The pharmaceutical industry continues to attract for its defensive qualities and AstraZeneca (LSE: AZN) (NYSE: AZN.US) remains in the portfolios of many, including a big slice in ace trouble-avoider Neil Woodfords CF Woodford Equity Income fund.
Hes the man who sold troubled supermarket chain Tesco when US investing guru Warren Buffett bought more shares in the firm. Neil was right and Warren was wrong on that one. However, its no good following any investing giant because their next decision could prove to be wrong.
With this investing game, we are on our own in the final analysis and the only decision to trust is our own. So lets see how AstraZeneca measures up.
A powerful trend
The demand for medicines remains stable as customers need to repeat-purchase, which is why AstraZenecas cash flow looks constant:
Year to December |
2009 |
2010 |
2011 |
2012 |
2013 |
Net cash from operations (m) |
7,841 |
6,797 |
6,250 |
4,375 |
7,222 |
Yet big pharmaceutical companies face competition from me-too firms that swamp the market when big-selling drugs come out of patent protection, and from companies that develop competing brand alternatives. Thats why big pharmaceutical firms such as AstraZeneca struggled to maintain their earnings in recent years.
The firm is working hard to develop a new pipeline of potential blockbusters and thats what investors are pinning their faith on. The pipeline has value and makes for an intriguing investment proposition. When we consider that populations are aging, and likely to require ever more medical supplies, the attraction of AstraZeneca increases.
What about valuation, though?
Pfizers takeover approach has stuffed up the easy decision on whether to invest in AstraZeneca or not. Since the US companys approach, AstraZenecas valuation remains stubbornly high there seems to be a takeover premium built into the price, and I dont like it.
At a share price of 4219p the firms forward P/E rating stands at about 17 for 2015, which, despite a recently easing share price, still seems well up for a company expected to show a decline in earnings of 7% that year. The dividend yield is running at around 4%, still low for a firm struggling to grow.
The valuation anomaly comes into even sharper focus when we compare the firm to London-listed peer GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US), which trades at a P/E rating of just under 14 for 2015 with a better dividend yield around 6%. City analysts expect growth at GlaxoSmithKline to get into gear sooner, too. They forecast earnings up 5% for 2015, which seems far better than AstraZenecas forecast decline.
What next?
Neil Woodford and others place their belief in the potential of AstraZenecas product development pipeline to deliver an earnings boost in the future. However, GlaxoSmithKline is developing new treatments, too, and its immediate forward earnings seem set to rise.
I have no special insight as to which firm has the most promising pipeline. Maybe AstraZeneca will emerge as the strongest player in the end, but until earnings rise, the firms new formulations are a jam-tomorrow promise. In the meantime, AstraZenecas valuation needs to ease back before Im likely to buy the shares.
I feel uneasy about shares in AstraZeneca right now. Answering the question, “which shares to buy?” can be difficult, especially when valuation issues stir things up.
A good place to begin research is by downloading the Motley Fool’s wealth report called Where We Think The Smart Money Is Headed. It’s free and without obligation.
The guide could signpost you to some great potential investments for the coming years, which could boost your portfolio’s performance.
To get your free copy, click here.
Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has recommended GlaxoSmithKline. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.