Should you pile into this healthcare stock after today’s update?

Is this healthcare stock a ‘must-buy’?

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Life science research tool supplier Abcam (LSE: ABC) has released an upbeat set of full year results. They show that the company is making encouraging progress and provide clues as to whether it’s a more appealing buy than healthcare sector peer AstraZeneca (LSE: AZN).

Abcam’s top line increased on a reported basis by 19.2% versus the previous year. This falls to a rise of 15.9% on a constant currency basis, but is still very impressive. Acam’s gross margins fell slightly to 70.2% from 70.5% in the previous year due largely to unfavourable exchange rates.

Its investment in Firefly and AxioMx also hurt margins we learnt lower down the income statement, with Acam’s earnings before interest, tax, depreciation and amortisation (EBIDTA) margins falling by 370 basis points to 33.6%. Meanwhile, Abcam’s major investment in systems and processes, as well as integration costs, caused earnings per share to decline marginally to 18.5p from 18.6p in the prior year.

Despite this, Acam has long-term growth potential. It delivered two times or better market growth in every geography and product category in which it operates and this shows that it has consistency as well as that growth potential. In fact, Abcam is forecast to increase its bottom line by 10% in the next year, which indicates that it continues to be a strong growth stock.

But the problem is that Abcam appears to be fully valued. It trades on a price-to-earnings (P/E) ratio of 34.8 and even though it has very bright growth prospects within a lucrative space, its potential seems to be more than adequately priced-in.

Bid target?

As such, it may be prudent to look elsewhere within the healthcare space. One option is to buy a slice of AstraZeneca. It has endured a tough period in terms of its loss of patents on key, blockbuster drugs. While this process isn’t yet over and further falls in earnings are forecast for the next couple of years, AstraZeneca is building an excellent pipeline of new treatments that could transform its profitability over the medium-to-long term.

It also remains a very realistic bid target. A closing of a US tax loophole may have made the company less obvious as an acquisition than it was previously, but a weakening of sterling means that AstraZeneca is now much cheaper to a foreign-based buyer than it was just a few months ago. And with its shares trading on a P/E ratio of just 15.1, they’re valued at less than half the value of Abcam’s shares.

In addition, AstraZeneca yields 4.4% versus 1.2% for Abcam. Although the latter’s dividend is covered 2.5 times by profit and could therefore rise at a faster rate than earnings over the coming years, AstraZeneca’s dividend is covered a healthy 1.5 times by profit. This indicates that its shareholder payouts are highly sustainable at their current level and could also rise over the coming years.

Alongside its lower valuation and bid potential, this makes AstraZeneca the better buy of the two companies at the present time, I believe.

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.

Peter Stephens owns shares of AstraZeneca. The Motley Fool UK has recommended AstraZeneca. 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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