Paul Hill, one of Britain’s top private investors, picks the worst share tip from the press and brokers’ reports. This week: you wouldn’t expect such a large company to be mispriced by the City, but this expensive pharmaceutical share is unlikely to offer value for money.
Turkey of the Week:
AstraZeneca (AZN: 31.94p), tipped by Citigroup and Dresdner
AstraZeneca is a real conundrum. It is covered by 43 research analysts and is the world’s eighth-largest pharmaceutical firm by market capitalisation (£50bn). I wouldn’t normally expect a business of this size to be mispriced by the City. However, at £31.94, I can’t see how the shares offer good value.
Eighteen months ago, the stock was trading at around £20, and has since risen by 60%, outperforming Glaxo by a massive 30%. This is despite AZN’s drug pipeline being hit by a series of high profile and costly new product failures over this period. First, in January 2005 it was found that its leading lung-cancer drug, Iressa, did not make patients live longer. Then in February 2006, its blood-thinning drug, Exanta, was refused approval by the US regulator due to fears that it may cause liver damage. Finally, in May 2006, its diabetes drug, Galida, failed late-stage clinical trials, because it offered no advantages over existing treatments.
Clearly, developing new treatments is the life-blood of any large pharma.
With such damaging news, I am amazed by the increase in AZN’s share price. On top of that, there is concern that some other drugs (for example, Zactima, a lung-cancer treatment and Cerovive for strokes) in late-stage clinical trials could also be duds, since they are perceived to be based on risky technology.
Worse still, AstraZeneca is also vulnerable to a handful of major patent expiries over the next five years. These are worth up to $26bn in annual sales, which will represent some 85% of the group’s revenue. Typically, once generics enter the market, prices and profit margins plummet.
These substantial holes in the pipeline need to be filled urgently. New uses for Crestor, its leading cholesterol-lowering drug, could redress part of this gap, but it is only a start. Not surprisingly, management have spotted this glaring issue and targeted replenishment of the pipeline as a major objective. The only problem is that drug discovery is a long-term game, and requires years of research and testing before new medicines can come to market.
I believe that the only way of achieving sales and profit growth is by acquiring other company’s pipelines and licensing new drugs, such as the recent £702m takeover of Cambridge Antibody Technology. Unfortunately, this strategy is far more expensive than developing new drugs in-house and also leads to lower profit margins. The danger is that if top-line growth starts to flounder, then profits will decline rapidly, due to the company’s high fixed-cost base.
Analysts predict EPS of 192p and 204p for 2006 and 2007, respectively, thus putting the shares on forward p/e multiples of 17 and 16, respectively. This does not appear too unreasonable for the pharmaceutical sector, but the likes of Glaxo have much stronger pipelines. The firm’s board believe that up to 2010, they will be able to increase sales and EPS on average between 6%-10% a year. I think this is challenging.
Finally, I think the shares have partly risen due to rumours of a takeover bid from Glaxo and also the perception that AZN is defensive in times of market turmoil. I can readily see the stock falling from these levels, particularly if no bidder steps forward in the short term. Therefore, I would advise shareholders to take profits and leave AZN to the speculators.
Recommendation: SELL at £31.94
Paul Hill’s personal portfolio has gone up by 483% over the last five years. To find out more about his specialist share-tipping service, ‘Half Price Shares’, click on the link below: