It has been a rough year for GlaxoSmithKline (LSE: GSK) and AstraZeneca’s (LSE: AZN) investors.
After a flurry of bid activity and rumours last year, it been a relatively quiet year for both companies as they double-down on their strategies to boost sales.
However, while these two pharma giants are working flat out to return to growth, the market is losing patience. Since the end of March, Astra and Glaxo’s shares have declined by 17.4% and 18.3% respectively, excluding dividends. Over the same period, the FTSE 100 has lost 8.3%.
But after these declines, Glaxo and Astra now look to me to be the most undervalued companies in the UK’s leading index!
Slow and steady
Claiming that Glaxo and Astra are the two most undervalued companies in the FTSE 100 is a bold statement to make. Nonetheless, these two groups exhibit all the traits of classic contrarian value investments.
And when compared to some of the other FTSE 100 companies that have underperformed this year, the likes of HSBC, Shell, BHP and Glencore, the two biotechs look to be vastly superior.
For example, Glaxo and Astra are still highly profitable. Glaxo’s operating margin was 50.5% for 2014 and Astra’s is expected to report a net profit margin of 22.4% for 2015.
What’s more, the two biotechs have pricing power, and, as a result, a certain degree of control over future profits. HSBC, Shell, BHP and Glencore are all subject to market forces when it comes to product pricing.
Then there are Glaxo and Astra’s R&D initiatives to consider.
Research and development
Philip Arthur Fisher is widely regarded as one of the best growth investors of the last century. His book Common Stocks and Uncommon Profits is still in print today nearly six decades after it was published.
Fisher’s strategy was simple; buy undervalued growth stocks and hold for the long term. Now, trying to find tomorrow’s winners today is difficult, but Fisher was able to succeed by hunting out the companies that were spending heavily on R&D. In Fisher’s own words:
“If the company is deliberately and consistently developing new sources of earning power…the price-earnings ratio five or ten years in the future is rather sure to be as much above that of the average stock as it is today…This is why some of the stocks that at first glance appear highest priced may, upon analysis, be the biggest bargains.”
Firms that continually invest for future growth will, over the long-term, achieve better returns for investors than those companies that are focused on boosting short-term profits.
Glaxo and Astra are both investing heavily for the future.
Specifically, Glaxo has 258 new products under development more than any other big pharma group. Around 40 of these products are in advanced clinical trials and management expects at least half of its drugs currently under development will be on the market by 2020.
Astra has 222 new products in its treatment pipeline, several of which are expected to be blockbusters. City analysts believe that these new blockbuster treatments will produce sales for the group of around $4bn per annum by 2018.
The bottom line
So overall, Glaxo and Astra may have underperformed this year, but explosive growth could be just around the corner.
Investors will be paid to wait for this recovery as Astra currently supports an attractive dividend yield of 4.5% and Glaxo yields 6.3%.
