How to Play UK-based Pharma Stocks

Zain is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A number of UK pharmaceutical companies trade on the NYSE and NASDAQ. However, in the presence of companies like Johnson & Johnson, local investors hardly pay any attention to these companies (which is shown by their low trading volumes). GlaxoSmithKline (NYSE: GSK) seems to be the only exception. In this article, I have briefly touched upon the UK healthcare sector and ranked them according to my preference.

I am a big fan of the superior growth profile at Shire (NASDAQ: SHPG) and Hikma Pharmaceutical (NASDAQOTH: HKMPF). AstraZeneca (NYSE: AZN) is my least preferred stock in the sector, supported by below-consensus forecasts. GSK and Smith & Nephew (NYSE: SNN) are likely to be well supported by their programs for cash return to shareholders. However, to me, S&N looks less compelling over the next 12 months.

Recent management commentary has given credibility to Shire's current consensus forecast for 2013, but I believe the performance can still be better, driven by continued strong growth from the ADHD franchise and augmentation from the ongoing share buyback. The extent of the multiple contraction seen at Shire has been extreme, and the stock now shows the largest P/E gap vs. peers seen in over 5 years. The market familiarity with Shire’s new CEO will continue to build and assist in closing this valuation gap.

Recent disappointments in the Generics division at Hikma (manufacturing issues) are mitigated by strong growth in Injectables sales and margins. I like Hikma, given its significant exposure to the high growth MENA region (>60% sales and profits) and its ability to attract local in-licensing opportunities from the multinational drug companies.

I have already covered GlacoSmithKline in one of my earlier posts. The bears say that management made it clear that margin leverage without top-line growth is very tough to achieve. Therefore the company will witness only 2% growth in sales per annum and no meaningful margin expansion through 2012-16. However, I am bullish on the stock given its new product innovations that are expected to hit the market by the second half of this year. Also, FX headwinds are stable for the time being. GSK’s superior dividend yield (>5%) and ongoing commitment to a sizable share buyback program provides support to my bullish thesis.

Smith & Nephew continues to reduce its dependence on hips/knees orthopedics and to shift to higher growth businesses, focusing on new technologies and emerging market penetration. The recent Healthpoint acquisition is a step in the right direction, and the move to increase the dividend payout ratio is a positive. Management remains open to the prospect of increasing cash returns to shareholders.

The new CEO of AstraZeneca is expected to increase the SG&A spending rather than cut costs. The revenue is expected to erode faster than what the consensus estimates show. In fact, the 2013/2014 earnings might be 6%-9% below consensus. The scale of the revenue problem for AZN is significant; over $6 billion of incremental sales would need to be acquired to deliver just 2% annual revenue growth 2012-2016.

Final words

The UK-based healthcare stocks trading on the NASDAQ and NYSE should receive more attention than what they are receiving currently. Most of them are expected to provide great returns to shareholders in the form of increases in dividends or impressive share buyback programs.

 


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