Acquisitions Can’t Save Falling Revenues and Dividend Yield
Mohsin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
AstraZeneca (NYSE: AZN) has been badly hit by the patent cliff. Its key franchises, Crestor and Seroquel, are facing generic threat after losing patent protection in multiple countries. There has been a sharp decline in sales, and management seems unable to stem the flow.
The company has made some smart acquisitions, but none of the assets will pay off before the end of 2016. It has recently acquired Omthera (NASDAQ: OMTH) for Epanova, but the drug is entering a highly competitive market. Amarin’s (NASDAQ: AMRN) Vascepa is already on store shelves, and initial sales data has not been encouraging.
AstraZeneca’s biggest revenue generator is Seroquel. The drug generated annual sales of around $5.8 billion only a couple of years back. Sadly for AstraZeneca, Seroquel revenues have already fallen below $2 billion and will reach $1 billion by 2018. In rare positive news, the U.S. appellate court has upheld its earlier hearing, shielding Seroquel XR from generic competition until 2017. Seroquel XR is an innovative formulation of Seroquel, with better patent protection.
The revenue streams of Nexium and Crestor are also under threat. Nexium had sales of around $4.4 billion in 2011, but it will decline to approximately $2.5 billion in 2020. Crestor is another drug facing generic threat. Its revenues are expected to decline from $6.6 billion in 2011 to under $2 billion 2020, depreciating approximately 70%. Overall, the Street expects AstraZeneca’s revenues to decline 35% by 2020, from above $33 billion in 2011 to around $20 billion.
The new CEO, Pascal Soriot, is trying to turn around the fortunes of this ailing healthcare giant. His first move after taking office was to cancel its share buyback program. Soriot plans to use this money to make strategic acquisitions to support the ailing pipeline.
The CEO has laid out a new strategy which will focus on ‘targeted medicines’ (i.e. treatments for diseases that affect a smaller audience). He has restructured AstraZeneca to target three primary areas of cancer, cardiovascular and metabolism disorders.
The company has already made two significant acquisitions. In April, it acquired AlphaCore Pharma for its drug candidate. ACP-501 is a genetically engineered liver-derived enzyme that reduces the chances of heart failure by managing cholesterol levels. However, any fruit from this investment is still a long way off because the compound is still in Phase 1 trials. It will have to prove itself in Phase II and Phase III trials before AstraZeneca can even think about eventual commercialization.
Adding to its cardiovascular portfolio, AstraZeneca has also acquired Omthera Pharmaceuticals for $443 million. Omthera’s primary candidate is Epanova, the ‘fish oil.’ AstraZeneca cardiovascular portfolio generates around $10 billion in annual sales. The company plans to formulate a combination of Crestor and Epanova. It will conduct more trials to assess the efficacy and safety of this combination.
GlaxoSmithKline is marketing a product pretty similar to Epanova. Lovaza has annual sales of more than a billion and will be a direct competitor to Epanova.
Epanova will enter an already saturated market. Other than Lovaza, Amarin’s Vascepa is also on store shelves. Sales of Vascepa have been below expectations. The company missed the market’s expectations last quarter, and the Street expects only $8.2 million sales from the recently concluded quarter. Despite the poor performance and low expectations, the Street expects Vascepa’s prospects to improve and sales to reach $260 million, by the end of 2014.
The chemical composition of Epanova and Lovaza is similar. Unlike Vascepa, both drugs are a combination of docosahexaenoic acid and eicosapentaenoic acid. On the other hand, Vascepa only contains eicosapentaenoic acid.
The biggest market concern is the timeliness of the efforts made by the new management. The company is focusing on candidates in Phase I trial and can be accelerated to Phase II. This strategy significantly increases the cost effectiveness of acquisitions but delays the probable impact on the top line. The company is also making no immediate promises of a growth revival. It expects to beat consensus 2018 revenue expectations of $21.5 billion. This is an indication that investors should not look for any immediate top-line revival.
AstraZeneca has one of the most lucrative dividend yields in the entire healthcare sector. It offers a dividend yield of 7.5% and a payout ratio of 62%. The company has increased its dividends an average 8% in the last five years.
AstraZeneca’s dividend investors have the following two worries:
i. Can diminishing cash flows sustain this high dividend yield?
ii. Will the expected capital losses outweigh the dividend gains?
If we take into account the consistent decline of AstraZeneca’s revenues, these concerns are not misplaced. The cash flows have declined from $10.6 billion (2010) to $6.9 billion (2012), a decline of 35%. The OCF yield is merely 10%, only 2.5% above the dividend yield.
Despite the consistent decline in revenues, the valuations have been pretty stable. This is due to a combination of reasonable valuations (forward P/E of 10x) and the expansive share buyback program. After the recent canceling of the share buyback program, the downward risk to AstraZeneca has increased. Therefore, dividend investors should keep an eye out for not only diminishing OCF but also capital depreciation. Therefore AstraZeneca is not a safe dividend investment.
AstraZeneca has suffered due to its expiring patent portfolio. The Street expects Crestor and Nexium sales to follow the trend of Seroquel. The management is making all the right moves, but its acquisition strategy cannot revive revenues in the short term. This is because the company is focusing on acquiring candidates still in Phase I trials and accelerating them to Phase II.
There are no substantial signs that AstraZeneca can stop its revenue decline in the short run. The pipeline has no depth and recently acquired candidates will not yield revenues before 2016. It's dividends are also under threat due to declining OCF and increased downside risk. Therefore, despite the recent positive news, investors should avoid AstraZeneca.
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