We look beyond the usual suspects in the pharmaceuticals sector.
Here at the Fool, we've been banging on for the past year or so about the attractions of the UK's pharma titans, GlaxoSmithKline (LSE: GSK) and AstraZeneca (LSE: AZN).
These elephants may not gallop, but they have great defensive qualities for uncertain economic times and offer income investors nice, chunky dividends.
Great tune though it is, some readers may have tired of hearing it! So, just for a change, let's see what's on offer in the pharma sector a little lower down the market cap scale.
The next two
Shire (LSE: SHP) is a FTSE 100 company, around eight times smaller than Glaxo.
Hikma Pharmaceuticals (LSE: HIK) sits in the top tier of the FTSE 250.
Before looking closer at the businesses of Shire and Hikma, let's see how they measure up against Glaxo and Astra on a couple of key metrics and on share-price performance.
All four companies conveniently have a 31 December financial year end, and the numbers that follow are based on the available data on Wednesday evening.
| Company | Market
cap
(£bn) | Share
price | Forecast
P/E
2010 | Forecast
P/E
2011 | Forecast
yield
2010 | Forecast
yield
2011 |
|---|
| GlaxoSmithKline | 63 | 1,206p | 11 | 10 | 5.2% | 5.4% |
| AstraZeneca | 46 | 3,230p | 8 | 8 | 4.9% | 5.1% |
| Shire | 8 | 1,387p | 17 | 14 | 0.6% | 0.7% |
| Hikma | 1 | 735p | 22 | 19 | 1.0% | 1.2% |
The chart below shows the relative performance of their share prices over the last five years.
Two pairs
As the table and chart show, Shire and Hikma are a very different species of animal to Glaxo and Astra.
Glaxo and Astra are trading on relatively low price/earnings (P/E) ratios, with analysts expecting little in the way of earnings growth over the next couple of years.
The trade-off is their juicy dividends. Glaxo's yield is slightly higher than Astra's, but its dividend is not quite so well covered by earnings -- around 2x versus Astra's 2.5x. For novice investors, that means Glaxo is set to pay out half its earnings in dividends; Astra, 40%.
Shire and Hikma are at the opposite pole. They are trading on high P/Es and analysts are expecting strong earnings growth. Again for the benefit of novices, the fact that their P/Es are lower in 2011 relative to 2010 is indicative of a forecast rise in the 'E' (earnings) side of the P/E equation.
At the same time, their dividend yields are paltry compared to those of Glaxo and Astra. Hikma's is covered around 5x by forecast earnings (it is due to pay out only 20% of earnings as dividends); Shire's cover is over 10x (dividends represent less than 10% of earnings).
High growth; low growth
In broad terms, Glaxo and Astra distribute a lot of cash to their shareholders, whilst Shire and Hikma plough back most of their earnings into their businesses.
For the benefit of novices once more, what we have is a classic illustration of some of the characteristic differences between high-growth companies (Shire and Hikma) and mature, low- or ex-growth companies (Glaxo and Astra).
Glaxo and Astra continue to look very attractive for income seekers on the pertinent valuations, but how attractive are Shire and Hikma for growth investors?
Sources of growth
Shire's business is founded on a strategy of snapping up promising drugs from small biotech companies and developing them in-house. Apparently, the directors were laughed at when they first talked about this 'harvesting' model.
Today, though, the big pharma companies, with their vast, expensive research and development departments, are increasingly looking to cut drug development costs by taking a leaf out of Shire's book.
Shire's experience and success in running its 'search and development' strategy has driven its growth and fostered expectations of further strong growth in the future.
Hikma's growth and the expectation of future strong growth have a different driver: emerging markets. The Jordan-based company is particular strong in the Middle East and North Africa region, where it has local knowledge and expertise -- and generates over 60% of its revenue.
Valuations
The price/earnings to growth (PEG) ratio is a useful measure for looking at companies with P/Es in the higher range. It gives us a way to measure whether the high P/E is justified by forecast earnings growth. A PEG of 1 represents fair value: above 1 is the pricey side; below one, the cheaper.
Analysts are forecasting 2010-11 earnings growth in the high teens for both Shire and Hikma. Shire's P/E of 14 for 2011 puts it on a sub-1 PEG. Hikma's P/E of 19 suggests it's only fairly-priced, at best.
However, Hikma's position may change. Interim results released on Thursday, which were ahead of market expectations, were greeted with a 5% share-price rise and are likely to lead to some earnings forecast revisions.
Dividend cash in the hand from Glaxo and Astra? Or capital growth in the bush from Shire and Hikma? … Or a bit of both!
More from G A Chester:
> G A Chester holds shares in AstraZeneca, GlaxoSmithKline and Hikma Pharmaceuticals.
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