You probably know everything about GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) by now: a bribery scandal in China, falling earnings and a patent cliff have all weighed on its equity valuation in recent times. You’ll surely also have heard of AstraZeneca (LSE: AZN) (NYSE: AZN.US): its revenue and earnings have dropped at a faster clip, but Astra’s valuation has been favoured by a takeover approach from Pfizer last year.
If I were to invest in the pharma space, though, I’d probably choose Shire (LSE: SHP), which will comfortably outperform Glaxo and Astra this year and next, in my view. Here’s why.
GlaxoSmithKline: It Could Get Better
I have been very bullish on Glaxo until recently but its fundamentals, a conservative corporate strategy, its pipeline of drugs as well as the stock’s relative valuation suggest that Glaxo won’t deliver huge capital gains for some time, although its dividend yield is particularly appealing. Upside is in the region of 10% in 2015, in my opinion.
“GSK faces a load of problems of its own. It’s a huge player in respiratory, which is facing precisely the same issues as diabetes for Sanofi – massive price pressure, basically turning it into a commodity segment,” one senior pharma analyst recently told me. “And GSK sold its oncology business to Novartis, which is seen as lunacy, (given that) oncology is probably the biggest growth area now for pharma,” he added.
The average price target from brokers has declined by 15% in the last 12 months to 1,505p, which is 9% higher than Glaxo’s current valuation of 1,377p. Analysts at JP Morgan took the brave decision to cut Glaxo’s price target to 1,300p (underweight, from neutral) earlier this week, but I think the shares could easily beat consensus estimates by the end of the year.
A soft break-up of the group would be great news for value investors.
AstraZeneca: Simply Overpriced
Astra is my least favourite pick in the pharma sector, although Astra’s management team has done a good job in managing expectations in recent times.
Based on trading multiples, fundamentals, R&D and the pipeline of drugs, my price target for Astra is much lower than Astra’s current equity valuation — say between £30 and £35 a share, for an implied downside of up to 33% from its current level. I appreciate Astra offers a decent yield, but roughly one third of its current stock market value is still based upon hopes that a suitor will show up with a blown-out offer, which is highly unlikely in my view.
JP Morgan raised its price target to 4,500p this week, which is about 6% below the average price target from brokers. I think most analysts are wrong, end of story.
Shire: Lots To Like In It At This Price
At 4,560p, Shire shares seem properly priced right now, one may argue. Following the integration of ViroPharma, additional bolt-on deals may boost shareholder value, however.
Shire stock has depreciated fast in recent months, but may surge if Shire exploits its strong balance sheet. According to press reports, the British company is one of the few bidders lined up for NPS Pharmaceuticals, which would be a good fit in Shire’s portfolio. Since merger talks with AbbVie collapsed, the shares of Shire have lost 15% of value, but a strong pipeline of drugs may also help it deliver a strong growth rate for revenue and earnings over the medium term.
I’d add Shire to a diversified portfolio based on fundamentals and trading metrics, which indicate upside could be at least 20% in the next 12 months or so.
If Shire managers get their capital allocation strategy right (I have little doubt they will), I may end up agreeing — for once! — with analysts at Citi and JP Morgan, who raised Shire’s price target to over 5,000p earlier this week.
