The job of a serious investor is to solve mysteries. One mystery I was keen on solving recently was why big pharma stocks were such bad performers in the last decade. The chart below plots the behavior of the stock prices for AstraZeneca (NYSE:AZN), Pfizer (NYSE:PFE) and Novartis (NYSE:NVS):
One can see that only the Swiss Novartis had kept pace with the S&P for the period, AstraZeneca returned -5% in ten years and Pfizer plunged to -35% of its 2002 value. In this chart, dividends, which are substantial for these companies, cannot be seen so the total return (including dividends) for Novartis was 57%, Pfizer -8% and AstraZeneca 37%.
What these companies are, or have been in the past, is monopolistic national and global players. The global market for pharmaceuticals was worth $839 billion in 2011, and when one sees that the sales of Novartis were $59 billion, Pfizer $67 billion and Astrazeneca $33 billion (which makes them hold 7, 8 and 4 percent of the global pharmaceutical market respectively), one can see that the market is dominated by these so called research & development based companies. Barriers to entry to this market are vast, least of all the fact that it costs anywhere from $3.7 billion to $12 billion to launch a new drug in the US which is clearly a price that only a financial mammoth like the above mentioned can withstand, not to mention the acres of regulatory paper that need to be complied with and the enormously complicated and dicey drug approval process. The moats around this monopolistic cluster are wide and legislatively enforced so I was puzzled that the companies that have given us Lamisil, Zoloft or Crestor (all paid for mostly by national budgets) were snubbed by investors.
My claim that we are dealing with government enforced monopolies is confirmed by the fact that the net profit margin for Novartis is 14.82%, for Pfizer 12.54% and for AstraZeneca 26.78%. Talk about drug dealers! Annual dividend rates for the companies under review are as follows:
- Novartis dividend yield: 4,77%
- AstraZeneca dividend yield: 6,79%
- Pfizer dividend yield: 3,98%
So considering their utility-like character, extremely fat margins that can't be found in any other big global industry and juicy dividends, the relatively poor stock performance can be mystifying.
The first reason is that these companies, just like Hollywood studios, depend on blockbusters, in their case - drug blockbusters. Of the $33.6 billion earned by AstraZeneca in 2011, $6.6 billion was made by Crestor (cardiovascular), $4.4 billion by Nexium (gastrointestinal), $4.3 billion by Seroquel (psychiatry) and $3.1 billion by Symbicort (asthma inhalator) - this micro chemical quartet was responsible for 56% of the company's revenue. This is a source of instability as the average lifespan of a drug is generally 15 years and such new drugs are hard to come by. It is always hard for a big pharma company to find new ones once the "golden" patent expires.
Second reason is the increasing reluctance of governments and insurance companies to pay up for these drugs whose production costs are rock bottom low. Since the "austerity measures" were introduced the pricing of pharmaceuticals became an issue and the haggling seems far from over.
Third problem is the heavy reliance of big pharma on the emerging markets (only the emerging markets now grow at a double digit rate for these companies and AstraZeneca has increased its headcount in those countries so that it is now greater than the one in US - their biggest market). Emerging market nations are, one must admit, not known for strictly enforcing intellectual property laws or inhibiting the locals to profit with generics and plain rip offs, so this strategy might prove a little hazardous.
I see little difference between these companies, other than that Pfizer is supremely well placed to live off the government teat with headquarters near Washington, D.C., Novartis is in Switzerland, the neutral country welcome east and west, and poor little AstraZeneca is originally a British and Swedish company, countries in which its sales are now below $2 billion in total. But AstraZeneca is based in London which is the attractive global capital and David Brennan, the outgoing CEO (who will retire in June), has done little else in the last 6 years but cut costs dramatically while aggressively increasing dividends and last year spending $5.6 billion repurchasing stock (repurchasing stock is an activity I very much like).
AstraZeneca stock has plummeted recently owing to disappointing 1st quarter results and the tumult at the top - the chairman Louis Schweitzer is to go and to be replaced by Leif Johansson, former boss of Volvo, who will be responsible for finding the new CEO. AstraZeneca could benefit from this further Swedish connection - the company's last year's largest foreign plant investment of 200 million dollars was in China, but the second largest was in Russia, traditionally a friendly place for Swedes to do business in.
I have decided to go with AstraZeneca because of a massive and relatively secure dividend. The free cash flow is currently 1.7 times larger than the annual dividend so you can look forward to a fine income while waiting for times to get better, as they surely will for this company.
Disclosure: I am long AZN.