If you are looking for relatively stable cash flows and solid balance sheets in a volatile market, there is a good chance that you may be right to invest in the pharmaceuticals sector right now.
That works in theory, at least — but is there also a change that the shares of AstraZeneca (LSE: AZN), Indivior (LSE: INDV) and Dechra (LSE: DPH) will double in value by the end of 2016?
Could Astra double in value?
Astra is a nice yield play but is very unlikely, however, to deliver meaningful capital gains into 2016 and beyond, in my view. Its stock is currently at about 4,200p, but I wouldn’t be surprised if it traded some 500p lower by the end of the year. A drop in its valuation could be an opportunity perhaps, but then would I bet on a stock price of 7,000p?
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Astra is on track to deliver earnings per share (EPS) of $2 this year, which puts its stock on a price-to-earnings (P/E) multiple of 30 times for 2015. Assuming that it can then grow EPS by 50% to $3 in 2016, a price target of 7,000p would imply a 2016 forward P/E multiple of 35 times. Ouch!
The problem is that the market has pencilled only a 10% rise in EPS in 2016 — and that’s a generous assumption. On this basis, at its current price I’d be now paying 27 times for its 2016 forward earnings (and 45 times assuming a price target of 7,000p), which is a crazy valuation for a mature business offering flat revenues and margins.
Indivior: Lots to like in it!
The stock of Indivior, a market leader in the treatment of opioid dependence, has become more expensive since it was spun off from Reckitt, but its shares are not that expensive, really — although it has a problem with generic competitors. Moreover, its size renders it an appealing takeover target, but an M&A premium is not priced into its shares, I’d argue. I’d expect lower earnings in future than in the past, but how much would INDV cost me based on its earnings profile?
In the first half of the year, EPS was 20 cents (H1 2014: 32 cents) both on a basic and fully diluted basis. Full-year guidance was raised earlier this summer when the company said that it expected net revenue in the range of $935m to $965m and net income of $185m to $210m at constant exchange rates.
So, if it hits the top end of its estimates, Indivior will report EPS of 28 cents on a fully diluted basis, based on about 733m shares outstanding.
Its stock price now is 224p. Once it’s converted into US dollars at the prevailing $/£ exchange rate, its implied 2015 forward P/E multiple comes in at 11.7 times. Well, I’d rather bet on a rise in its P/E to over 20 times in 2016, hoping that investors will be willing to pay that much for Indivior stock — even it generates a marginally lower level of earnings next year — than 27 times for Astra’s forward earnings, to be honest!
Dechra Pharmaceuticals: it’s pricey!
Dechra is a more complicated investment case. Even at a glance this is really a good business, and its results this week confirmed that view.
Its excellent performance showed all the way through its income statements, but here we are looking to double the value of our investment, and its prospects — its shares trade in Astra’s ballpark, based on P/E multiples — are less appealing than those of Indivior. For that reason, as well as considering its level of underlying profitability, which is 15 percentage points below Indivior’s (as gauged by their operating income margins), I’d not be prepared to bet on a steep rise in its equity valuation, although a takeover premium doesn’t seem to be priced into its shares.
