>SANOFI - AVENTIS (EUROPEAN STOCK)

Stock too cheap. Transformation on track

■ Low valuation underestimates turnaround potential
We maintain our Buy rating on Sanofi. Although, in absolute terms, the stock has recovered its losses from the (now significantly diminished) Lantus safety scare at the end of June, it has not yet caught up with the market rally over the same timeframe. As a result, on our estimates it remains the cheapest stock in our sector, trading on a 10E PE of 7.0x, 30% below its peers and at a 20% discount to our worst case DCF value (assumes generic Lovenox) and price objective of Eur60. This is despite scope for significant upside we see to consensus earnings and PE rating as the near and long-term growth outlook improves under the new management team’s turnaround strategy.

■ New management has delivered on turnaround to date
In our view management has delivered on the initial stages of its turnaround strategy. Specifically it has: 1) Rationalised R&D, centralising discovery sites, increased focus on in-licensing and external collaborations and ceased NPV negative late stage R&D; 2) Cut near-term costs leading to 7-12% EPS upgrades and committed to Eur2bn in long-term cost savings to help bridge its patent cliff in 2010-12; 3) Refocused on new sources of growth with value accretive acquisitions in emerging markets/generics businesses and animal health.

■ We see upside to management guidance and consensus.
Despite having recently been upgraded with 2Q results, we see Sanofi’s c10% CER EPS growth guidance (and consensus) for FY09 as conservative and likely to be beaten. Guidance implies an 800bp fall in 2H margins vs 1H which we see as unlikely. Longer-term, we see upside to Sanofi’s “roadmap” for 2013 profits in line with 2008. Although, this is in line with consensus we see upside from pipeline products, synergies from recent deals, the impact of any future acquisitions and upside to its Eur2bn savings target.

To see full report: SANOFI- AVENTIS (MERRILL LYNCH)