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• Pascal Soriot has transformed AstraZeneca over the past 10 years to make it one of the UK’s two most valuable blue chips.
• Focused research and development is expected to power double-digit earnings growth.
• ‘Its implied pipeline valuation is well below sector peers and offers highly attractive return characteristics against a difficult market backdrop.’ – Philip Harris, elite manager of the EdenTree Responsible & Sustainable UK Equity Opportunties fund

When Pascal Soriot rebuffed an audacious £69bn takeover tilt for AstraZeneca by Pfizer of the US, the FTSE 100 drugs group’s chief executive was taking a high-stakes gamble that the future would go his way.

It was 2014, and AstraZeneca’s share price had never even come close to the £55 that Pfizer had been prepared to pay. In fact, it would be another four years before it did – although when the time came, the price breezed past £55 and has never fallen below that level since. It now vies only with Shell to take the crown as the UK’s most valuable listed company by market capitalisation.

At the heart of Soriot’s argument that Pfizer’s offer proposal seriously undershot AstraZeneca’s implicit value was the company’s burgeoning pipeline of new treatments, particularly for cancer.

The drugs group’s boss and the board also threw in some fears about Pfizer’s alleged tax-driven motives for a combination and cast doubts about what might happen to future investment in drug research, development and manufacturing in the UK. Both of these fell away once Pfizer withdrew.

What has become clear is that Soriot, who has been the leading force in the drug group’s turnaround over the past decade, was right about the value of the AstraZeneca pipeline.

For example, this February, when the group announced its 2021 annual results, it reported bumper revenues of more than $37.4bn (£28.7bn) and told investors that it would hit a $40bn-a-year sales target, set at the time of the Pfizer bid, a year early.

Its results, which included a record final three months of the year, were driven by AstraZeneca’s blossoming roster of new drugs. Two became blockbusters (annual sales of at least $1bn) last year while five existing best sellers crossed new sales thresholds. The group is also riding high on the completion last year of its $39bn acquisition of Alexion, a rare diseases specialist.

AstraZeneca: brief overview

AstraZeneca is an Anglo-Swedish multinational that was formed in 1999 through the merger of Sweden’s Astra AB and Zeneca Group of the UK. Headquartered in Cambridge in the UK, the group is listed on the London Stock Exchange and is a constituent of the FTSE 100 blue-chip index. Its shares have secondary listings on a string of other exchanges, including in Stockholm and New York.

The turnaround

Price-to-earnings ratio, EPS growth and dividend yield based on 12-month forecast earnings
EPS = earnings per share; CAGR = compound annual growth rate; EBIT = earnings before interest and tax

Source: FactSet, adjusted earnings figures, data as of 20 Apr 2022

During his near 10 years in charge, Soriot has transformed AstraZeneca. When he became chief executive, in October 2012, it was a disparate business chiefly focused on primary healthcare – common illnesses, management of long-term ailments and disease prevention. The business he runs now is a truly global player built around three main areas: oncology, biopharmaceuticals and rare diseases. And all of this is driven by an emphasis on science and research and development (R&D). AstraZeneca’s R&D budget is among the sector leaders, running to more than $9.7bn last year, equivalent to 26% of its total annual revenues.

Analysts note that the company is due to report ‘catalysts’ for a number of treatments this year which, if successful, bode well for their applications in other areas (a successful catalyst might be a treatment found to be effective against ovarian cancer, which can then be applied to prostate cancer, for example).

The investment case

So what is the investment case now for AstraZeneca, which has attracted the buying interest of some of the world’s most skilled fund managers? Does the group’s future value still lie in its pipeline? Or does the case lie elsewhere, in its commitment to R&D or its growing specialism in the wake of the Alexion deal?

Source: Citywire/Morningstar, latest disclosed holdings data

Elite fund manager Louise Kernohan of Newton Investment Management argues that AstraZeneca has several competitive advantages over its rivals.

First, she highlights the company’s ‘five-R framework’ approach to drug discovery and development, namely: right target, right patient, right tissue, right safety, and right commercial potential. This approach was introduced following a comprehensive strategy review in 2010.

AstraZeneca says that over the period 2005 to 2021, it achieved a near sixfold improvement in the proportion of its pipeline that advances from pre-clinical investigation to the completion of Phase III trials, from 4% to 23%. This underscores the efficacy of the Five R framework and adds value to the business.

Next, Kernohan highlights the company’s focus on science. ‘It sounds obvious, but this leads to a positive cycle. If you’re a pharmaceuticals company that really focuses on science, then you attract the best scientists; and then that, in turn, attracts the best scientists. So you get that perpetuating cycle,’ she says. Moreover, AstraZeneca’s scientists are incentivised using the five-R framework, which means that they don’t just pursue the best drugs for commercial success, they also do so ensuring safety.

Among AstraZeneca’s other competitive edges, Kernohan argues that the company’s drugs portfolio is sufficiently focused to make it an expert in its chosen disciplines, but diversified enough so that it is not overly dependent on one area. She also notes its presence in high-growth emerging markets, which accounted for about a quarter of 2021 sales.

Trends and ESG

As a Fix the Future company, AstraZeneca is positively locked into the big overarching theme of social and demographic change – the longer people live, the more they tend to need healthcare and the more they are exposed to potentially fatal diseases such as cancer and diabetes. The group is also plugged into advances in medical technologies, including using artificial intelligence to develop a ‘genomic landscape’ for patients that can be used to treat rare diseases more effectively.

Possibly surprisingly for Big Pharma, an industry that frequently comes under fire for its marketing practice and restriction of treatments to those who can pay, AstraZeneca scores well on many fund managers’ sustainability measures.

At EdenTree, which is part of the charity-owned Benefact, all companies have to be screened on a series of environmental, social and governance measures before a fund manager can decide whether or not to buy their shares.

Philip Harris, an elite fund manager at EdenTree, says AstraZeneca has sharply improved its score for the EdenTree health and wellbeing screen, aided by its emphasis on improved access, including during the pandemic. The company has also set ambitious climate targets that have been approved by the Science Based Targets initiative, which EdenTree sees as the ‘gold standard’ for emissions-reduction targets.

‘Additionally, when screening pharmaceutical companies we also ensure companies are committed to reducing animal testing where possible, and AstraZeneca used fewer animals for research compared with some of its peers,’ says Harris.

The supplement to AstraZeneca’s 2021 sustainability report contains a number of targets, including reducing absolute Scope 1 and 2 (direct and indirect) emissions by 98% by 2026, with 2015 as the base year. The group also aims to use 100% renewable electricity by 2025 and to maintain its absolute water usage at 2015 levels.

Kernohan notes that, as with all pharmaceuticals groups, there is the risk that a competitor develops a game-changing treatment, that drugs coming off patent are not effectively replaced or that there is a heavy crackdown on drug pricing.

More specifically with AstraZeneca, there is a risk that the culture Soriot has rooted in the company is eroded. As yet, though, there seems to be little sign of that happening.

Covid-19 and the reputation trap

It’s not often that a UK national newspaper rushes to defend a drugs giant in its leader pages. But that is exactly what happened in early February, when The Times argued that AstraZeneca’s achievements with its Covid vaccine should be celebrated as heroic rather than decried by critics, including governments within the EU.

AstraZeneca developed its Covid-19 treatment, which it has trademarked as Vaxzevria, with the University of Oxford. The vaccine was found to be highly effective against the virus and its variants but was found in rare instances to cause blood clots, particularly in younger recipients.

Within a relatively short space of time, governments across Europe were suspending orders – admittedly against the backdrop of production shortfalls – and AstraZeneca found itself under criticism and its reputation under a cloud.

This is despite its promise to sell the vaccine at as close to cost as it could manage, and to prioritise ‘broad and equitable’ access to the vaccine through the Covax coalition to ensure that it was injected into the arms of low-income households in large numbers.

By the end of last year, AstraZeneca had released 2.5 billion doses of the vaccine worldwide, including more than 247 million doses through Covax, making the company the largest contributor to the initiative.

AstraZeneca generated revenues of $3.98bn from its Covid vaccine last year but is expecting margins to be lower than the average for its other products. It has told investors to expect revenues from its Covid medicines, which now also include the immune system booster Evusheld, to decline by low-to-mid 20 percentage points. Arguably the damage has been done.

Still, the farrago did not stop some of the most skilled fund managers, including Philip Harris at EdenTree, adding to their AstraZeneca holdings at favourable prices, which were also driven lower by concerns the company had overpaid for the rare diseases specialist Alexion.

Harris says: ‘Last year’s adverse comments on its Covid vaccine and fears over overpaying for acquisitions enabled us to build a substantial position in AstraZeneca at highly attractive prices. The core fundamentals of the business we believe remain intact; that of a highly attractive R&D pipeline in a number of growth areas that will generate returns above its cost of capital.

‘Going forward [AstraZeneca has] double-digit growth, a strong balance sheet and additional upside from R&D. Its implied ‘pipeline’ valuation is well below sector peers and offers highly attractive return characteristics against a difficult market backdrop.’