Adding AstraZeneca To Our Model Portfolio

| About: AstraZeneca Group (AZN)
This article is now exclusive for PRO subscribers.

Summary

We are initiating coverage on the common stock of AstraZeneca with a Buy rating and price target = $39.

Several data readouts in 2017 could act as a catalyst for the stock price.

Investors are under-appreciating the oncology R&D pipeline of the company.

We are adding AstraZeneca ADR (NYSE:AZN) to our model portfolio as the next investment with the first price target = $39. The dividend yield is also attractive while we wait for the stock price appreciation. Several data readouts in 2017 could act as a catalyst for the stock price.

(AstraZeneca ADR: Common stock price chart)

Investment Highlights:

Rating = Buy

Price target = $39

Current stock price = $28.24

52-week stock price range = $25.55 - 35.04

Market cap = $72.2 billion

Enterprise value = $85.6 billion

Average daily share volume = 7.4 million

Cash reserves = $4 billion

Long-term debt = $17.7 billion

Short interest = 1.87%

Short interest, days to cover = 2.2

Relative valuation is attractive compared to peers and median for the sector:

AstraZeneca's forward EV/EBITDA (2017E) of 9.73 is lower than rivals like Novartis (NYSE:NVS) and Roche (OTCQX:RHHBY) (comparing companies with strong immune-oncology assets). The 10-year range for the company's EV/EBITDA is 3.6 to 20.9. The dividend yield is also attractive at 4.6%.

(AstraZeneca: Comparison of valuation ratios and dividend with peers, data from Bloomberg)

Astra Zeneca's stock price has seen a pullback after the company's financials showed a decline in quarterly net income and EPS (from 12/2015 to 06/2016). Shares traded as high as $40.51 in May 2014. This was largely due to a decrease in revenue from patent cliffs on some prominent brands like Nexium and Crestor. The company also increased its long-term debt in late 2015 ($5.8 billion) to pay for some large acquisitions like ZS-9 (for hyperkalemia) and a 55% stake in Acerta Pharmaceuticals. The interest for the debt also contributed to the decline in quarterly net income.

(AstraZeneca: Comparison of profitability and efficiency measures, and long-term consensus growth estimate, data from Bloomberg).

We also like AstraZeneca's profitability measures like its operating margin (20.2%), which has expanded after bottoming in 06/2016 quarter. Financial efficiency measures like ROE and ROC are also attractive. ROIC exceeds the company's cost of capital, thus indicating value creation for stakeholders on the invested capital.

(AstraZeneca: Comparison of leverage measures, data from Bloomberg)

The debt taken by the company for recent acquisitions is manageable.

Recent acquisitions are expected to create value

AstraZeneca bought a 55% stake in privately-held Acerta Pharmaceuticals for a total $4 billion ($2.5 billion upfront).

In late 2015, it paid $2.7 billion for ZS Pharma whose ZS-9 (for hyperkalemia) is expected to exceed $1 billion in peak sales).

The oncology assets in the R&D pipeline are strong future revenue drivers and are under-appreciated:

Tagrisso:

Tagrisso is being developed in patients with EGFR mutations (T790 positive). Peak sales estimate from the sell-side is about $3.5 billion and could reach $6 billion if the drug is successful as a first line therapy in EGFR positive non-small cell lung cancer (NSCLC). EGFRT790 mutations may be seen in 10-15% of NSCLC patients in the U.S. and up to 35% NSCLC cases in Asia.

Tagrisso is being tested in several late-stage clinical trials. In AURA3 (first Phase 3 trial as second line therapy in EGFRY790 positive NSCLC), the therapy increased progression-free survival (PFS) by 5.7 months vs. chemotherapy and reduced the risk of disease progression by 70%. The therapy is already approved in T790 positive NSCLC indication in the U.S., E.U. and Japan.

In a Phase 2 trial as first line therapy in EGFR mutation positive NSCLC, the median PFS was 19.3 months with a 160 mg dose (with objective response rate, ORR=77%). This was higher than median PFS of 9.7 months to 13.1 months seen in 3 different Phase 3 trials of erlotinib (current first line therapy in this indication). Results of an ongoing Phase 3 trial of Tagrisso (FLAURA) as first line in this indication could be announced in the second half of 2017. Results of a Phase 2 trial of Tagrisso (+durvalumab or sulemetinib or savolitinib, TATTON trial) could be announced in H1 2018. Results of a Phase 2 trial of Tagrisso (BLOOM) in CNS metastases in advanced EGFR mutation positive NSCLC could be announced in H1 2018.

Tagrisso's potential competitors are Boehringer Ingelheim's Imutinib (approved in South Korea in NSCLC, partnership with Hanmi Pharma), ASP8273 (Astellas, Japan, in Phase 3), and EGF816 (Novartis, in phase 1/2). Clovis Oncology has discontinued the development of Rociletinib, which is positive for AstraZeneca.

Durvalumab (anti-PD-L1 antibody, check-point inhibitor):

Durvalumab is being tested in more than 30 clinical trials in combination with other targeted therapies and immune-oncology agents. Roche has a competing anti-PDL1, Tecentriq. Anti-PD-L1 antibodies could have higher clinical efficacy than anti-PD1 antibodies like Opdivo and Keytruda since they bind to the ligand. Peak sales estimate for Durvalumab is about $6 billion.

Durvalumab is being tested in a Phase 2 trial in stage IIIB-IV NSCLC (pre-treated with chemo) with an estimated primary completion date of October 2017. The estimated primary completion date for another Phase 3 trial in stage III NSCLC (prior chemo, PACIFIC) is May 2017.

Durvalumab (anti-PD-L1) and Tremelimumab (anti-CTLA4) combination could gain significant market penetration in various cancers:

AstraZeneca is the only immune-oncology company that owns a combination of anti-PD-L1 and anti-CTLA4 antibodies for various cancers. Bristol-Myers Squibb (NYSE:BMY), our open position is testing a combination of Opdivo (anti-PD1) and Yervoy (anti-CTLA4) in various cancers including NSCLC (the combination is already approved in melanoma).

Results of the pivotal MYSTIC Phase 3 trial (Durva+Treme vs. standard of care, SOC in NSCLC are expected in H1 2017. Positive results in this trial could be a significant catalyst for the stock price.

The primary completion date for an ongoing Phase 3 ARCTIC trial (Durva+Treme as 3rd line therapy in NSCLC) is H2 2017. Data from a Phase 3 trial of this combination in stage 4 urothelial (urinary bladder cancer) are expected in late 2018-early 2019. Results of an ongoing Phase 3 trial of this combination as first line therapy in urothelial cancer are also expected around the same time.

The combination is also being tested in squamous cell head and neck cancer (SCHNC). Data from a Phase 3 trial as first line in recurrent or metastatic SCHNC is expected in H1 2018.

Results of the combination as a second line therapy in pancreatic cancer could be announced later in 2017. The primary completion date for another trial as first line in pancreatic cancer is August 2018.

Adalabrutinib:

The product was acquired through Acerta Pharmaceuticals acquisition and is a second generation, selective, irreversible BTK inhibitor. It is competing against Imbruciva, the SOC therapy in CLL. Adalabrutinib peak sales forecast is about $5 billion as per the company management. Imbruciva sales were $8.4 billion in 2022.

The ORR was 95% (partial response = 85%) in relapsed chronic lymphocytic leukemia (CLL) after treatment with adalabrutinib. The response rate was 100% in chromosome 17p13.1 deletion. The drug is more potent and safer than Imbruciva and has Orphan drug designation in the U.S. for CLL and in the E.U. for CLL/SLL, mantle cell lymphoma and Waldenstorm's macroglobulinemia. It is also being tested in more than 20 clinical trials in various hematological cancers, solid tumors and rheumatoid arthritis.

Potential competition in CLL includes BeiGene's (NASDAQ:BGNE) BGB-311 and venetoclax (AbbVie (NYSE:ABBV) and Genentech).

Lynparza:

This is a PARP inhibitor being targeted at BRCA 1 or 2 mutation positive cancers like cancers of the breast, ovary and prostate. Peak sales estimate is about $2 billion. Data readout as second line agent in breast cancer is expected in H1 2017. Data readout from another trial as first line in ovarian cancer is expected in H2 2017.

Faslodex (Fulvestrant):

This is a selective estrogen receptor degrader. It is approved for the treatment of HR+ metastatic breast cancer in postmenopausal women with disease progression following anti-estrogen therapy. Regulatory decision in Japan is expected in H1 2017.

Key non-oncology assets are also expected to add to the future revenue over the next 5-6 years:

Farxiga (Dapagliflozin):

It is approved for the treatment of type 2 diabetes in adults. Peak sales estimate is about $2.2 billion.

Brilinta (Ticagrelor):

The drug had a setback after it failed in two pivotal Phase 3 trials in symptomatic peripheral arterial disease and for treatment of acute stroke. It is still approved for secondary prophylaxis against coronary artery disease and stroke. Peak sales estimate is about $1 billion.

ZS-9 for hyperkalemia:

ZS-9 was acquired through the ZS Pharma acquisition. The drug received CRL (controversy over sodium retention and increase in blood pressure) but a repeat NDA was accepted by the FDA in 2016. Regulatory decision about approval in the E.U. and Australia are expected in H1 2017.

Benralizumab:

It is a IL-5 receptor monoclonal antibody targeting eosinophilic asthma (in Phase 3, GRECO trial). Peak sales estimate is $450-550 million. It is also being tested in COPD with repeated exacerbations. Potential competition includes Mepolizumab (GlaxoSmithKline (NYSE:GSK), approved in the U.S. and E.U. for asthma), and Reslizumab (Teva Pharmaceuticals (NYSE:TEVA), approved in the U.S.).

Alzheimer's disease pipeline:

This includes LY3314814/AZD3293 (BACE inhibitor) in two pivotal Phase 3 trials. The study's primary completion date is August 2019. MEDI1814 (antibody against amyloid-beta) is in Phase 1 trials in this indication.

Roxadustat in anemia:

AstraZeneca has acquired commercialization rights to Roxadustat for the treatment of anemia in chronic kidney disease (dialysis and non-dialysis patients) from FibroGen (NASDAQ:FGEN) in the U.S., China and other territories not covered by the agreement between FibroGen and Astellas Pharma. Results of a Phase 3 trial in dialysis patients is expected in H2 2017. Results of another Phase 3 trial in CKD patients not on dialysis are expected in 2018. Potential competition includes Akebia Pharmaceuticals' Vadadustat (also in Phase 3 trials for both indications).

Shares could have 36% potential upside:

Shares could have 36% potential upside if they trade at an EV/EBITDA of 13.27 (mean for pharmaceuticals sector, as per NYU-Stern data, Damodaran). The upside could be higher if the shares trade at a forward EV/EBITDA of 14.6 (similar to rival Novartis). All-time high is $40.51 in May 2014.

Our first price target is $39. We are content with collecting the dividend while we wait for the R&D pipeline to play itself out. Several catalysts in 2017 are expected to add upward momentum to the stock price. The company has earlier rejected the takeover offer from Pfizer (NYSE:PFE) worth $118 billion and could receive another offer in the near future.

Risks in the investment:

It is possible that the ongoing clinical trials in the above-mentioned indications may fail, regulatory agencies might not approve the products, unexpected side effects might be seen in the future, clinicians might not widely prescribe the products or insurers might not reimburse them. Competing products from other companies might gain significant market share in the planned clinical indications.

Note: To get more investment ideas like this as soon as they are published, click on my profile and hit the big orange "Follow" button and choose the real-time alerts option.

Premium Research Service:

Get more investment ideas like this by subscribing to Vasuda Healthcare Analytics, our premium equity research service (listed in Seeking Alpha's Marketplace). Subscribers have earlier access to the research reports, can download the valuation models/spreadsheets in the research reports and have access to the model portfolio (with price targets and suggested allocation) and a contrarian portfolio.

Few investment ideas are exclusively limited to subscribers. Subscribers also have access to an active chat room with useful insights from myself and other active traders/investors. There is extensive coverage of companies with upcoming catalysts (trial results etc.).

A free 14-day trial is available to test drive the service (free trial extended until Jan. 15, only 25 more spots left).

Disclosure: This article represents my own opinion and is not a substitute for professional investment advice. It does not represent solicitation to buy or sell any security. Investors should do their own research and consult their financial adviser before making any investment.

Disclosure: I am/we are long AZN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.