Now that Pfizer (NYSE: PFE.US) has decided to allocate billions of capital to buy back its own shares, AstraZeneca (LSE: AZN) (NYSE: AZN.US) shareholders are faced with a big dilemma: should they stick with their bets?
The answer is no, in my view. A more relevant question is: how long will it take for their shares — which trade at £44 — to drop to £31?
Get Ready For The Drop
Between 2011 and 2013, the revenue and profits of Astra plummeted as many of its popular drugs went off-patent, but Astra continued to pay a healthy dividend. During that period, the shares of Astra traded in the £30-£36 range, and rose by 19.5%.
Astra stock has struggled to trade higher than £36 for about a decade until the end of 2013. That price is not only my best-case scenario right now, but is also the level where the shares changed hands before takeover rumours emerged in January.
Analysts
For the record, in November and December 2013, only a few weeks before takeover rumours emerged, analysts’ estimates were split as follows: a) a bull-case scenario, with a price target of £37; b) a base-case scenario, with an average price target of £32; c) and a bear-case scenario, with a price target of £25.
(Those price targets were maintained for most of 2013. There is no evidence, in my view, that Astra’s pipeline of drugs will deliver the growth rate that is necessary to justify a valuation above £36 a share.)
Earnings Per Share, Operating And Net Income Margins
In 2011 and 2012, Astra’s earnings per share (EPS) were much higher than the EPS that Astra is expected to report this year, in 2015 and in 2016. The dividend is still appealing, you may argue, but is not expected to skyrocket anytime soon.
Astra stock is pricey based on several trading metrics, but there’s more you should know before assessing its fair value. Even if Astra grows according to bullish market estimates until the end of 2017, it won’t be able to match the operating and net income margins that it reported in 2012, when its stock traded in the £25-£31 range.
If analysts are right, the net income margin of Astra in 2017 will be 13 percentage points below its net profitability in 2012. That means that cash flows will be less supportive of dividend payments. In fact, I believe Astra will be forced to cut its payout next year or earlier. Then, a 2015 price target of £31 makes a lot of sense.
This Isn’t Enough?
What Astra’s stock price tells us is that investors are aware of the possibility that Pfizer — whose quarterly results beat expectations on Tuesday — will not show up with a blown-out offer.
And even if Pfizer makes a comeback, how many investors will agree to receive 50% or more of the offer price in Pfizer stock? Surely, the cash portion of any potential offer will be lower than 50%. Then why would anybody want to hold stock in a slow-growth conglomerate whose management, rather than bidding up for a key target, decide to splash out $11 billion on a stock buyback?
Is that you? That’s certainly not me!
