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CSS Focus List: Pharmaceuticals

A Clinton win might not be a disaster for UK pharmaceuticals

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The closely watched US Presidential Election (8th November 2016) is a key event, for global pharmaceuticals. Assuming a Clinton victory, will she make an early move to end the unregulated nature of drug pricing in the USA? After all Hillary Clinton has been critical of drug industry pricing for 25+ years and attempted healthcare reform during her husband’s first term.

Last September 21st Hillary Clinton tweeted “price gouging in the speciality market is outrageous” referring to Turing Pharma’s decision to raise the price of an old medicine by 5000% overnight. She released a campaign ad directly targeting Valeant Pharma. The IBB biotech exchange traded fund sank 30% in a week.

The fact the USA is the only market where pharmaceutical pricing is unregulated is a highly anomalous situation. It is likely a new Clinton administration will introduce pricing regulations of some nature. To what extent has this factor been discounted already? Pfizer CEO Ian Read, an informed opinion, said last week that Clinton did not pose a substantial threat to his company or the industry. Maybe regulations will be soft.

We have had a look at the UK’s pharmaceutical sector, to determine the profit outlook and US exposure. Is the sector expensive at the moment?

Astra Zeneca – FTSE 100 – SELL

The board of Astra Zeneca rejected a takeover approach at £55 per share from Pfizer in late 2014 on the grounds that the offer “undervalued Astra Zeneca and its prospects”. Its response appeared aimed at requesting a takeover premium that it was certain Pfizer would not pay. Since 2014 changes in US tax treatment of “tax inversions” make it less likely that US buyers will acquire UK companies to lower their tax bill. The longer term implication was it set the bar very high for Astra’s oncology drug pipeline.

However Astra Zeneca revenues have declined since 2014 due to loss of patent protection on major drugs, such as Crestor (high cholesterol), Nexium (ulcers) and Seroquel (anti-psychosis). The board pinned its hopes on replacing these lost revenues with new blockbuster drugs including Brilinta (cardiovascular) and drugs in late stage development such as Faslodex (breast cancer) and Tagrisso (lung cancer). So far though the pipeline has struggled to replace lost revenues.

Q2 2016 was a pre-tax loss of $30m compared to Q2 2015 profit of $658m. The board guided investors to a continued revenue decline “in the mid-single digits”. The dividend was frozen at the interim stage due to the challenging outlook. The Q2 losses were a concern and somewhat out of the blue.

Astra Zeneca remains keen on drug development as the primary source of revenues. This leaves it very exposed to US markets for profit growth.

Given the weaker revenues and profits, current consensus profit forecasts look high. We would point out market expectations are Astra Zeneca’s revenues will decline by $2bn by end 2017. This leaves the company reliant on costs reduction. However savings are difficult given the Astra culture of reliance on drug development/ R&D.

Consensus profit estimates; Astra Zeneca
Year End Revenue ($m) PBT ($m) EPS ($) DPS ($) P/E (x) Yield (%) Share Price (p)
Dec-15 $24,710 $6,381 4.26 2.80 15.1 4.35% 4957
Dec-16 $23,620 $6,263 4.06 2.80 15.9
Dec-17 $22,790 $5,910 3.93 2.80 16.4

Source: Bloomberg

The aftermath of the Brexit vote has seen a significant devaluation of Sterling v US dollar. Astra Zeneca reports in US dollars hence the shares received a significant boost of c.500p per share due to perceived foreign exchange benefits that had little to do with any real improvement at the Astra Zeneca business.

Company AZN

Key Catalysts

Q3 2016 results due on the 7th November will be key to the integrity of the profit forecasts for both 2016 and 2017. A weak Q3, which follows a very weak Q2 is likely to lead to large EPS downgrades.

Sensitive to US presidential election and the prospect of a fresh approach to US drug pricing.

Sensitive to ongoing regulatory risks in respect of its new drug pipeline.

Share Price 4957p
Target Price 4500p
52 Week Hi/Low 5220p/3774p
Shares O/S 1.26bn
Market Capitalisation £63bn
Avg. Daily Volume 2.8m
Dividend Yield 4.35%

Source: Fidessa

Key Risks to Price Target

  1. Regulatory clearance of development drugs could see share price gains
  2. Further cost initiatives could result in a better than profit performance
  3. Executive changes could improve investors’ perception of the executive team

Dechra Pharmaceuticals – FTSE 250 – BUY

Dechra is the leading UK/EU veterinary healthcare company producing treatments for i) pets ii) food producing animals iii) horses. The business has grown organically and via acquisition typically into overseas markets, most recently in Australia, Austria and Mexico. In mid September 2016 Dechra acquired Apex Laboratories for A$55m.

Recent final results for 2016 showed total revenues up 21.7% to £247.6m with profits of £25.8m due to one off costs. Disregarding one off items, underlying pre-tax profits rose to £49.7m helped by acquisitions and new product launches; Osphos (equine navicular syndrome) and Zycortal (Addisons disease in dogs). Another key positive is the launch via the acquisition of Genera d.d. (a Croatian business) into the EU poultry vaccines market. This extends Dechra’s reach into the Adriatic area and brings a low cost manufacturing facility.

Consensus profit estimates; Dechra Pharma
Year End Revenue (£m) PBT (£m) EPS (p) DPS (p) P/E (x) Yield (%) Share Price (p)
Jun-16 247.5 49.7 42.7 18.46 32.4 1.34% 1382
Jun-17 306.6 63.3 52.6 20.00 26.3
Jun-18 360.1 78.1 64.9 21.00 21.3

Source: Bloomberg

The consensus forecast for Dechra suggests compound revenue growth of 20% over 2017 and 2018 with commensurate profit growth. 2017 revenues will be helped by the Putney acquisition ($49.7m revenues in 2015).

The shares are pricey on 32x historic profits and 26.3x 2017 estimates reflecting a premium to the pharmaceutical sector. However Dechra has limited US profit exposure (<10%) hence is relatively immune from US pricing issues.

The recent Putney acquisition for US$200m is being integrated – the business was bought pre-devaluation primarily using Dechra share placing proceeds. Putney brings 11 approved products with a further 10 in the pipeline and a strong product research team. Animal products have limited exposure to the type of US regulatory reforms likely to be introduced by Clinton.

Company DPH

Key Catalysts

The recent sterling devaluation favours Dechra, given its overseas revenues (EU/ USA and Far East/ Australia). The acquisition of Putney adds a significant US business.

The board is likely to spend 2016 / 2017 integrating recent acquisitions with more product development news expected. Key new approvals in the US could be well received.

 

Share Price 1382p
Target Price 1600p
52 Week Hi/Low 1400p/925p
Shares O/S 92.75bn
Market Capitalisation £1.28bn
Avg. Daily Volume 0.35m
Dividend Yield 1.34%

Source: Fidessa Plc

Key Risks to Price Target

  1. Dechra is valued at a significant premium to its sector peers.
  2. Recent currency movements could reverse impacting profit forecasts
  3. Dechra bolt on acquisition strategy does bring risks relating to the balance sheet (overpaying for purchases) and the income statement i.e. earnings dilution (buying unprofitable companies)

GSK – FTSE 100 – BUY

GSK is a leading UK pharmaceutical/ consumer healthcare company formed via the 2000 merger of Glaxo with Smithkline Beecham. GSK’s initial success was attributable to its development of Zantac, a leading anti-ulcer treatment one of the world’s first “blockbuster” drugs. The GSK business is split into three major divisions, i) Pharmaceuticals ii) Vaccines and iii) Consumer Healthcare. The board has promised to pay 80p per share in dividends in 2016 and 2017.

The board succeeded in bringing new products to market; new product sales were £1.05bn at H1 out of £6.5bn in total. Revenue growth in vaccines (+11%) and consumer healthcare (+7%) have helped counter pharmaceutical product growth of 2%. The board diversified GSK in the last decade away from one pill blockbusters and into steadier earnings from consumer healthcare and vaccines.

Consensus profit estimates; GSK
Year End Revenue ($m) PBT ($m) EPS (p) DPS (p) P/E (x) Yield (%) Share Price (p)
Dec-15 $23,920 $5,090 75.7 0.80 21.6 4.89% 1635
Dec-16 $27,060 $6,263 99.01 0.80 16.5
Dec-17 $28,360 $7,270 101.5 0.80 16.1

Source: Bloomberg

Consensus forecasts are not demanding for GSK and based on forward multiples, GSK appears decent value on this basis. There have been concerns (primarily due to GSK’s small £4.2bn balance sheet) that the dividend cover is very strained if profit growth does not appear in 2016 or 2017.

Company GSK

Key Catalysts

GSK reports results in sterling yet its revenues are mostly in USD and USD linked emerging markets currencies. The decline in sterling will boost GSK earnings in FY2017.

The board has to date delivered £400m of cost savings of its total £3bn annual cost savings plan by end 2017.

The US Presidential election is a risk factor given US sales are also declining (-2% at H1 2016).

Share Price 1635p
Target Price 1800p
52 Week Hi/Low 1712p/1237p
Shares O/S 4.87bn
Market Capitalisation £79.8bn
Avg. Daily Volume 6m
Dividend Yield 4.89%

Source: Fidessa Plc

Key Risks to Price Target

  1. A new Clinton Administration could revisit US pharmaceutical pricing.
  2. GSK profit growth is partly dependent on delivery of targeted £3bn in annual cost savings by end 2017.
  3. GSK drug development pipeline is mainly early stage, in Phase 1 (safety) and Phase 2 (efficacy) trials. Only 8 of its 40 drugs in development are in later stage Phase III (large scale clinical trials).

Hikma – FTSE 100 – HOLD

Hikma comprises three divisions a) Injectables (specialized generics and branded injectable products sold globally) b) Branded (branded generic pharmaceuticals in the Middle East/ North Africa regions) and c) Generic pharmaceuticals sold in the USA. The business has grown substantially and expects to report $2bn-$2.1bn revenues in 2016. This is due to growth in demand for generic “copycat” pharmaceuticals i.e. non branded drugs that have come off patent protection and are sold primarily by chemists and pharmacies.

Hikma is the least exposed to US pricing issues as its drugs are sold off patent mainly ex USA and pricing is competitive. Typically when a drug loses patent protection, its price declines 80%-90%. Hikma acquired a major US generics business, West Ward Columbus (US$597m) prior to the interims becoming the 7th largest US generics supplier.

Consensus profit estimates; Hikma Pharma
Year End Revenue ($m) PBT ($m) EPS ($) DPS (cts) P/E (x) Yield (%) Share Price (p)
Dec-15 $1,440 $318.0 1.43 17.00 18.4 1.09% 2023
Dec-16 $2,040 $209.8 1.11 32.00 23.7
Dec-17 $2,397 $442.5 1.57 40.00 16.8

Source: Bloomberg

Consensus forecasts have adjusted for weak interim results, EPS fell to 25.7 cents down 62% after delays in expected product approval hit sales. The weak interims suggest Hikma will struggle to meet profit forecasts.

Company HIK

Key Catalysts

Hikma is expecting key product launches in H2 in a mix of North African countries. Delays to launches could hurt H2 sales.

West Ward Columbus sales is sensitive to the launch of generic Advair (expected in May 2017).

Post a weak set of interim results the second half starts under some pressure. Hence there is more short term risk of a profits warning than usual.

Share Price 2023p
Target Price 2023p
52 Week Hi/Low 2676p/1704p
Shares O/S 239.9m
Market Capitalisation £4.83bn
Avg. Daily Volume 19m
Dividend Yield 0.94%

Source: Fidessa Plc

Key Risks to Price Target

  1. Hikma is exposed to weak North African currencies which have declined between 4%-44% in the last year.
  2. Hikma’s growth strategy brings significant acquisition related risks.
  3. Recent sell off appears substantial and reflects concerns over profit expectations.

Shire Pharmaceuticals – FTSE 100 – BUY

Shire Pharmaceuticals has grown substantially from a developer of “orphan” drugs, typically those used to treat a rare medical condition to a very large diversified pharmaceutical / biotech firm. Building on the success of Adderall, a blockbuster treatment for attention deficit disorder, Shire has a number of significant products including Vyvanse, for weight loss and Mezavant for ulcerative colitis. The Shire business is primarily “lifestyle” drugs that aim to improve the quality of life rather than curing disease.

Shire acquired Baxalta Inc on the 3rd June 2016, a deal that it expects will enable it to achieve $700m in costs savings by mid 2019. This acquisition significantly increased Shire debt to $23.6bn by mid 2016, it had ended 2015 with just $1.46bn of net debt.

Consensus profit estimates; Shire Pharmaceuticals
Year End Revenue ($m) PBT ($m) EPS ($) DPS (p) P/E (x) Yield (%) Share Price (p)
Dec-15 $6,417 $1,385 2.25 18.83 28.8 0.38% 4992
Dec-16 $11,390 $4,030 4.31 20.00 15.1
Dec-17 $15,280 $5,510 5.12 21.00 12.7

Source: Bloomberg

Consensus forecasts appear demanding for Shire given the integration issues and short term costs of the Baxalta purchase. The very high debt load could impact the dividend policy in FY17. There is significant exposure to US related issues. Shire’s impressive growth over the last decade

Company SHP

Key Catalysts

Shire Q3 on 24th October will be important for analysis of the enlarged business. Our expectation is recent 11%-14% sales growth should be maintained.

Shire’s impressive growth in the last decade is facing a test as growth is now more acquisition rather than organic growth hence more costly and risky. Shire’s move to debt funding from being predominantly equity funded suggests short term further acquisitions are unlikely.

Share Price 4992p
Target Price 5150p
52 Week Hi/Low 5315p/3480p
Shares O/S 902.02m
Market Capitalisation £44.92bn
Avg. Daily Volume 122m
Dividend Yield 0.37%

Source: Fidessa Plc

Key Risks to Price Target

  1. A new Clinton Administration could revisit US pharmaceutical pricing.
  2. Shire’s higher debt load will introduce higher financial costs
  3. Recent acquisitions are probably sufficient for a number of years possibly reducing Shire’s growth rate.

(NB. “PBT”- profit before tax, “EPS” earnings per share, “DPS” dividend per share, “P/E” price to earnings)

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