This blue-chip pharma company is on a cheap rating.
I added to my shareholding in AstraZeneca (LSE: AZN) last week, one of the UK's two big pharma companies. Warren Buffett, Jim Slater and Martin Zweig all had AstraZeneca on their shortlists last week, too. Well, sort of. The FT's screening tool, which purports to reproduce the investing style of these three greats, did.
Such screens are fairly crude, but it's a neat way to demonstrate that AstraZeneca is currently attractive on all manner of fundamental financial metrics. Attractive enough for Neil Woodford -- the flesh-and-blood Neil Woodford that is -- to have built a stake in the company to the tune of 8.4% of his Invesco Perpetual Income Fund, making it the fund's biggest holding. The market in general, though, is less enthusiastic.
Sector stress
There are sector-wide worries about big pharma firms, with a number of factors weighing on sentiment: concerns about the expiration of patents, competition from generic drug manufacturers, healthcare reform by the Obama administration in the US, and a generational turnover in the leadership of the major companies.
AstraZeneca and GlaxoSmithKline (LSE: GSK), which I also hold, have both underperformed the Footsie over the past 12 months and look attractive relative to their longer-term historical valuations, but it was AstraZeneca that I increased my investment in last week.
Astra anxieties
The company's share price is up a bit with the market since my purchase, but it still trades on a prospective price-to-earnings ratio (PER) of less than 8. GlaxoSmithKline and other sector peers, such as Novartis in Europe, and Merck in the US, are trading on PERs of 10+.
Astra has been singled out by analysts as being particularly vulnerable to the so-called 'patent cliff' -- the company is due to loose exclusivity on more patent-protected drugs than its peers over the next few years. However, the lowly rating suggests that the market has become fixated on this issue to the exclusion of just about all else.
The good stuff
There are factors which should go a long way towards maintaining AstaZeneca in rude health.
The drugs pipeline
The company has five products awaiting regulatory approval, two or three of which have blockbuster potential. It has also been active in supplementing the pipeline with late-stage development projects by in-licensing and acquisition -- four were added during 2009. The upcoming patent expiries are spread between 2010 and 2016, so there's plenty of time for replacement revenues to kick in.
A lower-costs research model
The company is in the midst of a substantial cost-cutting exercise, refocusing in-house R&D on the major high-margin product areas it does best, and using smaller biotechnology companies to develop other treatments cheaper than it could do itself.
Emerging markets opportunities
In recent years AstraZeneca has been steadily increasing its revenues from outside its core markets of North America and Western Europe. These other markets have gone from generating 14% of total company revenues in 2003, to 23% in 2009. Revenue from China will break through the £1bn mark in 2010 if the present growth rate continues.
Dividend discipline
The company is mindful that there will be some earnings lumpiness in a period of exclusivity losses and new product launches. It has changed its dividend policy to allow variable dividend cover, rather than pegging the dividend to the financial performance of each single year. At the current share price investors are being offered a forecast first year yield in excess of 5%, with an explicit statement by the company that it intends to maintain or increase the dividend over the next few years.
The market's price isn't right
The next five years will be challenging for the major pharmacos, no doubt about it. And AstraZeneca faces a round of patent expirations that is less than benign. But in my view the market is giving full weight to the risks of transition and little or no weight to the opportunities.
For a company with superb historical fundamentals, a strong balance sheet, and a credible strategy for facing the challenges ahead, a PER of less than 8 is just too cheap.
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The author owns shares in AstraZeneca and GlaxoSmithKline.
