Interactive Investor

Stockwatch: a FTSE 100 share in the early stages of a bull market

It’s underperformed its closest rival in the blue-chip index over the long term but has had a great 12 months. Analyst Edmond Jackon thinks the good times might only have just begun.

3rd May 2024 11:12

by Edmond Jackson from interactive investor

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Financial chart representing a bull market

Is GSK (LSE:GSK) leapfrogging AstraZeneca (LSE:AZN) for share price performance and prospects, or does Astra have overall better vigour?

Some long-term context is useful to appreciate the underlying corporate and market valuation dynamics. Also, how a multi-year view is appropriate to exact the best returns.

AstraZeneca affirms a modest PE, high-yield approach

I drew attention to Astra as a long-term “buy” originally in April 2012 at around 2,700p equivalent when it offered a 7% yield twice covered by earnings, and a forward price/earnings (PE) multiple easing below eight times. Remarkably, looking back, the PE was at a 45% discount to the rating for what was then called GlaxoSmithKline.

Versus this cautious investor sentiment, Astra’s drugs pipeline had 79 projects in clinical development and a further seven approved or launched. I therefore suggested: “The balance of progress could weigh in Astra’s favour in due course, at which point the low PE and high yield combination means the shares would re-rate...”

As an investment principle, this could apply to any industry sector, although pharmaceuticals are especially useful given the pace of medical science and resilient government expenditure on health globally. As and when the risk/reward is attractive, they merit a place in a diversified portfolio.

Astra began to rise but it took five years to truly embark on a bull run, and the various projects to fully bear fruit.

AstraZeneca chart April 2024

Source: TradingView. Past performance is not a guide to future performance.

You see this vigour maintained in Astra’s news flow last month, including a stream of approvals for treatments with wide applications. First quarter 2024 results showed (at constant currency) a 19% surge in revenue, with “core” earnings per share (EPS) up 13% and by 30% at the reported level.

Not only is the existing business performing very well, but Astra says: “our strong pipeline momentum continued and already this year we announced positive trial results...that were unprecedented in lung cancer...we are also looking forward to seeing the results of several other important trials throughout the year.”

Over a month, all this has sent Astra shares up 20% to 12,170p, an all-time high - representing a forward PE more like 18x and a 2% yield.

Not surprisingly, some profit-taking has crept in – the shares are down to 12,050p this morning. The rating is a modest premium to “core” earnings per share (and revenue) guided at low teens to low double-digit growth. You can see a status change from a classic “value” type rating to “growth” with an element of expectation. It would take quite a major setback to stall this, but Astra is well-diversified to cope, hence: Hold.

AstraZeneca - financial summary
Year ended 31 Dec

Turnover - $ million23,00222,46522,09024,38426,61737,41744,35145,811
Operating margin - %21.316.415.312.
Operating profit - $m4,9023,6773,3872,9245,1621,0563,7578,193
Net profit - $m3,4993,0012,1551,3353,1961123,2885,955
Reported EPS - cents2761881701032437.9211381
Normalised EPS - cents25213785.4149189277353341
Cash flow/share - cents327282207228365418629662
Capex/share - cents183128108189198154165242
Free cash flow/share - cents14515598.439167264464420
Dividend/share - cents270274275289283284289290
Earnings cover - x1.
Return on capital - %
Cash - $m5,9024,5545,6806,2187,9926,3986,4055,962
Net debt - $m10,90613,25313,43312,00912,38824,38322,82722,660
Net assets/share - cents1,1741,1819841,0001,1902,5342,3902,525

Source: historic company REFS and company accounts.

Is there broad potential for GSK bull market?

I cite this 12-year context on Astra given a sense of parallel with my “buy” case for GSK on 2 January at 1,450p when I explained “why GSK now fits the bill for a sound inexpensive investment”. The forward PE rating was a modest 9.3x and prospective yield 4.2% with 2.6x earnings cover and free cash flow trending strongly. It was partly because investors remained sceptical about what a new CEO since April 2017 was achieving, amid somewhat erratic financial performance:

GSK - financial summary
Year-end 31 Dec

Turnover (£ million)27,88930,18630,82133,75424,35424,69629,32430,328
Operating margin (%)9.313.917.820.624.617.521.922.2
Operating profit (£m)2,598 4,181 5,486 6,961 5,9794,3216,4336,746
Net profit (£m)912.01,532.03,6234,6455,7494,38514,9564,928
EPS - reported (p)23.366.088.011611169.2104120
EPS - normalised (p)40.911810716978.968.1114140
Operating cashflow/share (p)165175212200209196181165
Capital expenditure/share (p)59.955.745.253.955.672.355.357.0
Free cashflow/share (p)105119167146154124126108
Dividends per share (p)80.010010010010010061.358.0
Covered by earnings (x)
Return on total capital (%)6.514.015.412.510.37.817.217.8
Cash (£m)4,9863,9113,9584,7866,3704,3357,8774,992
Net debt (£m)13,80413,17822,10625,72220,78019,83813,11013,026
Net assets (£m)1,124-68.04,36011,40514,58715,05510,59813,347
Net assets per share (p)28.6-1.7111288363374263329

Source: historic company REFS and company accounts.

There has also been concern about US litigation over cancer risks with Zantac after this heartburn drug was withdrawn in 2019, and is why there are occasional announcements of “undisclosed settlements without accepting liability”. In the US state of Delaware, for example, some 70,000 cases are filed against various drugs companies, although in 2022 a Florida court dismissed some 50,000 claims as not supported by sound science. A trial now under way in Chicago is the first attempt to persuade a jury after all previous cases were settled or dropped.

I am reminded of this ongoing risk, although tend to regard it as the proverbial “wall of worry” a bull market can climb and which has contributed to a modest valuation versus GSK’s rising underlying momentum.

During January, the stock benefited initially from investors rotating from highly rated “growth”, then from February came a stream of positive news on different drugs. Last Wednesday provided a financial sense of it all: first-quarter revenue ex-Covid medicines was up 13% in context of total sales up 10%. Guidance for 2024 was raised (since the 31 January annual results): revenue goes to the upperend of a 5-7% range, “core” operating profit to 9-11% from 7-10%; and core EPS growth of 8-10% from 6-9%.

The shares have since risen around 4% to test 1,740p – continuing to rise this morning, versus profit-taking in Astra. The forward normalised PE looks around 10x and prospective yield 3.4% based on guidance for a 60p per share dividend in respect of 2024.

Again, like Astra, the rating is now roughly in line with earnings growth, but the market is starting to sense underlying momentum potentially for further upgrades in the medium to longer term.

GSK is yet to break out in chart terms; this marks the fifth sharp rally in over a decade after which it has fallen back each time. Strictly, break-out would be past the 1,820p level achieved in 2020, although that high was exceptional due to Covid boosting the sector.

GSK chart April 2024

Source: TradingView. Past performance is not a guide to future performance.

Adjusting for Covid’s boost in the 2022 results, consensus for £6.4 billion net profit (due upgrade) this year and £7.2 billion in 2025 certainly does mark operational break-out.

Mind, this is on a “normalised” basis. There is a “contingent liability charge” that GSK does not adequately explain in a forest of pharmaceutical detail; a key depressant on the reported income statement is a £533 million “other operating expense” which had been £297 million a year before. There is also a £152 million charge which includes “significant legal”, possibly litigation settlements over Zantac.

It shows a sentiment shift, how investors are prepared to focus on revenue dynamics despite the differential between £2,443 million “core” operating profit and £1,490 million at the reported level which is 28% down like-for-like. It meant like-for-like first-quarter operating profit fell 28% from £2,082 million to £1,490 million and earnings per share from 37.0p to 25.7p.

Net debt continues to fall, from £17.2 billion at the end of 2022 to just below £15 billion currently, helped by selling down shares in Haleon HLN which was de-merged. This still leaves net gearing at around 109% versus 68% for Astra, based on its £20.3 million equivalent net debt.

Operational progress means I believe GSK is now in the early stage of a bull market. Be aware of the Zantac liabilities continuing to smoulder, where the market now sees little chance of fire. Hold or buy a drop.

Valuations remain modest versus US peers

Johnson & Johnson (NYSE:JNJ) enjoys a trailing PE above 22x and prospective yield just over 3%. Pfizer Inc (NYSE:PFE) looks to be on a PE of around 15x but interestingly it sports an attractive yield above 6%.

Perhaps Pfizer is another example of an unloved big pharma stock with long-term potential for status change. It jumped 7% Wednesday after beating first-quarter revenue expectations versus caution that Pfizer is without any near-term “blockbuster” drugs, and with Covid vaccines waning. Mind, it is also caught up in Zantac litigation.

The stock is up from a $26 low a week or so ago but still down around 30% over the last year. While the downtrend could represent mean-reversion after the exceptional boost from Covid, the recent $43 billion acquisition of Seagen provides opportunities for new product launches.

Pfizer chart April 2024

Source: TradingView. Past performance is not a guide to future performance.

Pfizer also faces patent expiries on some of its biggest drugs. I have not had time to assess all this in context of a $157 billion (£125 billion) company, to derive a rating. Yet it could potentially be a “buy” and is relevant to compare with Astra and GSK.

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

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