20th December 2013
Per Ardua, ad Astra?
Edmund Shing gives his reasons why AstraZeneca represents a good long term buy.
While I may have been more focused on the strong performance of the UK economy and more industrial or housing-related stocks in recent articles, we should not ignore other segments of the UK stock market when looking for potential candidates to invest in.
My key stock screens focus on companies offering a good combination of attractive value and upwards price momentum – a combination of factors that has been shown in a number of academic studies to produce long-term investment outperformance.
One such company is the mega-cap global pharmaceutical AstraZeneca (AZN). This interests me for a number of reasons, one of which being the contrast between the bearish view of the average investment analyst on Astra on the one hand, and the surprising strength of its share price on the other.
First of all, a little background on the company. It is difficult to launch into a detailed discussion of a massive drug company like AstraZeneca without diving into a huge amount of detail on the company’s upcoming drugs pipeline. Suffice it to say that Astra focuses on a number of key treatment areas from heart disease and blood pressure to oncology (cancer) and respiratory disease (e.g. involving the lungs).
The bear argument: Why the majority of analysts dislike Astra
Well, there is no denying that AstraZeneca is one of the most challenged of all major global (legal) drugmakers – no, we are not talking “Breaking Bad” here. Professional investment analysts specialising in the Pharmaceutical sector are not keen on AstraZeneca at all – only 6 out of 38 covering analysts rate Astra a Buy, while 17 rate it a Sell.
Firstly, one of its most important blockbuster drugs, Crestor (a statin used to treat high cholesterol), is due to lose its US patent in 2016, which is expected to result in a large drop in sales and profits for Astra.
Secondly, it has struggled in recent years to prove that it can replace this future loss of sales with a solid pipeline of new blockbuster drugs. There has been a succession of failures in prospective new drugs in the Research & Development pipeline in recent years. As a result, consensus forecasts point to falling sales at Astra from 2013 out to the end of 2016, with a consequent fall in earnings per share as well.
Thirdly, Astra has also embarked on a series of acquisitions in an attempt to boost its sales and profit outlook to 2016 and beyond; but again, the City has generally remained sceptical as to whether or not these acquisitions will ultimately perform as the Astra management expects.
Unsurprisingly then, Astra sits at a hefty valuation discount to its European and US pharmaceutical peer group and also to the wider UK stock market. On a classic enterprise value to EBITDA valuation ratio (a typical value ratio used when comparing non-financial companies across regions), Astra today is valued at just over 9x EBITDA, while the European and US Pharmaceutical sector averages are 11.5 – 12.2x.
AstraZeneca Is Still a Lot Cheaper Than Other Drug Majors
Source: Bloomberg, Author
My bull arguments: Value, Momentum and Positive Changes
I have five reasons to take a more positive view on Astra than the consensus investment analyst, based on value, share price momentum and positive fundamental changes within the company.
1. Yes, it is cheap!
Firstly, we can see from the chart above that a lot of poor news flow and expectation has already been priced into Astra – which is why it trades at a 20%+ discount on EV/EBITDA to both its European and US peer group.
2. You are paid to wait by Astra’s high yield
Secondly, on a dividend yield basis Astra is an attractive income play, offering a 2013 yield of 4.8%, to compare to 3.5% for the FTSE All-Share index and under 2% for US Pharmaceutical sector. We should not neglect the fact that Astra is also a dividend “aristocrat”, having raised its dividend each year from 2003 to 2013 without exception, which is a pretty rare occurrence. Even with the earnings per share forecast to fall modestly to 2016, there is little risk that Astra will cut their dividend as it is well covered by earnings (a 62% payout ratio for next year).
3. The share price has hit a new year high, and is beating its peer group
Thirdly, it has just broken a new 52-week price high; typically stocks that show this type of positive price momentum tend to continue to rise (the so-called “Momentum Effect”, widely documented in the Finance academic literature). So the stock market would seem to disagree with the average bearish analyst consensus, as Astra has outperformed the European Pharmaceutical sector by 13% since the end of June this year.
AstraZeneca Hits A New 52-Week High
4. The R&D pipeline is looking more promising
Fourthly, on the fundamental Research & Development front, there have been a number of recent positive announcements on their drug pipeline.
They have recently announced positive Phase III test results (Phase III is the last big regulatory hurdle before moving to file for regulatory approval for a drug, and then launching the drug for sale on the market) for a treatment for gout, as well as a positive decision from the US FDA’s advisory committee on a treatment for Type 2 diabetes, which is a key symptom of obesity.
Both of these results have come as somewhat of a surprise to many investment analysts, and is starting to prompt them to revise their bearish opinion on the company’s outlook.
5. A positive reaction to the recent acquisition of 100% of their Diabetes Joint Venture
The restructuring of the joint venture in diabetes between Astra and US peer Bristol Myers Squibb is seen by analysts as a material positive driver for both companies: in the case of Astra, buying out their JV partner for up to $4.3bn ($2.7bn initially) to give them sole control of diabetes treatments Onglyza and Forxiga. This joint venture has up to now been loss-making, in an area which is seeing strong growth given the type 2 diabetes epidemic that is now sweeping the western world on the back of rising obesity rates.
Analysts see this buying out of the JV adding as much as 5-10% to earnings per share forecasts for AstraZeneca from 2015 and onwards, thus mitigating the fall in earnings from blockbuster drugs like Crestor and Nexium going off-patent. So the fall in earnings may well not be anything like as bad as a lot of investment analysts were predicting…
Other Long-Term Positives: Emerging Market exposure, high profitability
On top of all of this recent news flow, do not forget that over 20% of AstraZeneca’s sales come from Emerging Markets, an area that saw 5% growth in sales in Q3 (over a year earlier), driven in particular by 13% growth in sales in China over the period.
In terms of profitability, this remains a very respectable 20% when measured in terms of Return on Equity, which may be lower than in previous years but still strong in absolute terms. The operating profit margin is forecast to rise steadily next year and again in 2015, as the combined positive effect of new drug launches and a continued focus on cost-cutting bear fruit. All pretty respective profitability ratios for a company that is supposedly losing the profitability on some of its biggest products to generic competition in the near future!
More detailed information on all of this can be found at the company’s investor relations website: www.astrazeneca.com/Investors
Key upcoming catalysts
In terms of important upcoming events that could help Astra, Fiscal Year results for 2013 will be released on 6th February 2014 where the focus will be on the company’s profit guidance for 2014; and the big American Society of Clinical Oncology’s conference in June 2014, where Astra will no doubt present data relating to a number of cancer drugs under development.
Summing it all up
All in all then, AstraZeneca looks a good combination of value, share price momentum and fundamental change in the Pharmaceutical sector; in addition it is currently pretty unloved, and so requires less in the way of good news flow to get its shares moving higher from here. In the meantime, you are well rewarded to wait with a growing dividend that yields nearly 5% at the current share price.
The recent acquisition of 100% of its diabetes joint venture from its former parent Bristol Myers Squibb should, according to investment analysts, boost earnings per share forecasts for 2015 and beyond, thus offsetting some of the fall in earnings from drugs going off-patent. Should the positive company news flow continue over the next few months, the rerating of Astra could continue as investment analysts capitulate and revise their bearish opinion on this stock.
As always, please only take this article as a pointer and do your own research; the company’s website (link included earlier) is, as ever, a good place to start.