2 BioPharma Stocks With Eroding Profits: Buy or Sell?

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While the fiscal cliff may be behind us, investors still may be defensive on the market with the unsettled issue of the sovereign debt crisis. One attractive sector to back for the defensive investor is healthcare, since it benefits from high inelastic demand that is not manipulated by changing consumer incomes / uncertainty (if you need a drug to stay alive or improve quality of life, you purchase it before luxury choices) With that said, even healthcare companies have their problems. Below, I review two biopharmaceutical producers that are experiencing declines in earnings…

Buy AstraZeneca (NYSE: AZN) Despite Profit Erosion

AstraZeneca is a global biopharmaceutical company based in the United Kingdom. Annual growth has been around 6%, but AstraZeneca is not expecting to increase revenues y-o-y in the near-term. This is because there is an increase in competition and the focus on restructuring. Further, AstraZeneca has lost exclusivity in Seroquel XR, has supply chain problems, and is affected by the prevailing macroeconomic and FX headwinds in the market. Increased competition for Nexium, Merrem and Atacand is responsible for the decline in revenue in Western Europe.

Despite these negative factors, there are reasons to buy AstraZeneca’s shares. For one, AstraZeneca is still strengthening its partnership with Bristol-Myers (NYSE: BMY) and has recently announced a partnership with Pfizer (NYSE: PFE), wherein Pfizer will make Nexium available over the counter if it is approved by the FDA in 2013. Pfizer will pay a total of $250 million upfront to AstraZeneca, which will maintain exclusive rights. It is these kinds of partnerships that have sent Pfizer soaring to its 52-week high while maintaining its "buy" rating on the Street. AstraZeneca may also be near its 52-week high, but it trades compellingly at 8.5x forward earnings on top of a 5.6% dividend yield.

Some 83 products / variants of products are still being tested. As with many other pharmaceutical companies, AstraZeneca, in my view, is a good stock to buy, because its products will still be in demand even in a challenging economic climate. Assuming multiples elevate to a more reasonable 11x, there is 16% upside when you factor in dividend yields. With forecasts for earnings erosion in the near future, much of the downside catalysts have been well communicated.

Bristol: Positives & Negatives

Unlike AstraZeneca, Bristol is a $55 billion biopharmaceutical producer that is quite expensive at current prices. It trades at 18.6x forward earnings and has a dividend yield of 4.1%. The company has experienced a decrease in revenue arising from reduction in sales of Plavix and antiplatelet, which are both drugs used to prevent heart diseases and stroke. Bristol's problems are exacerbated by stiff competition, such as anticoagulant Xarelto.

On the positive side, Bristol has strong cash flow, reasonable debt levels, and widening profit margins. Free cash flow is currently yielding an impressive 8.7%, and the profit margin is currently at 14.9%. The debt to equity ratio stands at 0.53, and this is well below the industry’s average. Bristol has also developed a promising new drug that functions as a blood thinner, known as Eliquis. It reduces the possibility of blood clotting in the veins and in the lungs by 81%. If it is approved, it is expected to generate some $4.2 billion by 2018.  

And, though the company’s performance has been below expectations, management's willingness to return free cash flow to shareholders suggests optimism about the future. Volatility is only 40% of the broader market's, so I wouldn't buy this stock with the expectation of outperforming. Earnings growth is expected to be mute, so why not buy a cheaper peer, like AstraZeneca, which offers an even higher dividend yield?


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