We recently published a list of Ten cheap pharmaceutical stocks to buy, according to short sellers. In this article, we take a look at how AstraZeneca PLC (NASDAQ:AZN) compares to other cheap pharmaceutical stocks.
The pharmaceutical industry is one of the most interesting sectors to invest in. Although most industries can be broadly categorized as “vulnerable” or “resistant” to economic headwinds, pharmaceutical companies have the potential to operate in both categories. Companies that develop new drugs, especially those in the biotechnology industry, do not fare well in a tough economy because they find it difficult to raise capital and keep costs under control. At the same time, large pharmaceutical companies and those that develop and sell generic drugs can survive in a tough economy because demand for their products is relatively inelastic.
Like all other industries, the pharmaceutical industry has changed over the past few decades. This change has been driven by the rise of biotechnology and biopharmaceutical companies seeking to break new ground in drug development. Before we get to the data, some of the changes that have taken place include increased spending on acquisitions rather than just research, a global industry where multinational companies operate in multiple markets, and marketing campaigns aimed at extending product life cycles rather than maintaining competitive advantage through patents.
In terms of data, biotech has caught up with pharma in terms of revenue, accounting for 30% of total pharma revenue in 2014, compared to less than 1% in 1991. At the same time, biotech operating margins have also caught up, ranging from around 7% to 12% between 1991 and 1993, to negative over the next decade until 2024, and surpassing pharma margins of around 24% in 2014, standing at around 28%. This gap widens when we remove the impact of R&D, which disproportionately affects biotech companies, as in the five years between 2010 and 2014, pharma companies’ pre-R&D operating margins fell from 40% to around 28%, while the corresponding figure for biotech companies rose from 40% to around 56%.
During the same period, biotech’s growth to R&D ratio (which measures growth per R&D unit per unit of sales) was 0.95, more than ten times that of the pharma sector’s 0.08. This tremendous catch-up of biotech is also reflected in pharma valuations, as biotech companies accounted for around 40% of pharma valuations in 2014, a historic high. Measured by multiples, i.e. enterprise value relative to operating income before R&D, the biotech sector’s premium to that of the pharma sector has fallen significantly. It peaked at ~77x in 2000 and fell to ~18x in 2014, a significantly lower premium than the pharma sector’s premium of ~11x, which was 20x in 2000.
Building on this, although market-level valuations of pharmaceutical companies have shifted over the years due to the growth of biotechnology companies, this does not give us any details on what is driving company-level valuations. In this regard, a study using data from 101 companies over ten years shows that the top three drivers of pharmaceutical valuation are R&D, advertising, and manufacturing facilities. These three have regression-based valuation weights of 13.19, 15.85, and 19.13, respectively. This provides important insight as it suggests that R&D is far from the key competitive advantage in the industry as is commonly believed.
In fact, advertising and production are the main drivers of pharmaceutical company valuations if we consider the industry’s biggest thorn in its side, patents. In 2024, weight loss drugs have cemented their place in the market, and when their patents expire, the industry and the government could find themselves embroiled in even more thorny battles that could affect pharmaceutical company valuations. Industry critics accuse pharmaceutical companies of unsavory practices such as filing subsidiary patents that extend patent terms by filing patents for different features of the same product, filing differently worded but similar patents in so-called patent thickets, and intentionally delaying upgrades to take advantage of evergreening provisions.
While it may seem like this potential disruption to the pharmaceutical sector is still a long way off, the reality is different. GLP-1-based weight-loss drugs liraglutide, albiglutide and dulaglutide were first approved by the FDA in the 2010s, and companies in India and China have already begun producing low-cost biosimilars that could appeal to a broader market. Even in developed countries, things are moving quickly: Indian company Biocon has already secured approval for a generic version of liraglutide in the UK, and the FTC sent letters to 10 companies, including some of the largest weight-loss companies, in May as part of its fight against fake patents. Looking ahead, expect to see an increase in generics and an increase in patent litigation, as the weight-loss pie could be as big as $100 billion by 2030, according to one prominent investment bank.
Our methodology
For our list of the best pharmaceutical stocks to buy according to short sellers, we sorted specialty and general drug manufacturers with market caps over $300 million by the percentage of outstanding shares that were shorted and selected the stocks with the lowest percentage. Then we selected the stocks with a trailing P/E of less than 57.63 or a current P/E of less than 38.94, which are the industry averages for the pharmaceutical industry.
With these stocks, we also mentioned the number of hedge fund investors. Why do we care about the stocks that hedge funds invest in? The reason is simple: Our research has shown that we can outperform the market by mimicking the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks each quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (Further details can be found here).
Dozens of drug capsules stacked on top of each other illustrate the extent of the company’s pharmaceutical contribution to the industry.
A pharmacist dispenses prescription medications to patients being treated for cancer, cardiovascular, renal, metabolic and respiratory diseases.
AstraZeneca PLC (NASDAQ:AZN)
Short interest as % of outstanding shares: 0.18%
Number of hedge fund investors in Q2 2024: 49
AstraZeneca PLC (NASDAQ:AZN) is a British pharmaceutical company headquartered in Cambridge. It has one of the most diversified drug pipelines in the industry, consisting of products such as the drug ADRIATIC for small cell lung cancer, the drug LAURA for stage three lung cancer, and the drug DESTINY for breast cancer. All of these drugs are in late-stage development and are important catalysts for AstraZeneca PLC (NASDAQ:AZN). As if that wasn’t enough, the company’s drug for ovarian cancer called LYNPARZA has also received the positive recommendation from the European Commission, joining IMFINZI, a diversified immunotherapy treatment for various cancers, including bile duct and gallbladder cancer. These drugs have shown good results in Phase 3 trials, increasing their chances of successful launch and future revenue for AstraZeneca PLC (NASDAQ:AZN). As a result, the company trades at a high P/E ratio of 41 and a more modest forward P/E ratio of 20.
Regarding the current portfolio, AstraZeneca PLC (NASDAQ:AZN) management shared the following during the second quarter 2024 conference call:
“As Pascal just highlighted, we had a very strong start to the year with total revenues up 18%. This was primarily driven by significant growth in product sales across the portfolio. Allianz revenues also increased by 50% in the first half, mainly driven by an increase in HER2 sales in regions where Daiichi Sankyo has revenues. Please turn to the next slide. This is our core income statement. In the first half, total revenues increased 18%, as I just mentioned, and our gross margin on core product sales was 82.4%. We have already said that we expect a slightly lower gross margin on core product sales for the full year compared to 2023, and we expect downward pressure in the second half of the year driven by the usual seasonal impact of drugs like FluMist as well as a pre-delivery increase leading to a lower gross margin.”
Total AZN 2nd place on our list of cheap pharma stocks to buy according to short sellers. While we recognize AZN’s potential as an investment, we believe some AI stocks promise higher returns and do so in a shorter time frame. If you’re looking for an AI stock that’s more promising than AZN but trades at less than 5x earnings, read our report on the cheapest AI stock.
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Disclosure: None. This article was originally published on Insider Monkey.
