The pharmaceutical industry is a tantalising one for investors. It covers the full gamut of stocks, from high-risk, high-reward start-ups, to multi-billion pound blue-chip dividend payers. Yet some of those blue-chips can also be surprisingly volatile.
Two legs bad, four legs good
Just look at FTSE 100-listed rare disease specialist Shire (LSE: SHP). This is a major UK company, even if it doesn’t have the profile of AstraZeneca or GlaxoSmithKline, with a £30bn market cap. It was a lot higher before, but its share price has crashed from a peak of 5,550p in 2015 to just 3,258p today, a precipitous 41% drop.
That may scare some investors, but others will be tempted. They may consider now a cut-price entry point. If so, they should also look at FTSE 250 stock Dechra Pharmaceuticals (LSE: DPH), which specialises in prescription-only pet medicines and has a much smaller market capitalisation of £2.6bn. Its share price has performed very differently to Shire’s, soaring 53.8% in the past year, and 243% over five years.
Dechra is up, Shire is down. Which is the better prospect? Or is there a strong case to buy both of them?
Last month Dechra showed its teeth to post a strong set of first-half numbers across its European and US operations, with reported group revenue up 12.5% at actual exchange rates to £194.1m. Revenue growth in North American pharmaceuticals was particularly strong at 20.7%.
Underlying operating profit grew of 22.3% at constant exchange rates while operating margins expanded by 220 basis points to 24.6%. Before these results my Foolish colleague Royston Wild called it a no-brainer pharma stock to buy today, and he called it correctly.
Dechra is growing through acquisitions, recently bolting on RxVet in New Zealand, and announcing larger acquisitions of AST Farma and Le Vet. My concern is a predictable one: years of soaraway growth have pushed its forward valuation to a hefty 33.4 times earnings. Its PEG stands at a toppy 2.6. However, forecast earnings per share (EPS) growth of 17% in the year to 30 June 2018, then 18% the year after, appears to justify this. Momentum is on its side and soon those acquisitions will be bedding in too.
Contrarian investors may prefer Shire. In January, it posted an impressive 33% jump in full-year revenues but it is the future that counts, and markets were unnerved by warnings that revenue growth is set to weaken. This is mainly due to costs from its new US plasma manufacturing site start-up, as well as growing competition from rival generic treatments and lower royalties. Shire warned of a 3% cut in EPS projections for 2018.
Several brokers have downgraded Shire but private investors who take a longer term view, and are willing to sit tight for a few lean years, could benefit as a result. Trading at a forecast valuation of just 8.8 times earnings, Shire’s entry price certainly looks right. GA Chester certainly thinks this is the case, rating it a bargain basement buy. If I had £2,000 to invest, I might split my money evenly between the two of them.
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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended AstraZeneca and 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.