AstraZeneca: Get In Before The Bounce Back

Jun.14.12 | About: AstraZeneca Group (AZN)

AstraZeneca (NYSE:AZN) continued its long decline last month with another round of bad news. Since it paid out a $1.95 dividend to shareholders last quarter, its stock price has dropped over $6. Going forward, I expect its price to continue to slide, as it will be facing higher costs for the foreseeable future. More than anything, AstraZeneca could use a major new product announcement soon to help battle the losses that seem to be constantly accruing.

Last week began with a report that AstraZeneca was hoping to turn around its business beginning with IT solutions. At first glance this seems like good news, but I think it should have higher priorities. While IT solutions are certainly a worthwhile investment and can do wonders for a company, AstraZeneca has some much deeper problems, such as research and development debacles. Returning to higher profitability will require tackling this problem head on. Many companies before have built up IT expectations that could not be fulfilled and I fear this pharmaceutical giant might be going down a similar road. The company, while venerable and well-managed, needs to keep its regulatory compliance efforts in check.

Specifically, hitting its bottom line a bit harder, an EU court aide let on that a $67.5 million antitrust fine facing review should be upheld. The antitrust case focuses on how AstraZeneca kept drug prices artificially high by predatory competition. AstraZeneca can now expect to be under more scrutiny by officials trying to prevent any sort of anticompetitive behavior in the future. Unless it hits a home run with a new drug, it appears that its profitability might not be the same again, at least not now. Compliance efforts could divert management's attention away from new drug development and towards marketing compliance.

Efforts to cut costs are likely to yield only short-term benefits to its bottom line. Similar to the proposed IT solutions, it faces both a positive and a negative outcome by cutting its neuroscience research and development facility. Apparently, AstraZeneca wants to cut a total of 1,100 jobs at this facility. I expect this to have two results. First, neuroscience, while exciting, has been a poor income performer throughout the pharmaceutical industry as no company has been able to truly capitalize on this field's potential. For AstraZeneca in particular, neuroscience has been exceptionally poor. Cutting many jobs here will save it a large amount of money and bad press over the long run.

On the other hand, cutting this department is a reactive move and will provide it very little competitive advantage, as other pharmaceutical companies have already begun this process. These layoffs will occur over the remainder of the year, so I would not expect those employees who know they will be laid off to produce much over the next year.

The biggest headache for the company right now might just be Europe in general. As of late, the European crisis has been in full form, affecting the pharmaceutical industry as a whole. While pharma sales are relatively inelastic, much of Europe's drug industry is heavily subsidized by state-run healthcare. Margins could compress 100-200 basis points overall as countries push cost-cutting measures in the healthcare field.

Specifically, due to high demand for drugs, consumers in the UK are buying drugs and re-selling them to the rest of Europe at higher prices. Where the industry faces a mandate, in the UK patients who need the drugs are seeing shortages, resulting in less access. Adding to the problem, those in continental Europe are able to get the drugs, but at much higher prices. The most damning part of the problem is the same pharmacists who are supposed to help are the ones exporting the drugs at high prices. If this is proven to hurt patients, and I believe it will, I expect it to add another layer of regulation to a cost-burdened industry.

Another problem brought on by the European crisis is fears that a Greek exit from the Euro will cause shortages of necessary drugs. Greece's exit could result in transportation and regulatory barriers that do not exist currently. The good news is that the pharmaceutical companies are working on plans to make sure patients get the drugs they need. The bad news is that shareholders and patients have conflicting interests, and any solution reached will likely be mediocre. Since any drug supplied to Greece could realize a loss after currency adjustments, drug-makers could attempt to limit drug supplies to only necessary ones. Even with this, AstraZeneca could take a hit if Greek exits.

One possible bright light is the departure of CEO David Brennan, which some view as a crucial step in a turnaround for the company. I can only imagine stockholders hope the predictions are right. However, in my opinion, management issues run industry-wide. Indeed, many of AstraZeneca's peers have struggled over the past months as well.

Notably, Sanofi's (NYSE:SNY) stock price was shaved to the tune of $4 over the course of the past three weeks. Recently, it lost patent protection on the landmark drug Plavix, which it marketed along with Bristol-Meyers Squibb (NYSE:BMY). Increasingly, drugs targeting blood clotting and blood thinning have been targeted by other pharmaceutical companies. The two companies have been able to sit back and let Plavix bring in cash hand over hand, but with the prospect of generics taking the market share away, will no longer be able to be so comfortable. The market hit both companies hard on the expiration of these patents.

Even pharmaceutical giant Johnson & Johnson (NYSE:JNJ) has lost $3 on its share price over the previous month. Its prostate cancer drug received serious competition from a smaller competitor, and is likely to lose significant market share. Needless to say, this is great news for patients with prostate cancer, as the drug eliminates tumors in the prostate before they have been able to spread.

Competitor Pfizer (NYSE:PFE) is reporting that it had to recall over 650,000 Advil Liqui-Gels in March due to an odor problem. The news of the recall will perhaps take a toll on Pfizer's reputation and the trust of its shareholders.

As these bellwether companies demonstrate, the pharmaceutical industry had a tough couple of months. While there are other rock star pharmaceutical companies outperforming Sanofi, AstraZeneca, and Johnson & Johnson, the trend is generally stagnant to negative growth. Expect this to change. The pharmaceutical industry is very lucrative, bringing very high returns and providing strict patent protection. AstraZeneca might be facing a tougher road to prosperity than others in the industry, but these challenges are not insurmountable. I would keep an eye on this stock, but don't expect much to happen for some time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.