ASTRAZENECA PLC AZN LN Sector: Healthcare Industry: EUROPEAN EQUITY Pharmaceuticals RESEARCH I SHORT POSITION MEMO Market Unattractive position with a limited scope REDUCE Capitalization: €58,920.65 m With negative sales growth of 6 %, a loss of 23% in earnings per share (01/28/2014) compared to 2012 and a last quarter negative operating and net income, AstraZeneca is facing a challenge to recover a decent sales and profitability level in the Pharmaceutical industry. Country: GB FY 2013 ISIN: GB0009895292 In Millions Est FY 2012 FY 2011 FY 2010 FY 2009 Index: STOXX 600 12/31/2013 12/31/2012 12/31/2011 12/31/2010 12/31/2009 Market: London Stock Shares issued 1,257.00 1,261.00 1,361.00 1,438.00 1,448.00 Dividend yield (%) Exchange 2.26 1.99 1.77 1.48 Price 43.07 36.94 36.25 34.73 32.78 Revenue 20,462.28 21,768.38 24,151.51 25,129.22 23,588.60 oji Growth %, YoY -6.00 -9.87 -3.89 6.53 Source : Bloomberg # of employees: 53,500 CEO: Pascal Soriot AZN AVG P/E 17.38 21.32 P/S 3.05 3.56 P/EBITDA 8.04 11.11 P/B 3.45 5.72 2Y RV GR -2% OPE CF -5% ANALYST: Valentin ROUSSEL [email protected] The stock is outperforming the Legal & General Global Health and Pharmaceuticals Index since December (+24.6% in one year,Source +17.8% : Bloomberg in 5 years). The price should reflect a reaction to pipeline new introductions and investors looking beyond the patent cliff. But we are not confident about this stock performance. The standard deviation over the past 5 years was 21% (annualized). AstraZeneca’s PE is 18.5% below the industry average, as well as for other metrics, AZN is undervalued compared to its peers. Growth plans have been mentioned by the board. But we are suspicious about how the company is going to finance its future growth. The price may have reflected the instability in earnings and sales, even if it shown a positive performance last year because the market have priced inputs in the pipeline (Connolly, A., 2014). Introduction What is the company doing? AstraZeneca (AZN) is a UK based pharmaceutical company created through the merger of UK-based Zeneca PLC & Swedish-based Astra AB (6 th April 1999). It is a pure Pharmaceuticals company since the November 2000 de-merger of its agrochemicals business Syngenta AG. AstraZeneca PLC is a holding company. The Company, through its subsidiaries, researches, manufactures, and sells pharmaceutical and medical products. AstraZeneca focuses its operations on six healthcare areas: Cardiovascular, Gastrointestinal, Infection, Neuroscience, Oncology and Respiratory & Inflammation. What are the main products? (ranked by revenue) - Crestor (cardiovascular) : $5,622 million in 2013 (21% of total revenue) - Nexium (gastrointestinal): $3,872 million in 2013 (15%) - Symbricort (respiratory): $3,483 million in 2013 (13.5%) - Key growth platforms: Bilinta (216% revenue growth in 2013 with $283 million). What is the strategy? As the company lost patent protection on main medicines, revenues collapsed (-6% compared to 2012), they are trying to improve their R&D efficiency (lower costs for an increased number of projects) to fill the pipeline. It focuses on a core segment: diabetes. The market will represent 550 million people in 2030 according to the CEO, Pascal Soriot. It just purchased shares of Bristol-Myers Squibb to create a joint venture for $4 billion to increase their diabetes portfolio. The company puts big hopes in brilinta (anticoagulant), providing $283 million worldwide sales, and $92 million in the fourth quarter. AstraZeneca is focusing on highly innovative products and development in cancer medicines. $500 million are invested into a research hub in Cambridge led by Pascal Soriot (new CEO, one year before head of Genentech biotech unit at Roche). New medicines will be developed on Respiratory and Inflammation, Cardiovascular and Oncology (80% of the pipeline) to engage a recovery in the pipeline. As emerging markets growth in sales were positive compared to last quarter, they expect to increase their market share through acquired companies. US is also a big market for pharmaceuticals, almost 40% of their sales are coming from the US. It will probably take years to turn the company in, and sales and earnings are still expected to fall until 2017. Financial analysis Earnings and revenue expectations The company expects a low-to-mid single digit decline in revenue for 2014 and only in 2017 revenues will be in line with 2013. Revenue suffered from a loss of exclusivity in patents for main products since 2010. Earnings per share are also expected to decline (between 10 and 15% fro 2014), mainly due to impairments in R&D costs and Selling, General and Administrative costs. For the last 2013 quarter, the company had an operating and net loss ($591 and $524 m). Financial statement analysis Pharmaceutical companies are usually highly profitable, have a significant level of debt and of intangible assets. For 2013, 45% of non-current assets are intangible assets, but AstraZeneca does not have a high debt ratio (17.6% in 2013 compared to a 24% for the industry) and is less profitable than peers. - Profitability: The ROA is 4.67% and the ROE is 10.89% for 2013. The pharmaceutical median for ROA is about 8.5% and for ROE is at 17.8%. For those two metrics, AstraZeneca shows the worst profitability, after Sanofi. Costs as SG&A and COGS increased while net income declined, even went negative on Q4 2013. Net profit margin also declined (-12% in one year). - Liquidity: The current ratio declined gradually from 1.5 in 2010 to 1.27 in 2013, mainly due to an increase in trade payables and interest paying loans and borrowings and a decrease in receivables (linked to sales). It is lower than peers which are at 2.08 on average. The cash ratio remained around 0.5 on average over the past 5 years. - Solvency and leverage: Astra Zeneca is implementing a “Restructuring program” that is investing in the pipeline, key growth platforms (Brilinta, diabetes), IT organization and R&D costs management. The company bets on this to increase revenues and earnings. What would be the financing source? According to AZN, $1.1 billion per year in benefits (€800 million) will come back to them against $3.2 billion (€2,370 million) invested from this plan. If 17% of the outstanding gross debt is due within 2014, AstraZeneca has a significant amount of cash and retained earnings to offset this payment. Moody's : Long term: A2, Short term: P-1, Outlook: Stable 2013 2012 Standard & Poor's : Debt ratio 15.36% 17.58% Long term AA-, Short term A-1+, Outlook: Negative Debt to equity ratio 36.98% 39.33% Fitch : Interest coverage 8.51 13.06 Long term AA-, Short term F1+, Outlook: Negative The company has a lower debt ratio than its peers (25% debt ratio for Roche in 2013, 24% for its peers), the interest payment is not a burden and it uses more equity than debt. Retained earnings represent the double of long term debt in 2013. The company is not overleveraged, but the interest coverage is decreasing due to a lower EBIT and the outlook is negative. As the liquidity is also decreasing, the company can not bet on its retained earnings and cash to grow. But the lower level of debt could be one way to invest. Other financial statement observations: Selling, general and administrative (SG&A) represented 47.5% of sales in 2013 (R&D costs represent 17.8% of sales), they are also 14% higher than the last quarter of 2012. Depreciation, amortization and impairment almost doubled since 2012. In 2013, there were an impairment in R&D expenses for Bydureon, the cardiovascular medicine ($138 million) and SG&A of $1,620 million. There are no significant movement in investing activities, the company focuses mainly on operating activities. Risk analysis There is a patent issue : The company lost exclusivity for highly profitable products (Nexium and Crestor, the main source of revenues). It reduced revenue by 9%. Here we can see the impact on sales by region. Quarterly In % Fourth quarter change Full year 12/31 /2013 2013 US 38.49 - 7.00 37.69 EUR 26.62 2.00 25.90 JAP 9.76 - 22.00 9.67 CAN 2.35 - 23.00 2.48 EM (ex China) 12.97 3.00 13.80 CHINA 6.97 24.00 7.16 REST 2.83 - 30.00 3.31 Total 100.00 - 6.00 100.00 R&D costs are stable For 2013, R&D was up 1%, while the group implemented a joint venture for diabetics, and focuses mainly on these products. They also closed the R&D research in Bangalore and India. It will not help the company to increase market share in this highly competitive industry. R&D intensity for the pharmaceutical sector is the highest, above Software and IT, technology and equipment. But R&D represents 18.75% of sales (which declined significantly), above the industry mean. The pipeline compared to industry is weak Most of the pipeline products will be launched in 2016, 2017 and 2018. But they may fail the trials and not being approved. Actually, 11 new molecular entities are in Phase III (twice more than last year) . It is mainly due to external growth with acquisitions and joint ventures, which is questioning on the internal added value. Focused on prescription medicines Consumer are cutting back on their health care services and more use cheap generic pills, reducing the market size.