Pharmaceutical firm AstraZeneca (LSE: AZN) (NYSE: AZN.US) has been through a difficult patch over the last couple of years.
Faced with the prospect of several of the firm’s key cash-cow products losing patent protection, the firm’s former CEO, David Brennan, decided to turn a blind eye to the problem, and instead boost the company’s earnings per share by burning through cash on share buybacks, instead of investing it in new products.
Luckily, in a rare display of shareholder activism, Brennan was forced to resign last year. His replacement, ex-Roche COO Pascal Soriot, scrapped the share buybacks immediately, and begun a careful program of small acquisitions and tactical investments in new products.
Is Astra a turnaround play?
During the first half of this year, Astra’s revenues dropped by 10% as it lost exclusivity on several of its key brands. More worryingly, its operating profit fell by 36%, and earnings per share fell by 42%.
Astra’s underlying earnings per share peaked at $7.22 in 2011 and have been in decline ever since. Earnings are expected to fall to $5.24 per share this year, and $4.90 per share next year, according to analysts’ consensus forecasts.
Against this backdrop, Astra’s current P/E of 10 doesn’t look especially cheap, and although the firm’s share price has risen by 10% so far this year, in-line with the FTSE 100, I don’t expect much more from it in the near future.
Over the next eighteen months, Astra needs to prove that it has some major new treatments that can replace these lost profits, and justify investors’ support.
Short term vs. long term
Warren Buffet once said that “only when the tide goes out, do you discover who’s been swimming naked”. In my opinion, AstraZeneca has been caught skinny dipping, thanks to years of underspending on new products, and overspending on shareholder (and management) returns.
I think that the pain caused by this misjudgement is likely to last longer than some investors expect. Astra’s run of patent expiries isn’t over yet, and in the absence of proven new revenue streams, I rate the company as a sell, not a turnaround buy.
However, in the long term, I’m pretty sure Astra will succeed in returning to growth, as new products, and growing demand from emerging markets, will combine to deliver the next generation of growth, for all of the big pharmaceutical firms.
An alternative to AstraZeneca?
One person who agrees with me about the long-term prospects of the pharmaceutical industry is top City fund manager Neil Woodford, who, in 2011, described the sector as one of the “most compelling” opportunities of his career.
If you’d invested £10,000 into Mr Woodford’s High Income fund in 1988, it would have been worth £193,000 at the end of 2012 — a 1,830% increase!
Mr Woodford still has several pharmaceutical shares amongst his top eight holdings — for full details, click here to download this free, exclusive, Fool report, while it’s still available.
> Roland does not own shares in any of the companies mentioned in this article.