Interactive Investor

Stockwatch: core growth and inflation protection

29th April 2022 11:10

Edmond Jackson from interactive investor

This pharma stock’s recent progress in drug innovations makes it a particularly strong choice for delivery of both, says our companies expert.

Following my ‘buy' case for AstraZeneca (LSE:AZN) at 9,000p on 22 February - originally ‘buy’ at 7,100p a year previously – how secure is its stock at around 10,480p?  

This is more than 4% off an 8 April all-time high of 10,930p and the price is nearly 1% easier today despite strong first-quarter results.  

Capitalised near £164 billion, AstraZeneca is not the only international drugs stock rising lately: AbbVie Inc (NYSE:ABBV) has been on a tear from $117 at end-November to $175 on 8 April, before taking an 11% dip to $156. That AbbVie barely reacted to the Ukraine crisis shows ‘global pharma' as a prime safe-haven. 

Astra, however, has delivered a flurry of positive news on drug development in recent weeks – especially for harder-to-treat cancers, where mass-market potential is a key reason to own this stock.  

Classic growth rating affirmed by first-quarter results 

Todays announcement asserts a strong start to the year,” with total revenue up 60% to $11.4 billion (£10.0 billion) helped by the acquisition of Alexion medicines.  

With an operating margin of 8%, underlying earnings per share (EPS) have advanced 20% in line with a similar price/earnings (PE) rating, and 2022 guidance is re-iterated – for total revenue to rise by a high teens percentage and core EPS by a mid-to-high 20s percentage.  

At around 10,480p, the forward PE is 20x consensus for 2022 net profit of just over $10 billion and EPS of 667 cents (523p). This eases to a 17x PE assuming $11.8 billion net profit in 2023, hence EPS of 777 cents (610p). 

It compares with £89 billion GlaxoSmithKline (LSE:GSK) on a forward PE near 15x easing to14x, albeit with not quite the same earnings momentum. 

Bear in mind that both companies carry rather hefty net debt, which would temper gains in a worse-case scenario of interest rates being jacked up against inflation.  

AstraZenecas debt burden nearly doubled last year to £19.4 billion equivalent, for end-2021 net gearing of 62%, in order to buy Alexion – a potentially transformative acquisition focusing on treatment of rare disorders. Meanwhile GlaxoSmithKlines net debt eased 5% to £19.8 billion, although net gearing of 132% helps to explain why it is financially riskier.    

Consensus is for AstraZeneca to achieve dividend growth of 2% then 6% in the next two years; but the prospective yield is barely 2.3% at the current stock price, despite earnings cover towards 2.5x.  

GlaxoSmithKline meanwhile, is expected to cut its dividend by nearly a third this year, with only a 1% rise in 2023, for a circa 3% yield with similar cover to AstraZeneca. 

With both stocks, you need to be confident about the earnings growth trajectory, which AstraZeneca today affirms. 

Good news on developments since 14 March 

Lynparza gained US approval as a treatment for high-risk early-stage breast cancer; the first and only such approved medicine, with data showing an overall benefit for survival. This is the most diagnosed cancer globally, generating an estimated 2.3 million patients in 2020. Oncologists have given Lynparza a thumbs-up. 

On 24 March, however, a phase three trial for Imfinzi – an advanced cervical cancer treatment – did not achieve statistical significance for improving survival.  

More positively that same day, Evushelda treatment for preventing Covid-19, especially those immuno-compromised and hence unable to take a vaccine – showed a 77% reduction in the risk of developing symptomatic Covid. It is also proven effective versus the Omicron BA.2 sub-variant and on 28 March gained EU approval. 

Then on 29 March, Ondexxya, a treatment for major bleeds, was approved in Japan. 

On 19 April, another potential blockbuster against cancer was announced: Enhertu, jointly developed by AstraZeneca and Daiichi Sankyo, was granted priority review in the US for lung cancer, the second most-common cancer globally. A near-55% tumour response rate was shown.  

Last Wednesday, Enhertu also gained breakthrough therapy designation” – i.e. preliminary clinical evidence, with clear advantage over available therapy for low-metastic breast cancer.  

And only yesterday, Ultomiris was approved in the US for the treatment of chronic autoimmune disorder.  

It is hard to figure the collective financial upshot, yet the progress affirms Pascal Soriots stewardship as chief executive and mitigates the concern I expressed above about debt.  

Global pharma stocks seen as inflation hedge 

The power of this macro theme lately is shown by Glaxo rallying 8% to 1780p in early April without any specific news trigger. 

Unless recession tempers inflation to near central banks2% targets, I suspect it is more likely to settle at around 4%. Renewed lockdowns in China imply another round of supply chain issues and hence shortages; labour shortages are prompting UK wage inflation; and rising producer price inflation will affect consumer prices.  

Meanwhile, central banks cannot raise interest rates materially without causing a debt-bust.  Astute investors are therefore right to position now for the possibility that central banks will loosen their inflation targets. 

Meanwhile, consumer discretionary spending stocks are in the doghouse; profit warnings are awaited for industrial cyclicals; and smoking and fossil fuel stocks are off-limits for fund managers respecting ESG criteria.  

Leading pharmaceutical stocks therefore appeal as a relative safe haven, so long as the company in question shows successes with innovation and commercialisation. 

Pharma may also be benefiting from disillusion with big tech 

Global technology stocks became a very crowded trade, exposed to disappointments. A 35% plunge in Netflix (NASDAQ:NFLX) has been the starkest example, although its business model – requiring huge investment in content – is nowhere near as strong as those of say Google or Microsoft. 

Even those two – previously invincible stocks - are becoming tricky. Googles owner, Alphabet (NASDAQ:GOOG) eased 4% on Wednesday in response to lower YouTube revenues, while Microsoft (NASDAQ:MSFT) gained 5% after an earnings-beat, although some analysts were sceptical beforehand. 

AstraZeneca - financial summary
Year ended 31 Dec

  2016 2017 2018 2019 2020 2021
Turnover - $ million 23,002 22,465 22,090 24,384 26,617 37,417
Operating margin - % 21.3 16.4 15.3 12.0 19.4 2.8
Operating profit - $m 4,902 3,677 3,387 2,924 5,162 1,056
Net profit - $m 3,499 3,001 2,155 1,335 3,196 112
Reported EPS - cents 276 188 170 103 243 8
Normalised EPS - cents 252 137 85.4 149 189 277
Cash flow/share - cents 327 282 207 228 365 418
Capex/share - cents 183 128 108 189 198 154
Free cash flow/share - cents 145 155 98.4 39 167 264
Dividend/share - cents 270 274 275 289 283 284
Earnings cover - x 1.0 0.7 0.6 0.4 0.9 0.0
Return on capital - % 10.4 7.8 7.6 6.8 11.1 1.3
Cash - $m 5,902 4,554 5,680 6,218 7,992 6,398
Net debt - $m 10,906 13,253 13,433 12,009 12,388 24,383
Net assets/share - cents 1,174 1,181 984 1,000 1,190 2,534

Source: historic company REFS and company accounts

Good reasons for confidence in AstraZeneca 

Some would say pharmaceutical stocks have a parallel uncertainty with technology, given the challenge to predict drugstrials and regulatory decisions.

You should therefore diversify, or seek an exchange-traded fund (ETF). As Warren Buffett has commented: If we could buy a group of leading pharmaceutical companies at a below-market multiple, I think wed do it in a second.” 

But after some years of investor impatience for improved results (see the financial table showing 2017-2019 declines) AstraZenecas recent drugs progress reflects underlying vigour in innovation.  

Todays announcement cites continued investment to drive sustainable long-term growth,” and also plans for a new US strategic research and development centre. Management looks to be spreading its bets astutely; hence even holding this pharma stock alone I would say you get decent diversity, and in some of the most vital treatments. 

Mind aspects of boardroom succession 

This appears to be a key company-specific risk. The ‘turnaround king’ chairman since 2012 - which was also when the current CEO joined – will retire in 2023, and the calibre of his successor be important. 

If Soriot were suddenly to declare his intent to step down, it could cause a jolt. Going back to late 2018, some shareholders reportedly prompted a search for a successor; doubtless they changed their minds.  

Altogether, though, it looks premature to take profits. For fresh money, the hope has to be that the stock may drop if news momentum slows and the market drops. 

Another 20% plus of upside will take longer, but I continue to regard AstraZeneca as a long-term core ‘buy’ for wealth protection.  

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

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