- Higher SG&A spend than peers
- Pipeline remains strong
The bears are converging on AstraZeneca (AZN) after it released what analysts have deemed an underwhelming set of full-year figures. Although its sales might have aligned with market expectations, fears about mounting operating costs and shrinking margins have come to the fore this week.
With the likes of UBS and Deutsche Bank reaffirming existing sell calls – and Jefferies sticking with a newly issued hold rating – the stock has taken a 9 per cent tumble in the past month.
At the root of this pessimism is the group’s accelerated spending: its 2023 research and development (R&D) costs were up 9 per cent year on year and its fourth-quarter selling, general and administrative (SG&A) expenses were also higher than expected.
But the long-term drug pipeline should get see AstraZenecca investors come out on top, as its research spending results in far more effective cancer treatments.
Launch costs
The increase in marketing and research spending should not come as a surprise. The company initiated 27 phase III trials last year and ramped up marketing spending ahead of the imminent launch of three newly-approved drugs. It should also be noted that costs rise significantly through each successive phase of the three-step drug development process. According to a study by the US Congressional Budget Office, spending averages $28mn (£22mn) in phase I and $282mn in phase III.
Management expects growth in operating expenses to lag revenue expansion in the medium term, making its target of a mid-30s operating margin achievable – in theory. “We expect to keep [R&D spend] in the low 20s as a percentage of revenue and our improvement will come from SG&A,” said chief executive Pascal Soriot. “We are very committed to achieving this margin expansion in the mid term, as we’ve communicated now for quite some time.”
The question now is whether the company will be capable of getting its spending under control. It has historically had a higher SG&A budget line than either Pfizer (US:PFE) or Novartis (CH:NOVN) – both diversified pharmaceutical groups with comparable market capitalisations. This ratio measures a group’s SG&A expenses as a percentage of its revenue – meaning a lower figure is more desirable.
Crucially, R&D outlay is not included in the SG&A calculation, so the figure is not a reflection of investment in future drugs. In fact, it’s largely a reflection of marketing spend and various other launch costs. But with an average of 22 per cent over the past five years, AstraZeneca also has the largest R&D to sales ratio of the trio. Pfizer’s is 17 per cent, while Novartis’s is only slightly higher at 18 per cent.
Margin clarity
There’s little doubt the FTSE 100 group prioritises drug discovery, arguably even more so than similarly-sized peers. Analysts at Jefferies have said AstraZeneca is “primarily a top-line growth and pipeline story” – meaning it’s highly capable of growing both its portfolio of medicines and its revenues.
“However, margin clarity may be needed for stock upside and 2024 has fewer major pipeline catalysts [...] hence our hold,” the analysts added. In other words, the company is not expecting to announce much in the way of pivotal clinical trial data this year. These kinds of releases are among the major drivers of share price gains across the pharma and biotech industry.
One of AstraZeneca’s most promising treatments is an oncology drug known as Dato-DXd, which has been shown to halt the spread of certain cancers better than standard chemotherapies in clinical trials. FDA approval is likely to come towards the end of the year. In the meantime, investors will also need to keep an eye on quarterly SG&A figures to ensure they don’t creep up (and margins don’t creep down).
Analysts at UBS were some of the first to sound the alarm on an approaching period of trouble at AstraZeneca. In mid-January, its analysts forecast “a marked top-line slowdown as US Medicare Part D reform increases rebates on [AstraZeneca’s] oral oncology portfolio” from 2025. The bank's pharmaceutical analysts said the company had the "highest exposure" to US healthcare reform compared with peers.
A Trump re-election could reverse these changes, although the likely Republican nominee for the November election has also attacked the pharma industry for its high prices in the past. Outside of politics, generic alternatives for AstraZeneca's three high-earning drugs are expected to enter the market and it will have to lean on R&D to find replacements, sending spending up further.
In the short term, profits and margins will surely come down. But investors with a view beyond next week should see the value here.
