Stockwatch: is AstraZeneca at a turning point?

by Edmond Jackson from interactive investor |

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The pharmaceutical stock’s drop starts to look attractive for a maiden ‘buy’.

Is the downwards chart for this £95 billion FTSE 100-listed biopharmaceuticals group worth buying into? Since an all-time high of £87.05 last July, the stock has fallen 18% to £71 – which seems ironic given AstraZeneca (LSE:AZN) is among global vanguards for producing vaccines.

Yes, there was a 13% jump in early November, amid a general stocks’ re-rating triggered by far better-than-expected vaccine trials. Yet that was erased within the month, even more viciously than a persistent bear market.

It quite begs the question whether it is worth wracking wits over technical specifics of such drug groups if chart trends can so predominate. But are they reaching a point where probability implies a fair chance of mean reversion upwards? Today, I examine AstraZeneca. 

Currency translation may be a smokescreen factor  

Multinational drugs groups report in US dollars but are not wholly ‘dollar earners’: around 33% of Astra’s revenues are earned in US dollars and 40% for GlaxoSmithKline (LSE:GSK). Astra’s de-rating does, however, correlate by way of magnitude and timing, with a 17% appreciation in sterling versus the US dollar since last May. Back then, one pound sterling bought you $1.20 but this has risen steadily to $1.41. It does not explain an exact one-pound drop to £71 a share in early dealings this morning, with no news out. Glaxo’s de-rating has been 29% over the same timescale, however. 

My chief query is the net upshot – or cost – of Astra’s being in the vanguard of global effort for Covid-19 vaccines. Assuming the Oxford-AstraZeneca vaccine can, in due course, be tweaked against Covid-19 variants, there is long-term kudos from being involved. You might say it begins to justify the whopping $32.8 billion (£23.3 billion) intangibles within $15.6 billion net assets (i.e. negative net tangible assets). Production of the vaccine is happening at cost, unlike the Pfizer-BioNTech vaccine, yet the sheer scale of addressing Covid-19 must be weighing on group resources.  

In terms of senior management distraction alone, Astra’s CEO has recently been embroiled in controversy with EU leaders who accused the company of failing to deliver vaccines on time. It is hard to imagine lawyers’ fees being at special low rates due to the pandemic. 

The 11 February preliminary results for 2020 made no reference to net effects of the Oxford-AstraZeneca vaccine, only citing a “significant impact” from the pandemic generally.  

I regard cost/benefit issues of this major Covid-19 vaccine as contributing to uncertainty over underlying value, although at some point on the chart you begin to wonder if the downtrend factors this in. A 17% de-rating is not justified by 33% US dollar revenues, even if the company reports in US dollars.    

Over half of revenues derive from faster-growing new medicines   

This is a key element to a ‘buy’ case, where a 10% advance in 2020 revenue to $26.6 billion was described by the CEO as “marking a significant step forward”. Investment continues, especially in anti-cancer and biopharmaceuticals therapy.  

In particular, a targeted therapy called Tagrisso won its first regulatory approval for early stage, potentially curable lung cancer. Farxiga expanded its potential beyond diabetes treatment, and Tezepelumab is said to offer real hope for severe asthma patients.  

Such examples have headline-grabbing attention prompting event-driven traders to buy the story - especially if backed by meaningful chart action – despite the dilemma for outsiders to figure the net upshot for profits. Pharmaceuticals’ investment is often significantly a hope that well-capitalised groups have resources enough to produce the occasional blockbuster. 

Astra’s operational review does appear medium-term promising on this key score, hence I suggest the company at least merits following – and contrarians should consider using current weakness, to average into the stock. 

Halfway house on dividend policy is less impressive  

I question the board’s payout policy as a muddled compromise, at odds with the story of capital growth potential. 

The table shows capital expenditure as a percentage of operating cash flow rising from sub-50% in recent years to 83% in 2019 and 54% in 2020, yet since 2017 the dividend has been uncovered by earnings. That improves according to consensus for net profit to soar from $3.2 billion to $6.8 billion in 2021, then $8.8 billion in 2022. That is for normalised earnings per share (EPS) growth of 167% and 30% respectively, enabling earnings cover for a circa 285 cents pay-out to recover over 2x. 

But even with the stock around a one-year low, its prospective yield is 2.8% which is not exactly material for income investors. Compare this with Glaxo offering 6.5% with around 1.8x cover. 

Given Astra’s return on equity has rebounded from 10% in 2019 to 22% last year (having declined from 21% in 2016) and considering the CEO’s growth narrative, retaining earnings is surely the better policy. 

AstraZeneca - financial summary
Year ended 31 Dec

  2015 2016 2017 2018 2019 2020
Turnover - $ million 24,708 23,002 22,465 22,090 24,384 26,617
Operating margin - % 16.7 21.3 16.4 15.3 12.0 19.4
Operating profit - $m 4,114 4,902 3,677 3,387 2,924 5,162
Net profit - $m 2,825 3,499 3,001 2,155 1,335 3,196
Reported EPS - cents 223 276 188 170 103 243
Normalised EPS - c 415 252 137 85.4 149 189
Operating cash flow/share - c 263 327 282 207 228 365
Capital expenditure/share - c 220 183 128 108 189 198
Free cash flow/share - c 42.4 145 155 98.4 39 167
Dividend/share - c 280 270 274 275 289 283
Earnings cover - x 0.8 1.0 0.7 0.6 0.4 0.9
Cash - $m 6,853 5,902 4,554 5,680 6,218 7,992
Net debt - $m 8,200 10,906 13,253 13,433 12,009 12,388
Net assets/share - c 1,453 1,174 1,181 984 1,000 1,190

Source: histroric company REFS and company accounts

16% revenue growth targeted for 2021 and 2022 

Consensus expectations are for $30.9 billion and $35.8 billion respectively, with profit and earnings to soar by greater magnitude – i.e. operational gearing also. But this is not what the stock affirms, as if sharing my concern as to mixed benefits from producing vast quantities of the Covid-19 vaccine at cost (and being embroiled in controversies). 

In terms of raw price-to-earnings (PE) ratios, this equates to 54x the 2020 outcome, 20x the 2021 projection and 15x for 2022. That may look high enough, although on a price/earnings-to-growth (PEG) basis it is attractive, at around 0.7 going forward.

The general sense is a sub-1 PEG implying value for growth stocks, although a relatively short timeframe can distort this when dynamics are changing.  

This compares with Glaxo offering flat earnings prospects in 2021 and near 10% hoped-for in 2022, although its PE is lower around 11x.  

Balance sheet is fair, while low interest rates drag 

Another issue conflating for stock price weakness could be Astra’s $17.5 billion long-term debt and $2.2 billion short-term debt, plus a relatively modest $0.7 billion leases.

While mitigated by $7.8 billion cash, the 2020 net interest charge was $1.2 billion net finance charge against $5.2 billion operating profit. A CFO might justify that as “optimising balance sheet structure”, for example to invest in research and development, but that assumes a persistent new era of low interest rates.

Rising US bond yields have disrupted Nasdaq stocks this week, which shows markets are recognising incipient inflation and eventual rate rises. 

Call me conservative, but I think dividends should be cut both to prioritise investment and debt reduction.  

Tilting to a cautious ‘buy’ case 

Aspects of Astra’s profile give me genuine cause for concern, hence my modest conviction its drugs’ development heralds a turning point. The appropriate response however is to mark it as a company to watch: take an initial stake and manage your position henceforth. ‘Buy.’ 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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