Saturday, June 29, 2013

The Stock Picker's Guide to AstraZeneca

LONDON -- Successful investors use a disciplined approach to picking stocks, and checklists can be a great way to make sure you've covered all the bases.

In this series, I'm subjecting companies to scrutiny under five headings: prospects, performance, management, safety, and valuation. How does AstraZeneca  (LSE: AZN  ) (NYSE: AZN  ) measure up?

1. Prospects
Despite aging populations in developed countries, and increasing wealth in developing ones, the pharmaceutical majors are losing ground to generic manufacturers. None are suffering from patent expirations more than Astra. Things will get worse before they get better, with 45% of Astra's sales depending on just three drugs, with major patent expirations due between 2014 and 2016.

New CEO Pascal Soriot's strategy is to boost the pipeline of new drugs through improved R&D and acquisitions of biotech companies. Better marketing, improved penetration of emerging markets, and a big cost-cutting programme complete his turnaround plan.

2. Performance
Revenues and operating profits maintained a largely upwards path until patent expirations sent them crashing into reverse in 2012, with revenues down 15%, and core EPS down 9%. The trend has continued in Q1 2013, with the company expecting a "mid-to-high single digit" decline in revenues, and a significantly bigger fall in core EPS for the full year.

Dividend growth was maintained in 2012 at the expense of relaxing dividend cover, previously between 2.5 to 3 times, to just 2 times.

3. Management
A former veterinary surgeon who was COO of R&D-driven Roche, and CEO of biologicals business Genentech, Pascal Soriot has set a clear path for Astra as a science-led firm rather than diversifying, like rival GSK. It's a bold, if risky, strategy.

4. Safety
Astra faces the challenge of turnaround with a strong balance sheet. Net gearing is just 11%, with interest covered 11 times.

Tangible net assets are technically negative, but Astra's patents and marketing rights have real value, so roughly 30% of market cap is backed by assets. A pension scheme deficit is not significant.

5. Valuation
On a prospective P/E of 9.4, Astra is trading at a 35% discount to FTSE 100 peers GSK and Shire.

Its yield has risen steadily over the past six years, doubling from sub 3%, to 5.8%. That suggests the share price is more and more supported by the dividend.

The management team has given themselves flexibility to maintain or increase the payout while new drugs come on stream, with a target of covering core earnings two times "over the investment cycle." But if the pipeline doesn't develop as hoped, the shares are trading on thin air.

Conclusion
Astra is basically a big biotech play -- with a fat dividend to keep investors happy while they wait to see if the new science is successful.

One very successful investor who has kept faith is Invesco Perpetual's star fund manager Neil Woodford. Nearly a quarter of his 22 billion pound funds are invested in just three companies in the pharmaceutical sector, including Astra.

Mr Woodford has an unrivalled record for stock-picking. His high income fund is "the best performing of any fund investing in the U.K. since it launched" according to Hargreaves Lansdown.

You can learn more about how Mr Woodford selects stocks in a newly updated report: "Eight Shares Held By Britain's Super-Investor." You can download it by clicking here -- it's free.

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