Competitive and regulatory headwinds that have plagued the industry continue for the large pharmaceutical companies, but the fortunes for the better established and well managed companies are starting to change. These companies have survived a difficult decade, and many are in good financial health, inexpensive, and full of new opportunities. Here is my analysis of the healthcare landscape:
AstraZeneca PLC (NYSE:AZN) - While AZN is down 12.5% for the trailing 12 months and is under-performing the S&P 500 (NYSEARCA:SPY) index, it is out-performing the market the last six months from new capital flows to defensive stocks and positive developments with the company. But while AZN has bounced back with the healthcare sector recently, its under-performance to its peer group the last year is a product of worries over patent expiration on best selling products like cancer drug Armidex, and a set-back for the promising new coronary drug Brilinta. These and similar events resulted in AZN’s recent quarterly revenue being down a little more than 3% over last year. At current prices, AZN now has a dividend yield of 5.1%, and a reasonable pay-out ratio of 43%. While it has missed earnings recently, AZN is trading around 8.5 times earnings estimates. This valuation, which is at the low end of its historical range, is attractive given the company’s forward looking efforts. AZN management has done a good job of cutting costs, and improving profitability as it positions the company to transition into its next phase. This phase consists of a new pipeline of drugs in all of the six pharmacy categories in which it operates, as well as a more diversified global revenue base that emphasizes Japan, emerging markets and China. AZN is a true story of buying the future rather than selling the past, and we recommend AZN for longer-term investors that share management’s vision.
Eli Lilly and Company (NYSE:LLY) – Like many of the big name pharmaceutical stocks, LLY has its issues with drug patent expiration and growing competition and regulation generally in the markets for which it manufactures drugs. LLY has performed about in line with the S&P500 market index the last 12 months, but under-performed the healthcare sector due to these headwinds for the pharmaceutical industry. However, it appears that the smart money has been seeing things differently. LLY has out-performed both the general stock market and the healthcare sector the last six months, an indication that the stock is being accumulated. The reason is likely a combination of things, but valuation is certainly a major factor. LLY, with its 5.3% dividend yield and reasonable 46% payout ratio, is a cash cow. LLY has over $5 per share of cash on its balance sheet, which is also roughly equivalent to its debt. LLY’s valuation on cash and cash flow are attractive. Management has focused LLY on growing emerging markets, and drug solutions to large and growing problems like diabetes, Parkinson’s disease, and cancer where it is in late-phase trials. We recommend that longer-term investors consider adding LLY to their portfolios.
Glaxo Smith Kline (NYSE:GSK) – like the better positioned big pharmaceutical stocks, GSK has lagged the S&P 500 market index the last 12 months, but has out-performed it and the healthcare sector the last six months. What has investors buying these names? For one, the market downturn has caused new attention to go to stable, dividend paying stocks. But a closer looks reveals that the better large pharmaceutical names may be starting their own renaissance of sorts as they prepare of a new phase of drugs in new and growing markets. GSK is a good example of a company that has had stiff headwinds from increasing competition and regulation, long-term trends that have resulted in a downward revision to the valuation the market has awarded the company. GSK continues to be one of the biggest, with a market capitalization over $100 billion. GSK is well managed, with profit margins at the top of the group. GSK’s management and their ability to execute is a primary reason why the company trades at a slight premium valuation to the large phara group. While usually a reason to look elsewhere, this premium comes with the best growth outlook and results in a PEG ratio (P/E to growth) of less than 1.0. GSK has a current dividend yield of 5%, but a high pay-out ratio and a leveraged balance sheet. GSK is more of a growth story than a value play, which may be useful for longer-term investors seeking diversification and more growth.
Bristol Meyers Squibb (NYSE:BMY) – BMY has turned a lot of heads recently, as it has performed well recently and compared with both the S&P 500 market index as well as the healthcare sector. BMY is trading near its five-year high for several reasons. First, it is are beating earnings estimates from new drugs with significant growth potential in areas such as hepatitis and cancer. The new drug release pipeline, which includes some that already have FDA approval, is doing a good job of creating visibility to products that will offset the older drugs coming off of patent protection soon. Second, BMY’s management continues to do a good job keeping profitability high. All of these factors have contributed, and have awarded BMY for its efforts. From a valuation perspective, BMY is trading at around 15 times forward earnings. This P/E multiple is on the high side of the valuation range for large pharmaceuticals. However, BMY’s healthy balance sheet is reassuring, as its 4.2% dividend yield is now around the reasonable 50% dividend pay-out ratio. BMY is currently the pride of the large pharmaceutical company group, and is attractive for longer-term investors.
Merck (NYSE:MRK) – While MRK is down about 12% over the last year and has under-performed the S&P 500 Index, it has out-performed the same market index for the trailing six month period. This turnaround reflects a few things that may well continue to the advantage of MRK. First, as uncertainty about economic growth has set in recently and caused market volatility to increase, investors have sought out quality companies in economically defensive industries. MRK, a large, diversified pharmaceutical company in the healthcare sector, has benefited from this trend. Second, MRK’s quality management, research, and products continue to showcase the company within the industry. While the product line-up is strong, the pipeline for new drugs is not as attractive as it has been in previous periods, and the patent expiration on its number one selling asthma drug Singular will likely cause some uncertainty and volatility in the stock. The company’s management continues to seek ways to grow, and has been cutting costs, seeking research partnerships, and looking for geographic expansion. Along this line, MRK has been deepening its marketing efforts in China to bring more of its products to that country’s huge population. MRK currently has an attractive dividend of 4.7%, and an equally attractive dividend payout ratio of 40%. Combining these characteristics with a forward P/E ratio of 9, makes MRK attractive in our opinion. We believe longer-term investors are well compensated to wait for a resumption of growth from this market leader.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.