well during the recent market sell-off. With many the leaders in the large cap biotech/big pharma space selling off double digits (Gilead (GILD)is currently down more than 10% from its recent highs, Amgen (AMGN) has sold off more than 12%, Johnson and Johnson (JNJ) and Pfizer (PFE) are currently off by more than 13%, Merck (MRK) is down more than 17%, and a couple of the big European names, Roche (RHHBY) and Sanofi (SNY) are down more than 20%). Needless to say, there are red numbers popping up all over the healthcare space. I imagine the President’s comments regarding the overpriced nature of prescription drugs during his recent State of the Union address plays a role here as well.

Surprisingly, it’s BMY that has been the relative out performer here, down less than 5% from its recent highs. To me, this relative strength is not justified. BMY is more expensive than most of the names on that list and while it might have better growth prospects than some, it is not the highest quality holding, in my opinion. I own a large stake in BMY because of a handful of contrarian purchases I made in 2015 and 2016 when the stock sold off drastically due to Opdivo concerns. This lead to an overweight position with a cost basis down near $50. BMY’s recent bounce back has given the the opportunity to take profits.

In June of 2016 I sold some of my BMY shares for $56.00. In October I trimmed again, selling another lot for 64.27. And on Thursday, I trimmed my stake again, selling a lot of shares that I purchases for $55.86 for $63.33, locking in more BMY gains.

After all of these sales, my BMY position is falling back in life with a typical “full” position within my portfolio. Right now, it’s weighted at approximately 1.2%, which is about right. When I went so overweight (at a certain point, BMY made up ~4% of my portfolio) it was because I thought the sell-off had gone too far. I thought Opdivo would continue to be a powerhouse, even if it lost first-line status in lung cancer to Keytruda and I liked the rest of BMY’s product portfolio/pipeline. What’s more, I thought that an M&A floor would form under BMY shares in the ~$45 area, limiting my potential downside.

I think the likelihood of M&A is smaller now with cash rich companies targeting small/mid cap companies in recent months. Also, BMY’s return to the mid-$60’s has pushed its market cap back up over $100b and when you factor in a likely 20%+ M&A premium there are simply too few companies in a position to make such a move to count on it.

What’s more, this move back into the $60’s has pushed the stock back above 20x earnings on a ttm basis. Looking forward, BMY is trading for ~19x 2018 EPS expectations and ~16.5x 2019 estimates. Neither of these valuations are very cheap for a company that is likely to post single digit top-line growth moving forward.

BMY’s recent quarter was impressive. The Opdivo/Yervoy combo is making headway in the 1L NSCLC space. This would be huge news for the company, resulting in billions of incremental sales. The company lead with news regarding recent lung cancer trials and the market bought it. As previously stated, BMY has been holding strong throughout recent market weakness and Merck has plummeted. The lung cancer market is paramount in the oncology space and whoever controls it will be a popular company on Wall Street.

BMY posted solid, 7% top-line growth in 2017 with many of its top drugs growing much faster than that.

Source: BMY ER CC Slides, page 16

EPS increased 6% during 2017, which is solid performance considering that 3 out of the last 6 years resulted in double digit bottom-line losses for BMY.

2018 guidance was fine, in my opinion. Mid-single digit bottom line growth isn’t setting the world on fire, but I’m willing to hold a full BMY position due to the potential of its oncology portfolio. What I’m not willing to do is overweight this company at what I also consider to be a full valuation (especially when there are higher quality companies, both in terms of business operations and dividend growth prospects, selling off at the moment). As you can see in the F.A.S.T. Graph below, after falling below its long-term, historical average P/E ratio, BMY has closed the gap and is now essentially trading back in-line with long-term averages.

Source: F.A.S.T. Graphs

I’ll close with the dividend. I know many hear Bristol-Myers Squibb and think dividend aristocrat. I imagine Jim Cramer’s hype has something to do with this. For years, BMY was his go to recommendation for the retail investors who called his show. Well, that simply isn’t the case. BMY has increased its dividend for 9 consecutive years. BMY hasn’t cut its dividend recently, but the company did freeze it for 3 years in the early-mid 2000’s.

Source: F.A.S.T. Graphs

9 years of consecutive isn’t terrible though. Management mentioned a commitment towards shareholder returns during the recent quarterly call, highlighting dividends and an “opportunistic buyback” which resulted in ~$2.5b of repurchases in 2017. I’m pleased to see this commitment, but it doesn’t change the fact that BMY has given investors annual dividend increases in the 3% range every year since 2011. Low single digit dividend growth coming from a yield in the 2.5% range simply isn’t enough for me as a DGI investor. I’m looking for double digit Chowder Numbers from my DGI holdings, especially those in the somewhat volatile healthcare space.

Because of BMY’s lackluster dividend growth, my position remains a somewhat speculative, growth oriented position for me. If shares continue their upward rise I wouldn’t be opposed to selling some more, locking in further gains. I think BMY is a fine long-term hold for many investors, but if income growth is one of your primary concerns, BMY isn’t exactly up to snuff.

UPDATE: Later in the trading day I locked in more BMY gains as the market sell-off steeped but BMY's relative strength held up. This is an easy place for me to raise cash due to its lackluster dividend growth history. I sold a lot of shares purchased at $50.06 for $62.69, locking in ~27% gains. These two moves increased my cash percentage by roughly 1%, giving me more flexibility to pick up beaten down shares of high quality DGI names (I'm also looking at some of the top tech names who've been loss leaders during this downdraft).

disclosure: I am long BMY, GILD, JNJ, AMGN, MRK, PFE, KO, PEP, UL


Portfolio Management