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GlaxoSmithKline (GSK), AstraZeneca plc (ADR) (AZN): The High-Yield Biotech Play

LONDON — Two scientists in white lab coats stare into a microscope. The picture on the front of AstraZeneca plc (ADR) (NYSE:AZN)‘s website sums up the company’s new strategy perfectly.

GlaxoSmithKline plc (ADR) (NYSE:GSK)“We see no case for diversification” was the unequivocal message from CEO Pascal Soriot last week, in sharp contrast to rival GlaxoSmithKline plc (ADR) (NYSE:GSK). Instead, Astra plans to remain focused on being a scientific R&D-led developer and marketer of prescription drugs.

Patent cliff
That leads to an obvious question: how will AstraZeneca plc (ADR) (NYSE:AZN) get over its patent cliff? Revenues dropped by 20% last year. Soriot’s remedy is:

Better marketing of existing patented drugs, such as heart-attack therapy Brilinta, getting more doctors to prescribe it. The company is also targeting sales growth in emerging markets.

Streamlined and focused research. AstraZeneca plc (ADR) (NYSE:AZN) will concentrate on just three therapeutic areas, management has been re-vamped and the R&D function is relocating around three bioscience clusters.

Slashing administrative costs. More than 5,000 jobs will go by 2016, with a $2.3 billion restructuring charge expected to yield annual savings of $800 million.

Soriot aims to beat the current market consensus forecast of $21.5 billion of sales in 2018, equaling 2011’s outturn. That’s hardly a stretch target.

Is the dividend safe?
Many investors hold AstraZeneca plc (ADR) (NYSE:AZN) for its 6% yield. The good news is that the board has adopted a policy of maintaining or growing the dividend while new drugs come on-market. It’s targeting a cover of two times core earnings over the investment cycle, giving it a lot of wriggle room.

The plan is to spend half of free cash flow on R&D and most of the rest on dividends, with any cash remaining used for bolt-on acquisitions or share repurchases. That’s a great plan if there’s enough cash, but it depends on the boffins getting new drugs authorized.

AstraZeneca plc (ADR) (NYSE:AZN)’s strategy is significantly higher risk than GlaxoSmithKline plc (ADR) (NYSE:GSK)’s, whose over-the-counter products like Lucozade don’t need years of R&D and testing. It will take a couple of years to find out if it’s working, and if it isn’t then the progressive dividend policy will be out the window.

Hedging bets
But if Soriot pulls off the new strategy, investors will be rewarded with a re-rating of the shares. In contrast, GlaxoSmithKline plc (ADR) (NYSE:GSK)’s diversification makes it a safer but more boring play.

Which to choose? It could make sense to hedge your bets with some money in each. One very successful investor who’s done just that is Invesco Perpetual’s star fund manager Neil Woodford. Nearly a quarter of his 22 billion pound funds are invested in just three companies in the pharmaceutical sector: AstraZeneca plc (ADR) (NYSE:AZN), GlaxoSmithKline plc (ADR) (NYSE:GSK) and one other.

Woodford has an unrivaled record for stock-picking. His high income fund is “the best performing of any fund investing in the UK since it launched” according to Hargreaves Lansdown PLC (LON:HL). It has grown at 12.6% a year since 1988.

The article AstraZeneca: The High-Yield Biotech Play originally appeared on Fool.com.

Fool contributor Tony Reading owns shares of AstraZeneca and GlaxoSmithKline. The Motley Fool recommends GlaxoSmithKline.

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