11 December 2018

AstraZeneca

With an increasing importance being placed on healthcare globally, along with a growing and ageing population, few industries offer such large market opportunities

by Michael Bray

Research Analyst


With an increasing importance being placed on healthcare globally, along with a growing and ageing population, few industries offer such large market opportunities. Few however, have such high barriers to entry for competition. Not only is extensive scientific expertise required to develop new products safely, but it also takes many millions of dollars (if not billions) and many years to bring them to market. This has resulted in an industry that is dominated by a few major players.

Fortunately, the UK is home to one of these companies, AstraZeneca (AZN). AZN focuses on discovering, developing and commercialising prescription medicines for three main areas: Cardiovascular & Metabolic, Oncology (cancer) and Respiratory & Inflammation.

As one of the smaller major pharmaceuticals companies, AZN is very much exposed to the performance of each of its products. The company has established six key growth driver drugs: Targrisso (oncology), Lynparza (oncology), Imfinzi (oncology), Calquence (oncology), Farxiga (cardiovascular) and Fasenra (respiratory).

These drug assets are high quality - whether due to efficacy, low toxicity or convenience. Competitive dynamics are favourable, with the likes of Tagrisso and Imfinzi facing no direct competition currently. Lynparza could see some price competition, as it is likely to face a number of similar competitor products. However, as physicians in the US (where the bulk of pharmaceutical profits are made) are indifferent to a drug’s cost - insurers pay for them - they become attached to the first product to market, like Lynparza. They are therefore unlikely to switch en masse to rival drugs that show no material benefits. Importantly, oncology is a protected therapeutic area and is thus largely removed from US payor - organisations that make drug purchasing decisions - pricing pressure. 65% of AZN’s revenue growth to 2023 is expected to come from its oncology franchises.

Non-oncology drugs Farxiga and Fasenra are in areas of relative payor pressure, but still display defensive characteristics. Farxiga is cheaper than rival products and has a relatively inexpensive price point, whilst Fasenra has health economics that are extremely favourable for insurers. Subsequently, these drugs are not currently at risk from payors’ quest to drive down costs.

Despite being one of the smallest major pharmaceutical companies, AZN has one of the largest advanced stage pipelines. Much of the pipeline is in areas with proof of concept, whereby drugs have already proven to work but are now being tested in additional areas; Lynparza is a good example of this. It was approved for breast cancer but is now being tested for prostate cancer. Additionally, 70% of pipeline drugs are personalised, meaning that they are targeted at a specific therapeutic niche (i.e. a certain type of breast cancer). This means they’re likely to encounter less competition and command better pricing dynamics. These characteristics help to de-risk Astra’s pipeline.

Not only is extensive scientific expertise required to develop new products safely, but it also takes many millions of dollars.

The outlook for AZN isn’t all rose-tinted. There are still a number of serious headwinds which the business needs to address.

Crestor (cardiovascular) and Symbicort (respiratory) are two drugs which are off-patent and account for a sizeable 23% of revenues (fiscal year 2017). Being off-patent, competitors can now develop similar drugs, eroding prices and the value which AZN can derive. Although both have been off-patent for some time, and sales declines are widely anticipated, any greater than expected decline will have a material impact. This will remain the case for the next few years until AZN’s growth drivers ramp-up. They are however likely to find support in emerging markets, which typically exhibit greater brand stickiness than in the West.

AZN’s reliance on operating profit which has been generated from non-core income (outside of normal business operations) has also been a concern. These sources of non-core income have come from the disposal of periphery drugs and through a controversial externalisation strategy of selling drug licensing rights to rival drugmakers in return for upfront fees and payments linked to success. Why did Astra do this? Well, when CEO Pascal Soriot took over in 2012, AZN was a business with minimal growth prospects. He invested heavily in research and development to turn the business around, all whilst maintaining the company’s generous dividend. This strategy has begun to pay off with the establishment of a number of growth drivers, but was funded through disposals and externalisations, as well as increased debt. AZN is expected to wean itself off these sources of income, but it is nonetheless vital the company provides evidence of this in order to prove the profitability of its core business and the sustainability of its current dividend.

AZN has some exciting growth prospects but a number of historical issues face the business: the future performance of the company depends on how successfully they can navigate through them.


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