While the healthcare sector is often viewed by investors as being defensive, the pharmaceutical industry can be anything but. In fact, due to the focus on key, blockbuster drugs and their patents, a major pharmaceutical company can be delivering superb profit growth for a period of time, before net profit takes a nosedive due to the loss of exclusivity on specific drugs and the competition from much cheaper generic producers.
That is exactly what has happened to AstraZeneca (LSE: AZN). It was a hugely successful business that posted impressive growth numbers but, since 2012, has seen its bottom line fall by 41% as it has lost the exclusivity on various blockbuster drugs. More importantly, it has failed to adequately replace them and, looking ahead, the run of disappointing earnings performance is set to continue with flat earnings forecast for this year and a drop of 3% being pencilled in for next year.
However, AstraZeneca is in the midst of gradually turning its fortunes around. In recent years, under a new management team, it has refreshed its strategy and become much more focused on improving its pipeline. This has meant multiple acquisitions and, with AstraZeneca having such a strong balance sheet and impressive cash flow, it seems to be more than able to make further purchases should it uncover more businesses with long term growth potential.
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Clearly, AstraZeneca’s dividends have been less of a priority in recent years, with the company understandably prioritising acquisitions rather than shareholder payouts. However, and despite its share price rising by 40% since the start of 2013, it still yields a very impressive 4.4%. That’s among the higher yielding shares in the FTSE 100 and, even if AstraZeneca were to trade at £50 per share (up 23% from its current share price) it would still be yielding a relatively appealing 3.6%. For a major pharmaceutical stock with bid potential and an improving pipeline, that still seems very fair.
Furthermore, AstraZeneca currently trades on a price to earnings (P/E) ratio of just 14.9. This appears to be rather low and, while the chances of a bid from a US rival are smaller now that the US tax authorities have set about closing a loophole that would have reduced the tax bill for a US company purchasing a UK rival, AstraZeneca remains very attractive for a larger sector peer that is struggling to grow its top and bottom lines. As such, and were it to trade at a share price of £50, AstraZeneca would have a P/E ratio of 18.3 which, when compared to a number of other pharmaceutical stocks across the globe, does not appear to be a particularly high price to pay.
Looking ahead, there will be more pain in the short run in terms of AstraZeneca’s financial performance. However, it is very much a stock for the long term, with for example its focus on diabetes and acquisition of the remaining half of the Diabetes Alliance with Bristol-Myers Squibb showing that the company is thinking long term, with the number of people with the illness set to soar across the developed world. So, while it may not be dirt cheap and its performance may be somewhat disappointing, £50 per share seems to be very achievable and could just be the first step towards a very bright long term future.
