Interactive Investor

Stockwatch: fresh opportunity to bet on this FTSE 100 defensive stock

7th October 2022 10:12

Edmond Jackson from interactive investor

There’s a discussion under way as to whether this stock’s 10-year bull run has further to go, but analyst Edmond Jackson thinks it remains a core holding.

AstraZeneca (LSE:AZN) has been quite a favourite of mine – initially drawing attention to the pharmaceuticals giant as a “buy” at 7,100p in February 2021, along a rationale that more than half its revenue derives from faster-growing new medicines, especially in cancer and biopharmaceuticals therapy. 

More recently, and as economic prospects have deteriorated, healthcare spending – especially on therapies able to limit the cost of hospital treatment – ought to be relatively resilient.  

Furthermore, and as the US dollar has soared especially against sterling, that 38% of revenue originates in the US constitutes quite a hedge for sterling-based portfolios.  

It is also a useful stock lest the UK becomes mired in stagflation: Astra’s first-half 2022 results also showed revenue comprising 28% emerging markets (half of which is China), 20% Europe (including the UK) and 14% rest-of-world.  

Emerging markets can be relatively more dynamic, although bear in mind they also suffer in a global recession when product demand from the developed world eases, while the Chinese economy also has domestic issues. 

For what insights of the World Bank president are worth, he recently declared: “A tough reality confronts the global economy – and especially the developing world. A series of harsh events and unprecedented macroeconomic policies are threatening to throw development into crisis.” 

It means the defensive assumption about pharmaceutical stocks will truly be put to the test. 

Reverting to the chart’s 200-day moving average 

AstraZeneca shares have fallen over 14% from 11,450p in late August to around 9,800p currently. Meanwhile, GSK (LSE:GSK) (previously GlaxoSmithkline) is down around 6%.

Yet in a five-year context, AstraZeneca has essentially mean-reverted to its 200-day moving average in a long-term uptrend. Whereas GSK is decidedly volatile-sideways.

It is worth also setting healthcare in relative equity context. Not surprisingly during market jitters, financial stocks have borne the brunt in recent weeks - Lloyds Banking Group (LSE:LLOY) is down around 20% and Legal & General Group (LSE:LGEN) by 16%. While rising interest rates help banks in one respect, loans and other financial assets are put at risk by a recession. 

BAE Systems (LSE:BA.) (I rated “buy” at 735p last March) is proving a key blue-chip winner, up around 8% to 820p in the last month as fears persist about Russia remaining a rogue state.  

British American Tobacco (LSE:BATS) (rated “buy” at 2,800p last November) has eased 6% to 3,260p over the same period, with new vaping products possibly limiting downside from high-priced cigarettes in a recession. 

It is with some irony how weapons and smoking are outperforming healthcare, at least in the short term. 

Results and drug approvals affirm underlying momentum 

AstraZeneca’s 29 July interim results cited a 48% revenue leap to $22.2 billion (£19.8 billion), with organic growth in all disease areas and a contribution from acquiring Alexion which treats rare disorders.  

Full-year revenue guidance was raised, enabling further investment in new drugs. 

Operating profit halved to $1,417 million, however, as general administrative expenses rose from 39% to 43% of revenue (significantly with inflation) and R&D spend rose from 23% to 43% - although investors for growth would regard that favourably. 

A strong mid- to late-stage pipeline was said to support the growth story, affirmed by a blitz of news during August and September, especially for cancer and asthma drugs – albeit to little avail, share price wise. 

AstraZeneca - financial summary
Year ended 31 Dec

 201620172018201920202021
Turnover - $ million23,00222,46522,09024,38426,61737,417
Operating margin - %21.316.415.312.019.42.8
Operating profit - $m4,9023,6773,3872,9245,1621,056
Net profit - $m3,4993,0012,1551,3353,196112
Reported EPS - cents2761881701032438
Normalised EPS - cents25213785.4149189277
Cash flow/share - cents327282207228365418
Capex/share - cents183128108189198154
Free cash flow/share - cents14515598.439167264
Dividend/share - cents270274275289283284
Earnings cover - x1.00.70.60.40.90.0
Return on capital - %10.47.87.66.811.11.3
Cash - $m5,9024,5545,6806,2187,9926,398
Net debt - $m10,90613,25313,43312,00912,38824,383
Net assets/share - cents1,1741,1819841,0001,1902,534

Source: historic company REFS and company accounts

Affected by rotation from growth to value 

At around 9,800p currently, the stock trades on 50x last year’s sterling equivalent normalised earnings per share (EPS) of 197p.  

It emphasises the need for success in near-trebling EPS to 583p equivalent this year – as is the consensus forecast – then 670p in 2023. In which scenario, the price/earnings (PE) eases from 17x to below 15x. 

Its dividend is expected only to sustain low-single-digit percentage growth to around 300 cents on a 12-month forward basis, or 264p equivalent, hence a 2.7% prospective yield. 

Such valuation continues to affirm AstraZeneca in a growth stock universe, where recently rising interest rates have prompted an element of switching to “value” – i.e. low PE/high dividend stocks. 

The stock is likely to remain significantly at the behest of interest rates while macro events have gripped investor sentiment.  

If inflation is judged as peaking, then potentially expectations will shift again – especially in a recession – towards central bank easing. Ironically again, I suspect this is likely to be the key short to medium-term, potential driver than drug developments. 

A balanced portfolio is the only real way to address such uncertainty, although with fresh money I would be wary about how “trough earnings” on industrial cyclical stocks could be a way off.  

While all this can seem detached from pharmaceuticals, it does, I believe, chiefly explain the shifts in market value. 

Might debt also be a factor in pharma stock volatility? 

Last February, I re-iterated “buy” at 9,000p, the again in April at 10,480p as AstraZeneca released a flurry of drug news. 

The forward PE was 20x the consensus for 2022 EPS, easing to 17x for 2023 - versus GSK on 15x easing to 14x, albeit with not quite the same earnings momentum. 

I did note how “both companies carry rather hefty net debt, which would temper gains in a worse-case scenario of interest rates jacking up against inflation”.  

As that is precisely what has unfolded, debt is likely another reason both stocks have eased. 

Quite where AstraZeneca’s interest charge currently stands, I don’t know, but in respect of its first six months of 2022, a $612 million net interest charge took a hefty 43% of operating profit.  

The 30 June balance sheet showed a minor shift in the debt profile to short-term loans, albeit 92% weighted to long term. It can still be tricky to gauge exactly what is the interest charge as rates rise. Total debt was $28.6 billion mitigated by $4.8 billion cash, for net gearing of 66%. 

It is another reason the macro context is important; whether central banks are now fixated on achieving 2% inflation targets, using higher interest rates as their prime means, or they live with higher inflation or recession mitigates it anyway. 

Two broker upgrades target at least 20% upside 

Perhaps industry analysts at other brokerages pay more regard to company marketing and other intrinsic progress than including macro factors, as I do. 

It may explain why during September, Deutsche Bank was confident enough to raise its AstraZeneca price target from 11,500p to 12,000p; then at the month-end, ODDO BHF, a Franco-German investment group, raised its target from 11,800p to 12,300p. 

ODDO likes European pharmaceuticals company growth profiles, where it favours AstraZeneca and Novo Nordisk A/S ADR (NYSE:NVO) – despite AstraZeneca trading around a 5% premium to US and European peers, justified by its earnings growth and pipeline. 

I continue to see the chief risk as succession of 63-year-old Pascal Soriot, the CEO of 10 years, given investors regard him as a catalyst for the stock’s decade-long bull market. Planning for this has reportedly been underway for at least four years, the calibre of the next CEO being what counts.   

Inflation and interest rates are likely to remain perhaps the dominant near-term influence. Yet this current drop in AstraZeneca merits attention as another opportunity to average into a stock that merits being a core holding. Buy.   

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

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