AstraZeneca May Be at a Turning Point

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 |  About: AstraZeneca Group plc (AZN), Includes: JNJ, MRK, PFE
by: Michael R. Brown

AstraZeneca (NYSE:AZN) is a large cap biopharmaceutical company based in London. It operates globally and develops and produces a wide portfolio of drugs that fall mostly into six categories: gastrointestinal, cardiovascular, respiratory, oncology, neuroscience and infection. The stock closed Wednesday trading at $49.19 a share, roughly 8% below its 52-week high of $53.53.

Bearish concern emanates chiefly from two categories: Firstly, AstraZeneca – along with many of its most notable peers – has recently been caught in the headwinds of patent expiration. This danger cuts into top-line revenue two-fold; not only do generics steal many customers entirely, they often lead biopharmaceuticals to cut prices in an attempt to remain somewhat competitive. Healthcare reform has only exacerbated this problem. Secondly, Brilinta (ticagrelor), an exciting new pipeline drug for the treatment of acute coronary syndromes, received a CRL from the FDA in December under the statement that further analysis was needed. Brilinta is regarded by analysts as one of the key victories needed for AstraZeneca to hold its current position on store shelves in the U.S., which is the world's largest market for prescription medication.

MRQ revenue was down nearly 3.5% from the same quarter last year. Using constant currency, U.S. and Western Europe sales fell 4% and 7% respectively. But there is another side to this story.

Although revenue was down this quarter, AstraZeneca's income statement does contain some promising signs. The cost of sales was down over 3% from last year, raising gross margin from 80.71% to 83.85%. This is substantially more competitive then peers Johnson and Johnson (NYSE:JNJ), which reported a gross margin of 70.5%, Merck & Co. (NYSE:MRK), which reported 64.95%, or Pfizer Inc. (NYSE:PFE), which reported 77.62%.

This exceptional gross profit margin has allowed AstraZeneca to increase expenditures on research and development, just as other firms are scaling back in an attempt to cut costs. AZN's expenditure on R&D in the most recent quarter was up 17% from the same quarter last year. AstraZeneca recently announced that it will be opening a new predictive science center in St. Petersburg and has continued to strengthen its research division in China. PFE, on the other hand, recently announced that it would be closing six research facilities.

This is crucial due to the nature of the biopharmaceutical industry. As patents inevitably expire, top selling products lose much of their value overnight. It is therefore necessary to continuously be filling the pipeline funnel with new technologies in order to offset the expiration of past cash cows. AZN currently has 92 products in clinical phases, nine of which are in Phase three. Of these nine, there is at least one drug for each of the six areas of health mentioned in the first paragraph of this article.

Furthermore, AstraZeneca now operates in more than 100 countries and is steadily continuing its infiltration into emerging health care markets. Declining sales in the U.S. and Europe were partially offset by increased revenues stemming from all corners of the earth. Total revenues from Canada, Japan, Australia and New Zealand were up 4% from the same quarter last year, while revenues from the "Emerging World" (Brazil, China, Mexico, India, Turkey, etc.) were up 13%.

This is important because unlike the troubles in the U.S. market, which are finite in nature (i.e. we know when patents are going to expire or health care bills will take effect and we can estimate the level of damage on revenues), the growth in these new markets is actually infinite by nature. Populations in these countries are not only getting bigger but they are getting older (most notably Japan). In the emerging world, millions of people are gaining access to health care and prescription medication for the first time and their needs sync well with the drug portfolio of AZN. The largest health problem in the world is cardiovascular disease. It accounts for 30% of all global deaths. Of that 30%, 80% is from low and middle income countries. AZN is among the global leaders in cardiovascular medication. Furthermore, infectious diseases claim millions of lives a year in emerging countries. AstraZeneca continues to aggressively turn out medications in this area while peers shy away from the "non-western" problem.

And right now AstraZeneca is cheap. The street has beaten the stock down due to the news pertaining to patent expiration and the Brilinta delay, while strides in research and development and emerging market infiltration have fallen mostly on deaf ears.

Look at AZN compared to its peers in regards to valuation:

AZN compared to JNJ, MRK, PFE, Sector and S&P 500 (all ttm)

AZN JNJ MRK PFE Sector S&P
P/E 8.62 15.03 68.06 19.11 21.6 18.66
P/CF 6.44 12.16 10.74 7.95 11.74 10.63
P/Sales 2.01 2.62 2.21 2.38 0.58 0.47
P/Book 2.85 2.01 2.01 1.84 4.51 4.1
Click to enlarge

The only lag by AZN is in the price to book ratio. Remember that one of the most important assets for a biopharmaceutical firm is its competitiveness in regards to research and development and that is not tangible.

Furthermore, the pullback in share price has raised the dividend yield to roughly 7.5%. This is substantially higher than peers and is a great safety cushion in the event of more bad short-term news. Brilinta has been approved in over 30 countries – including in the European Union – and the Food and Drug Administration (FDA) has acknowledged the receipt of AstraZeneca’s resubmission to the CRL.

It is the nature of the biopharmaceutical industry that sometimes the arrival of new drugs and the expiration of patents do not match up perfectly. But AstraZeneca has several exciting projects in the works and the sun has far from set on what the company is capable of. For those who believe in due diligence and that profits are not quarterly, this may be a great time to pick the stock up on sale.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AZN over the next 72 hours.