The pharmaceuticals sector has been one of the stock market’s poorer performers over the last 12 months. It’s fallen over 16% compared with a broadly flat return for the overall market. I reckon there are some bargains to be had in the sector.
Two companies in particular have caught my eye: a FTSE 100 giant whose shares have performed even worse than the sector average and a FTSE 250 firm whose shares have bucked the trend.
Rare diseases specialist Shire (LSE: SHP) completed a $32bn acquisition of US firm Baxalta in June 2016 and its shares went on to reach a post-acquisition high of over 5,200p a few months later. However, market sentiment has since waned conspicuously. The shares started this year at under 4,000p and annual results a fortnight ago failed to arrest a further decline. The shares are currently trading at little more than 3,000p.
At the time of the Baxalta acquisition, Shire had projected over $20bn annual revenues by 2020. It’s disappointing this has since been revised down to $17bn-$18bn but I believe the share price has fallen much too far.
The company’s 2018 earnings guidance is for between $14.90 and $15.50 per American Depository Share. Converted to ordinary shares at current exchange rates, the range is 355p to 370p, giving a price-to-earnings (P/E) ratio of between 8.5 and 8.2.
The P/E makes Shire cheaper than its sector peers and net gearing of 53% is also relatively low. Strong free cash flow during 2017 reduced net debt by $3.4bn to $19.1bn, while year-end shareholder funds stood at $36.2bn. With its market capitalisation of £27.5bn ($38.5bn) and bargain basement sub-10 P/E, I rate this Footsie blue-chip a ‘buy’.
Also on my ‘buy’ list is FTSE 250 veterinary pharmaceuticals specialist Dechra (LSE: DPH). The company announced strong half-year results today and the shares are up over 5% to 2,450p, as I’m writing. This is a new all-time high and takes the return over the last 12 months to more than 50% to value the business at £2.5bn.
Dechra reported a 12.5% rise in first-half revenue (11.2% at constant exchange rates), with North America contributing 20.7% and Europe 5.8% at CER. Higher profit margins fed down to a 20% increase in earnings per share (EPS).
Continued growth at this rate would see EPS of 77.6p for the company’s current financial year ending 30 June. On the face of it, the resulting P/E of 31.6 looks expensive, but the company has just completed two exciting acquisitions, of AST Farma and Le Vet Beheer, for a total consideration of €340m.
These two companies have been a primary target for Dechra for a number of years. The board said the deals realise “a rare opportunity to strengthen our EU segment in all the major European countries in which we operate.” I believe the springboard this provides Dechra for both expanding its pipeline and improving its reach makes the premium P/E worth paying and I rate the stock a ‘buy’.
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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Shire. 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.