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Why I’d ditch this defensive dividend stock to buy AstraZeneca plc

Dairy Crest (LSE: DCG) today reported a “strong first half of the year” in a pre-close trading update for the six months to 30 September. Management said it expects combined volumes of its four key brands — Cathedral City, Clover, Country Life and Frylight — to be ahead of the same period last year, with group profit also ahead. It added: “Our profit expectations for the full year are unchanged.”

The shares are trading up 1.6% at 616p, as I’m writing, putting the FTSE 250 firm on a forward price-to-earnings (P/E) ratio of 16.4, with a prospective dividend yield of 3.7%. This valuation looks quite attractive for a company in the defensive food producers sector but I see greater attraction in a similarly rated stock in another defensive sector.

At a share price of 4,700p, AstraZeneca (LSE: AZN) trades on a forward P/E of 16.8, with a prospective dividend yield of 4.4%. If I needed to free-up funds to invest in the FTSE 100 pharma giant, I’d be willing to sacrifice Dairy Crest.

Revenues and profits

AstraZeneca’s revenue has fallen from $28bn to $23bn over the last five years, as patent expiries on some of its top-selling products have taken a toll. Meanwhile, Dairy Crest’s revenue has declined more modestly from £430m to £417m (after stripping out its Dairies operation, which it sold in 2015).

Top-line growth is essential for profit growth in the long run and the good news is that Dairy Crest’s revenue is forecast to begin increasing from this year and AstraZeneca’s from next year. Even if the pharma group falls short of chief executive Pascal Soriot’s ambitious target of $45bn in annual revenues by 2023 — as its strong pipeline of new drugs begins to bear fruit — I expect it to comfortably outpace the top-line growth of Dairy Crest.

The vast majority of Dairy Crest’s revenues come from the mature UK market but it’s diversification into supplying ingredients for infant formula — a high-growth, high-margin global market — should help profits move higher. Nevertheless, I reckon AstraZeneca’s cost-base restructuring of the last few years should lead to superior profit advances as its top-line growth kicks in.

Dividends and debt

Dairy Crest has increased its dividend — if rather unspectacularly — from 20.7p to 22.5p over the last five years. However, its net debt has increased from £60m to £249m during the period, giving sky-high gearing of 346%. Furthermore, despite its defensive qualities, it rebased its dividend 25% lower back in 2009.

By contrast, AstraZeneca has managed to maintain its dividend at 280 cents over the past five years of protracted pressure on revenues and profits. Its net debt has also risen (from $1.4bn to $10.7bn) but gearing is a far more comfortable 72%.

If my top- and bottom-line growth expectations for AstraZeneca are on the mark, it should be capable of providing a superior dividend return in due course, particularly from a current starting yield of 4.4% versus Dairy Crest’s 3.7%

Other qualities

Finally, Dairy Crest not only has far more limited geographical diversification than AstraZeneca, but also higher customer-concentration risk. Almost half its revenue comes from just three customers.

This contrasts with its larger and more diversified food producer peer Unilever, which has no single customer accounting for 10% or more of its revenue. And like Unilever, AstraZeneca has a wide diversity of customers and suppliers across different geographic areas. Only one wholesaler accounts for greater than 10% of its product sales.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended AstraZeneca. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.