AstraZeneca is still a blue chip to depend on

Different diseases, in other words, require distinct approaches to treatment. This is a fact that presents tremendous challenges and opportunities for companies working to develop new cancer therapies. Commercial intelligence provider Evaluate Pharma notes that oncology has “absorbed the lion’s share” of pharma R&D (research and development) funding for years. By 2026, the company predicts that 22 per cent of all prescription drugs sold will be cancer treatments. 

Given that backdrop, it’s little wonder that AstraZeneca (AZN), the UK’s largest pharmaceutical company, has worked to boost its oncology franchise in recent years. When chief executie Pascal Soirot took the reins in 2012, two of the company’s best-selling drugs – a heartburn remedy and a treatment for high cholesterol – were hurtling towards the patent cliff. Under Soirot, the company made a decisive pivot towards cancer treatments, just in time to fend off a takeover bid from Pfizer (US: PFE) in 2014.

Battle of the blue chips

When the US pharma giant came knocking, AstraZeneca’s management cited the strength of its oncology pipeline as evidence that it had been undervalued by the £55 per share offer. At the time, Soirot made the bullish claim that his company could achieve a 75 per cent rise in sales by 2023. Next year, total revenues are estimated to hit $46.9bn (£40.5bn), according to FactSet-compiled consensus figures, up 82 per cent from the $25.7bn recorded in 2013.

Since the 2014 bid, Astra’s compound total shareholder return of 15 per cent a year has matched its US peer, suggesting it was right to walk away from a cash-and-shares deal that would have increased its acquirer’s leverage.

With oncology now accounting for more than a third of revenues, the largest of any of the company’s divisions, it’s clear that AstraZeneca’s move into cancer treatments has quite literally paid dividends. Nor is it about to tail off. The strength of the oncology portfolio and pipeline alone is a compelling reason to invest, especially with the threat of a recession looming large over the stock market.

With a market cap of more than £160bn, AstraZeneca has no scale competitors in the UK pharmaceutical sector. Following its de-merger this year, rival GSK  (GSK) is worth just over £50bn. Instead, closer FTSE 100 peers in terms of size include oil majors BP and Shell, diversified miner Glencore and HSBC, the global bank. However, if you’re looking for a blue-chip stock which is likely to retain value in an economic downturn, it’s easier to make the case for a big pharma company than one that specialises in the sale of volatile commodities or credit. 

According to research published in the British Medical Journal, recessions and high levels of unemployment have previously been associated with lower rates of cancer detection and treatment in the US. Data collected between 1973 and 2007 showed that for every 1 per cent increase in unemployment there was a 2.7 per cent decrease in cancer diagnoses. 

If the trend holds true in a protracted downturn, it could put some pressure on AstraZeneca sales. But the company is less at risk from external shocks than other blue chips. Shell, for example, was hit badly by the financial crisis of 2008, and the recession that followed, as it sent the price of oil tumbling from $134 to $39 a barrel in under a year. Prices again cratered in 2014 and 2015, and the first half of 2020.

Price volatility also means that miners and oil and gas firms often see dramatic year-to-year changes to their operating margins. On the other side of the coin are the consumer staples firms – such as Diageo and Unilever – whose pricing and distribution power helps protect their profitability levels. AstraZeneca sits somewhere in the middle: it’s neither a stalwart with slow sales growth and highly predictable margins, nor a captive to boom-and-bust cycles. 

There is, of course, a degree of risk inherent in all pharmaceutical companies. Failed clinical trials, lawsuits, patent expiries and costly capex cycles can all pose threats to profit margins. Some of the resulting impacts are easier to plan for, while others can take shareholders by surprise. But while AZ may not be the most stable firm at the top of the FTSE in terms of margins, it’s among the top performers in terms of return on common equity (ROCE).

The ROCE ratio measures how much profit a company’s shareholders receive relative to their original investment. It’s generally accepted that quality companies generate returns on equity of at least 10 per cent a year, given this tends to be well above the real cost of capital. The best companies do this year after year. In the past decade, AstraZeneca’s average ROCE was 15 per cent, was never negative, and only fell below 10 per cent twice.

Though less than the average returns of the slower-growing Diageo and Unilever, these rates compare favourably with Shell’s average ROCE of just 6.3 per cent, or the uneven return profiles typical of the miners. Shareholders can, in other words, have some confidence that AZ’s business model should deliver value through the economic cycle.

Stronger for shareholders

Management has also spent the past few years strengthening the company’s cash conversion ratio, which analysts have in the past singled out as a weak point. A steelier approach to deal-making is helping on this front. Last year, the company acquired Alexion Pharmaceuticals, a maker of so-called “orphan” drugs that treat rare diseases, which UBS believes is set to improve cash generation.

“Due to its R&D budget needs, the company in the past had to enter convoluted deal structures that didn't allow for sufficient conversion of top-line growth into cash flow,” wrote the bank’s analysts in a recent note to clients. “We believe the Alexion acquisition fixes this and makes AZN a cleaner story with high single-digit sales CAGR and double-digit EPS CAGR. The dividend is covered and can grow thanks to the transaction.”

AstraZeneca’s oncology chief recently told Bloomberg of its ambition to become the world’s fastest-growing maker of cancer drugs, and there are plans to double the size of the new oncology treatment portfolio by the end of the decade.

There are signs that the company is already on track to achieve those aims. Its breast cancer drug Enhertu, sales of which remain embryonic, has received the approval of US and EU regulators in the past few months, and trial results have shown it may also be effective in a certain type of small-cell lung cancer. This month, AZN also announced another drug, Imfinizi, demonstrated clinically meaningful effectiveness in patients with advanced biliary tract cancer. Imfinizi is already one of the company’s blockbuster drugs – those that post $1bn or more in sales each year. AstraZeneca has four such drugs in its oncology portfolio alone, none of which are nearing patent expiry. Its most recent oncology blockbuster, blood cancer drug Calquence, has continued to enjoy particularly rapid sales growth in the first half of 2022.

This continuous drumbeat of innovation is first and foremost a positive for cancer sufferers. But it also paves the way for future earnings growth.

That is poorly reflected in a share priced at 15.7 times’ consensus earnings forecasts for 2023, just shy of the sector peer average of 15.3. We’d argue that the strength of its pipeline and proven ability to deliver value for shareholders justifies a greater premium. A decade ago, the more than a third of sales came from a heartburn drug and a cholesterol treatment, neither of which were particularly groundbreaking.

Under Soirot, the company has evolved completely, and is now well on its way to revolutionising the treatment of cancer. The investment case remains strong.