The AstraZeneca (LSE: AZN) share price has retreated from a high of 6,525p made as recently as 21 March. Currently trading at not much above 6,000p, could this dip be an opportunity to snap up some shares?
Here, I’ll discuss the valuation and prospects of the FTSE 100 giant. I’ll also look at small-cap peer Alliance Pharma (LSE: APH), which released a trading update this morning.
Contrasting business models
Astra and Alliance may be in the same industry, but they have very different business models. The £80bn-cap Footsie group is a traditional, research-led big pharma business, trusting in heavy research investment to unearth its share of blockbuster drugs.
By contrast, £400m-cap AIM-listed Alliance licences or acquires pharmaceutical and consumer healthcare products — it has a portfolio of over 90 — at prices on which it believes it can make a good return.
Growth at a reasonable price
In today’s update ahead of its AGM, Alliance said it continues to trade well, with overall performance in line with expectations. It added: “We look ahead to the remainder of 2019 with confidence.”
City analysts are forecasting earnings per share (EPS) growth of 11% to 5.03p this year (following 12% growth last year). At a share price of 76.5p, this gives a forward price-to-earnings (P/E) ratio of 15.2.
I believe this proven, relatively low-risk business merits the P/E rating, and offers growth at a reasonable price. I think fairly consistent annual double-digit EPS growth is a credible prospect, supplemented by dividend growth from the 1.6p forecast for this year (prospective yield of 2.1%). As such, I rate the stock a ‘buy’.
Return to growth
Meanwhile, AstraZeneca has struggled for growth for many years, a string of patent expiries on some of its biggest blockbuster drugs taking a heavy toll. Revenues from these products fell off a cliff when exposed to competition from cheap generics.
It’s taken a long time for the company to rebuild its pipeline, and for new products with blockbuster potential to come through. However, that pipeline is now looking strong, and revenues and profits are forecast to start growing again.
The company has guided for core EPS of between $3.50 and $3.70 this year which, at the midpoint, would be 4% ahead of last year. At the current share price of 6,030p, and at current exchange rates, the midpoint $3.60 EPS equates to 285p and a P/E of 21.2. A running dividend of $2.80 (222p) gives a yield of 3.7%.
Heydays gone for good?
Despite the prospect of a return to growth in coming years, I reckon Astra’s P/E of 21.2 is far too optimistic. I think the heydays for the big pharma of earlier this century — when companies were making a terrific profit margin and return on capital employed — are gone for good.
There are two principal reasons behind my belief. First, every breakthrough drug sets the bar higher for the next. I think this is manifested in endemic falling returns on R&D investment in the industry. Secondly, as my colleague Stepan Lavrouk recently pointed out, public health bodies, such as the US Food and Drug Administration, are “increasingly seen to favour lower-cost alternatives to some of the more expensive options.”
For these reasons, I’m inclined to avoid Astra on its current P/E. There’s growth to come, for sure, but I don’t think it’s growth at a reasonable price right now.