AstraZeneca (LSE: AZN) has released a slew of positive drug updates over the summer, and its shares have been making new all-time highs. Investors have become increasingly excited about its pipeline, and a return to top- and bottom-line growth.
However, I think we’re looking at a case of market over-exuberance. In this article, I’ll explain why I believe the stock is far too highly rated, and why I’d rather invest in gene-editing firm Horizon Discovery (LSE: HZD) where I see not only exciting growth prospects, but also an attractive valuation.
Now bigger than GSK
Remarkably, within the last year, AstraZeneca has overtaken long-time bigger FTSE 100 peer GlaxoSmithKline. AZN’s market capitalisation currently stands at £94bn (up from £57bn five years ago), while GSK’s is £83bn (up from £70bn five years ago).
AZN trades at 4.9 times current-year forecast sales of $24bn (£19.2bn at current exchange rates), while GSK is rated at just 2.5 times its far higher forecast sales of £32.6bn.
I’ve highlighted AZN’s sky-high price-to-sales multiple relative to its rival, because I believe AZN’s preferred ‘core’ earnings measure overstates its real core earnings. In recent years, AZN has divested numerous non-core older drugs, but included the profits from these in its ‘core’ earnings. My sums say this has plumped up core earnings by between 20% and 33% a year.
The company has guided on core earnings per share of $3.50 to $3.70 (288p at the mid-point) for the current year. The share price of 7,167p represents about 25 times the guided earnings. This is a high multiple as it is, but if what I consider to be real core earnings are 20% to 33% lower, the multiple goes up to between 31 and 37.
Now, AZN’s earnings prospects are good, but not earnings-multiple-in-the-30s good, in my opinion. This is why I’m avoiding the stock.
Founded in 2005, and listed on London’s junior AIM market in 2014, Horizon Discovery is a global leader in cell engineering, using innovative gene editing and gene modulation technologies. Its customers are academic institutions and pharma companies, including AstraZeneca.
Horizon appointed a new chief executive last year — a veteran biotech tools commercial leader — who’s put together a highly experienced team, as the company transitions from building scale to profitable growth.
Ahead of its latest half-year results, released last week, its shares were trading at 138p. They ended the week at 158p, giving the company a market capitalisation of £238m.
Management reported a strong start to the second half of the year and said it anticipates full-year revenue to be in line with market expectations. These expectations are for £63.8m, meaning the stock is trading at 3.7 times sales, compared with AZN’s 4.9 times.
This time last year, Horizon’s shares were comfortably above 200p, the board having rejected a 181p-a-share offer from Abcam some months earlier. Why can we buy them for just 158p today? I reckon it’s probably down to persistent selling by beleaguered fund manager Neil Woodford, who thankfully now seems to have completed the disposal of his one-time 25% stake in the company.
I think Horizon is a credible growth prospect, and with a valuation of 3.7 times sales and the Woodford overhang finally gone, I rate the stock a ‘buy’.
G A Chester 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 Abcam and 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.