The AstraZeneca (LSE: AZN) share price has risen by more than 90% since May 2016 as investors have bought into CEO Pascal Soriot’s more focused strategy for the business.
However, the shares dipped on Friday after Mr Soriot warned that 2020 earnings may be hit by the coronavirus outbreak. In this piece I’ll explain why I think there are broader reasons to be careful about buying AstraZeneca.
I’ll also take a look at a FTSE 100 stock that’s very unpopular at the moment. I reckon it could be a contrarian buy.
AstraZeneca’s 2019 results looked good at first glance. The firm’s adjusted ‘core’ measure of operating profit rose by 13% to $6,436m, while sales rose 12% to $23,565m. Core earnings of $3.50 per share were only slightly below broker forecasts of $3.59 per share.
Although most companies use adjusted profits, I feel that AstraZeneca’s approach to calculating its core profits is aggressive and excludes some costs that should really be left in.
The 2019 results are a good example. The group’s core operating profit was $6,436m. But its reported operating profit, which includes all standard accounting costs, fell by 14% to $2,924m. That’s less than half the core figure.
What on earth?
I might accept such large adjustments if they only happened occasionally, perhaps following a major acquisition. But at AstraZeneca, there’s a similar divide every year.
The main reason for this is that AstraZeneca excludes the amortisation of intangible assets from its core profits. This non-cash accounting charge relates to the gradual reduction in value of intellectual property such as patents, licences and software. As you can imagine, this kind of asset is a big part of a pharmaceutical business — AstraZeneca carries about $21bn of intangible assets on its balance sheet, reflecting historic spending.
Last year, the amortisation charge on these assets was $2,497m. In 2018 it was $2,345m. And in 2017 it was $1,807m. As you can see, this charge is quite similar each year. It accounts for most of the difference between the firm’s core and reported profits.
Using my preferred measure of reported profit, AstraZeneca generated an operating profit margin of just 12.4%. That’s well below rival GlaxoSmithKline‘s figure of 20.6%.
AstraZeneca currently trades on about 23 times 2020 forecast earnings, with a dividend yield of just 2.8%. I’m not convinced the stock offers much value at this level.
A great British brand
However, I’m starting to wonder if it might be time for a fresh look. There’s now just one major problem remaining with the group’s troubled Trent 100 TEN engine. A fix isn’t expected until 2021, but this news is now public and has been factored into the firm’s financial planning.
The rest of the jet engine business seems to be performing well enough. Trading is also stable in the group’s Defence and Power Systems businesses.
In November, Rolls confirmed its “mid-term ambition” for free cash flow of £1 per share. If this can be achieved, then I think the shares would look very cheap at under 700p. This level of free cash flow could also support an attractive dividend.
Risks remain. But I’m planning to take a close look at the firm’s results later this month. I’m starting to get interested.
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Roland Head owns shares of GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. 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.