Astrazeneca Plc And GlaxoSmithKline Plc: Double Or Quits?

After lagging the global pharma sector persistently over five years. is now time to go double or quits on GlaxoSmithKline Plc (LON: GSK) and Astrazeneca Plc (LON: AZN)?

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Astrazeneca (LSE: AZN) shares have fared much better than Glaxosmithkline’s (LSE: GSK) over the last 24 months, mostly due to the after-effects of Pfizer’s pursuit in 2014, although neither company’s performance really merits celebrating.

The pharma universe has been a source of significant returns for investors over the last few years however, both Glaxo and Astra have consistently under-performed the pack over a five-year period.

The pipeline problem

The biggest challenge facing Glaxo and Astra is a combination of patent expiries and a lack of promise in their respective pipelines.

Glaxo’s Advair business is in terminal decline, one that could deepen further when its final Advair patent expires later this year, leaving a considerable portion of sales exposed to generics. 

Astra has fared better in that it has developed a drug, Forxiga, that almost had blockbuster potential.

Forxiga reduces blood glucose levels in type II diabetes patients but it’s yet to get the all-clear in long-term safety studies, the results of which aren’t due until 2018/19.

However, a cruel twist of fate has seen Eli Lilly’s Jardiance clear all hurdles to emerge on the market as ‘the real blockbuster’ for diabetes.

Not only has Jardiance reduced deaths among some groups of type II patients by as much as 30%, it also doubles up as a cardiovascular treatment.

Balance sheets, dividends & valuations

Glaxo’s dividend of 80p per share has been ‘guaranteed’ until 2017/18. However, consensus projections suggest it will struggle to fund this payout from earnings and will need to draw down the funds it has left over from its asset swap with Novartis.

Meanwhile at Astra, the dividend is covered 1.5 times over, although the yield is lower.

In terms of balance sheets, Glaxo’s gearing was at 73% and debt/equity at 3.2 times at the end of the third quarter, which is high for almost any company but particularly one that faces revenue pressure to the extent that GSK does.

Astrazeneca’s balance sheet is much leaner, with debt/equity at just 0.6 times and gearing at 31%. Yet despite each of these factors, there isn’t much difference in valuation between the two. Both trade on roughly 15 times consensus estimates for EPS in the current year and the next.

All in all…   

We’re in a world where equity markets are falling apart at the seams and the outlook for the global economy is beginning to darken. So steady or guaranteed dividends, reasonably low valuations and pharma’s relative insulation from economic gyrations could be enough to convince some investors that the shares are still a good store of value.

However, investor interest is only likely to be maintained over the medium-to-longer term if both companies are able to rejuvenate their pipelines in order to address looming revenue shortfalls.

Given the time, costs and the risks associated with homegrown development of drugs, it’s beginning to look like M&A will be the only way forward for these two companies.

While I wouldn’t rule out GSK as a worthwhile holding over the longer term, if I were forced to choose between the two companies, it would have to be Astrazeneca that wins the day. Not least because its leaner balance sheet mean it’s better equipped to prosper in a world where M&A is the best, and quite possibly the only, lifeline.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James Skinner has no position in any shares mentioned. The Motley Fool UK has recommended AstraZeneca and GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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