Shire has defensive appeal

5 mins. to read
Shire has defensive appeal

Since the inauguration of Donald Trump on Friday, market conditions have become increasingly volatile. The FTSE 100 has fallen by as much as 70 points since then, bringing its total decline for the last six trading sessions to 170 points (2.3%).

This decline may or may not continue, but in any case it seems likely there will be indecision, uncertainty and even fear among investors. The new President has already started the process of withdrawing from the TPP and has stated there will be high import taxes on US companies which have relocated abroad. More major changes could follow.

In these conditions, buying low beta, defensive shares which have lower positive correlation to the wider market and/or economy could be a good idea. They may provide superior performance to the wider index and add value during what may prove to be a difficult period for investors.

One company offering these attributes is pharmaceutical stock Shire (LON:SHP). It also offers growth potential from the merger with Baxalta, a solid pipeline, low valuation and the potential to benefit from a weakening dollar.

A new President

A new US President is bound to cause a degree of uncertainty. It can often mean a change in policy and how the economy reacts is a known unknown. However, this time I believe it really is different.

The scale of change which could be undertaken by Donald Trump is exceptional. He looks set to pursue a much more protectionist economic policy. For example, this week he stated there would be ‘major taxes’ on certain imported goods. He also withdrew from the TPP and will apparently look to renegotiate NAFTA.

In my view, this is a step change in decades of US policy. Previously, there may have been rhetoric about protecting US jobs, but this scale of change is unprecedented.

While it must be stated that these policies could work and create more jobs, more growth and higher share prices in the long run, I feel they will contribute to a growing sense of unease among investors. Forecasting in the current environment is tougher than in more settled times and I feel this will be reflected in a higher risk premium in asset values, as well as above average volatility.

Low volatility stocks

Buying stocks which are well suited to these conditions could be the right move. In this regard, companies operating in sectors which are less positively correlated to the performance of the wider index and economy may be a prudent option to take.

For example, healthcare companies are more dependent on the patent cycle than the business cycle. Therefore, they could outperform many of their index peers. Similarly, buying companies which have low betas could mean an avoidance to some degree of yo-yoing share prices in the near term.

Shire is forecast to increase its EPS by 22% in financial year 2017, and by 15% in the 2018 financial year.

Shire ticks both of these boxes in my view. It has a beta of 0.6, which means its shares should be a lot less volatile than the index. Further, its business performance is more closely linked to the delivery of its pipeline and since its merger with Baxalta, a successful integration and delivery of synergies.

Admittedly, there is a risk the two companies won’t prove to be a great fit. But in terms of Shire’s appeal during a volatile period for markets, the relative dependence of its share price on company-specific factors could be an appealing attribute.

Growth prospects

In my opinion, the strength of the dollar could be hurt by the uncertainty surrounding Trump’s actions. He has also stated recently he thinks the dollar may be too strong. This has at least contributed in my view to a weakening of the greenback to take it to a six week low versus the euro.

More weakness could be on the way, even if the Fed adopts an increasingly hawkish stance in future months. Since Shire reports in dollars, this trend could be beneficial at a time when it hurts a large number of the company’s FTSE 100 peers which report in sterling.

Already, Shire is forecast to increase its EPS by 22% in financial year 2017, and by 15% in the 2018 financial year. Given it has a P/E of 13, I feel it offers good value for money and could become even more appealing if its sales and EPS gain a tailwind from a weakening dollar.

Long term potential

Shire has a sound long-term growth plan in my view. The combination with Baxalta is now expected to yield $700 million in operating cost synergies by year 3. Shire’s pipeline has been boosted by the merger, as well as relatively recent acquisitions such as the $6 billion purchase of Dyax.

The pipeline has shifted towards a focus on rare diseases in recent years, with around three quarters of its approximately 41 clinical pipeline programmes being within that space. This makes it a global leader in rare diseases, where there is an extremely high medical need and a regulatory path which is untrodden due in part to there being little understanding of the diseases present. This could signal growth opportunities for the company in the long run in my opinion.

The right time to buy

The start of Donald Trump’s Presidency has caused share prices to become more volatile. In my view, this trend will continue as he introduces more policy changes. Therefore, I believe holding shares with low betas and business models which are less reliant on the wider economy and/or stock market could prove beneficial. Shire ticks both of these boxes in my opinion.

Further, Shire could register upgrades to its guidance from a weakening dollar, which Trump has already stated is too high. The company’s pipeline also provides long term growth potential, while its merger with Baxalta should generate synergies if integration goes as planned.

While there is a risk this will not be a smooth or successful process, the company’s appealing valuation and already strong growth forecasts make it a buy in my opinion. This year could be a rocky road for share prices and Shire could perform relatively well.

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