Equity analysts have updated their fair value estimate for AstraZeneca (AZN) to £51 per share due to changes in the exchange rate. Despite major patent losses over the next two years, analysts project 1% annual sales increases over the next 10 years as new products should eventually offset major patent losses.
AstraZeneca is significantly cutting costs to mitigate lost profits
AstraZeneca has built its leading presence in the pharmacetical and biotech industry on patent-protected drugs and a developing pipeline that add up to a wide moat. However, the recent massive patent losses on gastrointestinal drug Nexium and cholesterol reducer Crestor will weigh on the company's near-term growth prospects.
Although AstraZeneca's pipeline ranks toward the middle of its peer group, we think the company is developing several key products that hold blockbuster potential. Further, the company is developing several late-stage cancer compounds where approval requirements tend to be lower and pricing power remains strong.
In addition to internal development, AstraZeneca has aggressively pursued acquisitions, with mixed results. The $15.6 billion price paid for MedImmune in 2007 appears to have been too high. However, the acquisition of full rights to several diabetes drugs from Bristol look like steps in the right direction as far as a solid external development strategy. Further, we are more confident in the ZS Pharma acquisition and 55% stake in Acerta.
AstraZeneca is significantly cutting costs to mitigate lost profits from products losing patent protection. Initially announced in 2007 and subsequently expanded several times, AstraZeneca's cost-saving initiatives should save the company more than $6 billion annually. Further efficiency enhancements are likely to add to the cost savings over the long run. The cost savings should help the company navigate the patent losses on several high-margin drugs.
Sustaining a Competitive Advantage
Patents, economies of scale, and a powerful distribution network support AstraZeneca’s wide moat. The Morningstar Economic Moat Rating represents a company’s sustainable competitive advantage. A company with an Economic Moat can fend off competition and earn high returns on capital for many years to come.
Astra's patent-protected drugs carry strong pricing power, which enables the firm to generate returns on invested capital in excess of its cost of capital. Further, the patents give the company time to develop the next generation of drugs before generic competition arises.
Additionally, while Astra holds a diversified product portfolio there is some product concentration with the company’s largest drug, Crestor, representing 20% of total sales, but we expect new products will mitigate the generic competition in 2016. Also, Astra’s operating structure allows for cost-cutting following patent losses to reduce the margin pressure from lost high-margin drug sales. Overall, Astra's established product line creates the enormous cash flows needed to fund the average $800 million in development costs per new drug.
In addition, the company's powerful distribution network sets up the company as a strong partner for smaller drug companies that lack Astra's resources. Astra's entrenched respiratory franchise creates an added layer of competitive advantage, as interchangeable respiratory competition seems several years away due to the complexity of gaining generic approval for drugs that enter the body through the lungs.
