Sales fell by 5% to $23bn at pharma giant AstraZeneca (LSE: AZN) last year. The group’s revenue has now fallen by a stunning 31% since peaking at $33.5bn in 2011. Chief executive Pascal Soriot said this morning that “2017 has the potential to be a turning point for our company as we near the end of our patent-expiry period”.
AstraZeneca — which was fund manager Neil Woodford’s biggest holding at the end of last year — has been hit harder than most by the so-called patent cliff, but this will eventually pass. The question for investors is whether the company can develop or acquire enough blockbuster products to replace these lost sales.
The case for buying
Based on today’s 2016 results, AstraZeneca shares don’t look expensive. They trade on an adjusted P/E ratio of about 12, and offer a trailing yield of 5.4%. That’s an appealing valuation.
Looking back at the group’s historical levels of profit, there’s no reason to think that the current share price is unsustainable.
What could go wrong?
In 2017, the group expects sales to fall by a “low-to-mid single-digit percentage”. Core — or adjusted — earnings per share are expected to fall by a “low-to-mid-teens percentage”. 2017 may prove to be a turning point, but it will be 2018 at the earliest before the benefits of what Mr Soriot calls the firm’s “ongoing transition” start to lift profits.
Timing the bottom here is impossible. The key to the stock’s appeal is Mr Soriot’s goal of using new medicines to lift sales to $45bn by 2023. If he’s successful, then the shares should prove to have been cheap at £42. I’m uncertain, but I do share Mr Woodford’s view that AstraZeneca should be able to deliver significant long-term growth. On balance, I’d hold.
Will this big bet pay off?
US pharmaceutical group Shire (LSE: SHP) made its reputation with ADHD medicines. A need for greater diversification and fresh growth saw it spend $32bn to acquire US firm Baxalta in 2016.
Shire expects to make cost savings of more than $500m per year and believes Baxalta will boost earnings from 2017 onwards.
The risk is that the Baxalta deal has left Shire with net debt of $23.3bn. That’s around five times the group’s forecast 2017 net profit of $4,695m. Net debt of five times profit is higher than I like to see, although it’s not necessarily a deal-breaker for a profitable company.
This high level of debt is one reason why Shire stock trades on a fairly modest 2017 forecast P/E of 11. Investors are pricing-in the group’s debt burden and waiting for evidence that the acquisition of Baxalta is delivering the promised benefits.
Another consideration is that Shire has never really been a dividend stock. The group’s $0.29 per share payout last year only equates to a yield of 0.5% at the current share price of £44.
I’m not really attracted to Shire at current levels. Although I suspect the Baxalta deal will deliver most of the promised benefits, I think the need to reduce debt levels will effectively restrict shareholder returns and growth for a few years. I feel there are better options elsewhere, and would certainly rather buy AstraZeneca.