Saturday, February 5, 2011

AZN.L - What's going on?

AZN (Atrazeneca) seem a somewhat perplexing company. Trading at a price of 2933p and a PE of 6.7 (!), is it good value, or a value trap? The Market seems to think the latter, as a lot of their drugs will come off patent in the next few years. Over the last 6 months, AZN has seen its share price decline by 10%, compared with an increase of the Footsie by 12%. The market definitely doesn't like AZN. AZN has been buying back its shares, and that still hasn't stopped the rot in its share price.

Here's some recent discussions that have been going at the discussion boards for AZN over at Interactive Investor.

dave wrote:
I think PIs are often a little too optimistic (and perhaps naive) about future revenues for pharma companies. Here are the patent expiries and 2009 revenues for some top AZ drugs that will run off patent in the next five years (taken from their 2009 annual report).

Seroquel 2012 $4.9b
Atacand 2012 $1.4b
Symbicort 2014 $2.3b
Nexium 2015 $5.0b
Synagis 2015 $1.1b
Crestor 2016 $4.5b

That's a total of $19.2b coming off patent in the next five years, and those drugs make up almost 60% of the 2009 sales! They will make some more money from these drugs after they run off patent, but the revenues will drop off rapidly.

So they need some newer drugs to replace them and by all accounts the pipeline doesn't look very strong (Billinta is expected to peak at around $2.5b, if memory serves).

I'm not saying AZN is overpriced, or a sell, or whatever - I think pharma company valuation is incredibly complex. I'm just saying that concluding that AZN is cheap because the PER is lower than a Utility/Oil/Car Manufacturer/etc company is a little too simplistic. Healthcare will become more important in an ageing society, but that doesn't mean that 'payers' will have an appetite for brand new, expensive medicines that have only a marginal benefit over available generic drugs.

As a side point, I see Pfizer announced the closure of their UK R&D site today - one of their four big R&D sites. That's more evidence that the futures for the big pharma companies aren't going to be quite as rosey as previous couple of decades.

LK Hyman had this to say:
"concluding that AZN is cheap because the PER is lower than a Utility/Oil/Car Manufacturer/etc company is a little too simplistic."

AZN looks a bit like an oil company, with the big tabs being analogous to oil fields.

In an oil company you're in trouble if your big fields are declining rapidly and your explorers are failing to find new fields to replace the tired old elephants.

That sounds like AZN from the looks of your off patent numbers, which are pretty terrifying.

Many oil companies engaged in frenzied merger activity to paper over the cracks of their failure to replace their oil reserves.

It must be on the cards that the same thing will happen with Big Pharma, and I'm keeping my fingers crossed that AZN is the acquiree rather than the acquiror, so I'm holding and enjoying those chunky divis.

I'm also holding GSK (about the same weighting as AZN) as I feel that GSK's "explorers" are better than AZN's, and I like their consumer healthcare business, which AZN doesn't have AFAIK.

There was some discussion about what was priced into the market:

GatorHex responded:
"run off patent in the next five years"

i'll worry about it in 4 years

LK Hyman wrote:

"i'll worry about it in 4 years."

You'll regret that if Mr Market worries about it sooner!

Gatorhex responded:
"You'll regret that if Mr Market worries about it sooner!"

Mr Market has already priced it at half it's earnings.

For the record, I own AZN, and I am inclined to think that the news of the impending patent problems is fully priced in by the market. AZN is one of those "Magic Formula" stocks. It enjoys high returns on capital, and is available cheaply. It is also the biggest holding of Invesco Perpetual  Income (and the High Income Fund), run by Neil Woodford. Shrewd decision, or investment blunder?

As a crude measure, revenues for AZN for p/e 2010 were $33b. The patents listed above amount to $19b. That would still leave $14b in revenue. At current prices, this would give a projected PE of 15.8 = 6.7*33/14. I am, of course, assuming that profits would scale according to revenue, which is probably a little over-optimistic. Counter-balancing that is the fact that a PE of 15 is not too out-of-whack, and the company is buying back shares. AZN may be in for a period of lower growth, but I don't think things are too bad provided it doesn't drop the ball. I would like to think that AZN will continue its research and development program, so that new drugs will eventually make themselves into the pipeline.

Don't forget that Brilintia is in the works. The FDA will review it at the end of July 2011, as there is scepticism as to whether the drug actually worked. AFAIK, the drug has been approved for use in Europe, where it is known as Brilique.

The Motley Fool did a write-up on AZ in July 2010.

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