The elephant in the room with AstraZeneca’s latest update

The AstraZeneca share price jumped over 5% on a trading update last week, but there’s a big reason to avoid the stock, argues G A Chester.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The AstraZeneca (LSE: AZN) share price jumped 5.5% after releasing its Q3 trading update last week. The FTSE 100 pharma giant said: “The third quarter again saw all three therapy areas and every sales region produce encouraging performances.” Management upgraded its full-year sales guidance to an increase by “a low to mid-teens percentage” from its prior guidance of “a low double-digit percentage.”

Bulls have been buoyed by the update but, for me, it highlights what I think is an elephant in the room. This particular pachyderm has been hiding in plain sight in the AZN atrium for several years, growing bigger all the time. Let me show you how it’s developed, and how I think it impacts the valuation of the company.

Smoke and mirrors

Earlier this month, AZN announced it’s agreed to sell the commercial rights for Losec for $243m. Now, you might think the one-off gain from the sale of this non-core asset would be excluded from its core operating performance as an exceptional item. Not a bit of it. AZN includes such “gains on disposal of intangible assets” in its core numbers. The table below shows their contribution to total core operating profit over the last five years.

 

2014

2015

2016

2017

2018

Total core operating profit ($bn)

6.9

6.9

6.7

6.8

5.7

Core operating profit before gains on disposals ($bn)

6.9

5.9

5.4

5.3

3.8

Gains on disposals ($bn)

0.0

1.0

1.3

1.5

1.9

Gains on disposals as percentage of total core operating profit

0

14

19

22

33

As you can see, gains on disposals of drugs AZN has deemed no longer core to the business have made an increasing contribution to core operating profit. Such disposals have gone from £0 in 2014 to £1.9bn in 2018, the latter representing a whopping 33% of total core operating profit. At the same time, what I view as the true core operating profit (before gains on non-core disposals) has fallen each and every year from £6.9bn in 2014 to £3.8bn in 2018.

A cynic might say AZN has used non-core disposals to try to maintain core operating profit, and keep investors onside, while it waits for real operating profit to come through from new drugs. In other words, it’s employed smoke-and-mirrors accounting.

Crystal ball

Happily for the company, it looks nailed-on that 2019’s core profit (before gains on non-core disposals) will increase for the first time in five years — i.e. be higher than 2018’s $3.8bn — and gains on non-core disposals will be lower than 2018’s $1.9bn.

Last week’s Q3 update told us total core operating profit for the year to date is up 41% at $4.9bn, while core ‘other operating income’, the lion’s share of which will be gains on non-core disposals, is down 7% at $1.1bn.

Looking into my crystal ball, I can see AZN posting investor-friendly strong and steady core earnings growth in the coming years, built on rising real core profits from new drugs and a managed decline in the contribution of non-core disposals, deflating the elephant in the room. However, if AZN runs out of non-core assets to sell — or willing buyers — before real core earnings have increased sufficiently, investors could be in for a nasty shock.

At a share price of 7,383p, the company is trading at a whopping 41 times my calculation of real 2018 core earnings of around 180p a share. As such, I’m inclined to avoid the stock until I’ve seen the extent to which real earnings have risen and non-core disposals have deflated in 2019.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended AstraZeneca. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

US Stock

The Nvidia share price falls! Here’s what I think happens next for the S&P 500

Jon Smith reviews the overnight results from Nvidia and explains why this could stall the S&P 500 performance through to…

Read more »

Investing Articles

Down 15% today, is this FTSE 100 share too cheap for me to miss?

JD Sports' share price has tanked after the FTSE 100 share released another profit warning. Is this the opportunity I've…

Read more »

Investing Articles

Up 8% today, is this FTSE 100 growth stock a slam-dunk buy for me?

Halma's share price is soaring thanks to another headline-grabbing trading update. Is the FTSE 100 stock now too good for…

Read more »

Investing Articles

With a P/E ratio of just 10.5 is now a brilliant time to buy a cut-price FTSE 250 tracker?

Harvey Jones says a recent dip in the FTSE 250 leaves the index trading at bargain levels. One stock in…

Read more »

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

To build a passive income flow, I’d follow this Warren Buffett approach

Warren Buffett has set up passive income streams most people can only dream about. Our writer sees some practical lessons…

Read more »

Growth Shares

As the boohoo share price falls, could it become a penny stock in 2025?

Jon Smith outlines some of the recent problems involving the boohoo share price and considers if things could get even…

Read more »

Young Asian woman with head in hands at her desk
Investing Articles

Here are the worst-performing FTSE 100 shares over the last 5 years

These five FTSE 100 shares have been complete duds over the last half decade. But is there potential for a…

Read more »

Investing Articles

Nvidia stock has tripled this year! Can it keep rising?

Nvidia's latest sales update showed strong growth and the stock's been on a tear so far in 2024. So is…

Read more »