AstraZeneca: Longer term attractions?

AstraZeneca at 4,109p, after the annual report for last year to 31^st December 2015. The shares tick a sufficient number of boxes for to make an attractive investment at this level, including maintenance of the dividend and the fact that the share price is towards the bottom of its recent trading range. The big attractions are longer term, but there seems scope for some shorter term recovery in the shares after the recent price decline. AstraZeneca shares this year reached a high of 4,863p.   

AstraZeneca’s (AZN) annual results were headlined in dramatic terms in one place; a bit like a ship saved from the rocks by divine providence. One can well understand the motivation behind the headline, but as with all headlines, it misleads as much as it informs. I make two simple points: first, it was a comparatively short time ago that a US pharmaceutical giant saw £55 per share of value in the equity when it attempted to gobble it up with its bid at that price; and second, the company has a more than sporting chance of longer term success due to its pipeline of drugs in development.

If you take a glance at the share price over the last year, you will observe that it has been in a trading range of between and about £40 to £45 and on a slightly longer term time scale between £40 to £50. You will note that the share price of £41.09p (last seen) places the share much closer to the bottom end of the trading range than the top. In simplistic technical terms, the shares are probably more for buying rather than selling. However, trading ranges do not last forever, and like a ship carrying life buoys for passenger safety, you need to ask whether the share is likely to stay within or break out of the trading range. In this case, will it brake out by going through the bottom range?

The thing that is most likely to prevent that from happening is the thing that prompted the failed £55 bid from Pfizer; a price not only offered by the US company but then recognised as insufficient by most institutional shareholders. That prospect, in the shape of the company’s pipeline of drugs in development,   is still there. This suggests that the AstraZeneca share price is offering both an attractive short and long term buying opportunity for those who would like to acquire an equity stake in such an R&D pipeline at around a near twenty five per cent discount to the Pfizer bid price.

So how well did AstraZeneca do in 2015? Top line sales revenue was down seven per cent and core operating profit was reported as being down 1% with no growth in core earnings per share, which were reported at $4.26 (this is one of those companies that accounts and reports in US dollars). That may be regarded as not too bad a result for a company that is suffering from what they call ‘patent wall’ problems – i.e. having medicines that are going off patent, to re-emerge as competing, lower priced generic drugs supplied by other companies. In fact the figures may be judged as better than they appear, because most of the decline was due to currency movements. Taking that out of the equation and recasting the results in constant currency exchange rates, AstraZeneca tells us that sales revenue would have been up one per cent and core operating profits would have risen six per cent – as opposed to the reported fall of one per cent.

I calculate that core operating profits of $6.9 billion give an operating margin of just under 28%, which is a good deal better than the reported operating margin of 16% for last year. That suggests that, according to the company managers, the operations of the company are considerably more profitable than they look. The important thing, from an investor’s point of view, is that the annual dividend was held and not cut.

The significant feature of the annual accounts was the big rise in debt. The accounts show that total debt increased 49%, from about $10 billion dollars last year, to just over $15 billion in 2015, releasing five billion dollars with which to finance the business and the annual dividend. The good news about the rise in debt is that most of it was the 68% increase in long term debt when the cost of such financing is historically low. That strikes me as a good management, as the debt to capital ratio rose to 45% and the crucial debt to equity ratio moved up to a towering 81%. If the current pipeline of products does produce enough regulatory approvals to produce a future significant rise in sales and profits, such gearing will be advantageous although it will also have to be brought down. It makes it doubly important that the pipeline does produce the goods. Not all drugs – even those in late stage III of development – get regulatory approval to enter the medicine market place.

So what is the market looking for from AstraZeneca now? In its consensus the market seems to be estimating a 9% drop in earnings to 265p, which is at the top end of the company’s guidance to the market. The current consensus forecast is for the dividend payout being held giving a prospective, estimated dividend yield of over 4%.

Like the Battle of Waterloo, the battle for AstraZeneca’s future value will be a ‘damn close-run thing’. However, one is getting a decent dividend yield ‘rent’ from the shares in the meantime although that cannot be sustained in the longer run without more profits.

The company CEO Pascal Soriot, has pinned his colours to the mast with his expectation that sales in 2023 will be $43 billion – up some 87% from last year’s sales revenue figure of $23 billion. The suggestion is that the outlook for the company will look much better by 2017. To assist profit progress, the company is considering ‘bolt on’ acquisitions which will be earnings positive and not merely add to the pipeline of potential products.

The nearer term bull case for shares include the likely positive news flow from the development pipeline in terms of data and hopefully approvals; sales from new products coming to the market to more than offset the decline in sales from long established market products going off patent; a high maintained dividend in the meantime; and the technical position of the share price chart, which shows that the shares are at the bottom of an established trading range. The company has sunk a lot of resources into its pipeline, which was attractive to Pfizer at a higher bid price. On balance, I think the shares look appealing at this stage.