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Companies mentioned: AZN, ABT, BIIB, LLY, GSK, VRTX, ZTS
AstraZeneca (AZN) Treading Water in 2016
AstraZeneca reported total revenue growth of 1% in the first quarter of 2016 on a year-over-year basis, but this growth rate climbs to 5% when not including the impact of foreign exchange headwinds. Core operating results, which excludes the impact of amortization, impairments, restructuring and other non-operating costs, did not hold up well compared to the first quarter of 2015. Core operating profit and core earnings per share fell 8% and 7%, respectively, on a constant currency basis from the year-ago period. Core R&D spending grew 15% in the quarter as a result of acquisitions and continued focus on the firm’s pipeline, which more than offset the decrease in core SG&A costs. Reported bottom-line growth was strong in the first quarter of the year, though it was mostly due to lower amortization charges compared to the same period of 2015.
AstraZeneca’s Cardiovascular & Metabolic disease segment, its largest segment in terms of product sales, grew revenue 3% on an as-reported basis from the year-ago period, or 7% on a constant currency basis. The next biggest segment, Infection, Neuroscience & Gastrointestinal experienced a 17% decline in sales on an as-reported basis, as nearly all of the segment’s major products reported an as-reported decline of more than 20%. For example, generic similars to Nexium (gastro-esophageal reflux disease) entering the US market helped cause actual product sales to fall 28% from the year-ago period. A similar scenario took place in the competitive landscape for Symbicort (asthma), whose sales declining 11% dragged the Respiratory, Inflammatroy & Autoimmunity segment sales down 3% on a year-over-year basis. The company’s relatively small Oncology segment reported the highest growth in the period, as sales advanced 9% thanks to multiple new product offerings.
The company’s guidance for full-year 2016 remained unchanged. Total revenue is expected to decline at a low to mid-single-digit pace due in part to the loss of exclusivity for Crestor in the US. Core earnings per share declines are expected in the low to mid-single-digit range compared to 2015 as a result of dilution from the Acerta Pharma and ZS Pharma acquisitions. Improvements in core SG&A costs will be ongoing in 2016 and 2017, and the growing Oncology segment is expected to play a growing role in AstraZeneca’s target of $45 billion by 2023. This is a very lofty target, and we’re not sure it’s achievable. If this target proves to be more realistic in the coming years, there may be material upside to our fair value estimate. Shares of AstraZeneca are currently trading at ~$29, very near our fair value estimate of $31.
Abbott Laboratories (ABT) Looking for Growth Via Acquisition
Abbott Laboratories reported a difficult start to the year April 20. Net sales were approximately flat from the year-ago period on a reported basis as foreign exchange headwinds were a major factor. Total sales on an operational basis, which excludes the impact of currency headwinds, advanced more than 5% on a year-over-year basis. The firm’s Nutrition segment reported solid operational revenue growth of 4.3% as both Worldwide Pediatric Nutrition and Worldwide Adult Nutrition grew at a similar rate. Nearly 7% operational sales growth was reported by the Diagnostics segment, driven by solid growth in point of care and in emerging markets. The Established Pharmaceuticals segment, which only serves international markets, reported strong sales growth before the impact of foreign exchange rates thanks to growth in key emerging markets such as India, Russia, Brazil and China. Abbott’s Medical Devices segment was the weak link in the first quarter, as sales climbed 0.5% in the period as strength in Worldwide Medical Optics was offset by weakness in Worldwide Diabetes Care.
Abbott’s bottom line was strained considerably more than its top line in the first quarter, though a majority of the negative forces were not operational in nature. Diluted earnings per share from continuing operations fell nearly 90% from the year-ago period, mostly due to a large loss from foreign exchange rates related to Venezuela. When excluding special items, diluted earnings per share from continuing operations dropped a much more reasonable ~13% from the first quarter of 2015. Nevertheless, cash from operations turned negative in the quarter, and free cash flow generation was negative, as it was in the first quarter of 2015.
Despite the rough performance in the quarter, Abbott was generally pleased with its results. The company increased its earnings per share from continuing operations, excluding specified items, guidance to a range of $2.14-$2.24 from previous guidance of $2.10-$2.20. The firm also recently announced the acquisition of St. Jude Medical (STJ), “April Deals May Flower Future Growth.” Though the deal will create a market leader, we are not particularly fond of the amount of debt Abbott will be taking on as a result of the purchase, especially considering recent quarterly free cash flow trends. Shares have fallen considerably since the announcement of the deal, indicating that the market is having some of the same hesitant feelings that we are.
Biogen (BIIB) to Spin-off Hemophilia Segment
Biogen reported a strong start to its 2016 April 21. Total revenue advanced 7% from the year ago period thanks to strong performance from Tecfidera (multiple sclerosis), Eloctate (hemophilia), and Alprolix (hemophilia). Both GAAP and non-GAAP earnings per share jumped 25% or more in the quarter on a year-over-year basis, and the bottom-line improvement was driven by lower SG&A and R&D spending as well as the top-line expansion and a falling share count. Free cash flow generation was strong in the quarter as well.
The growing success of Biogen’s Hemophilia segments has led the firm to proceed with a spin-off of the segment into an independent, publicly-traded company, expected to be complete by the end of 2016 or early 2017. The new company will be able to focus more effectively on the continued commercialization of Eloctate and Alprolix, and what remains of Biogen will be able to commit a higher proportion of its energy and resources for the development of therapies for neurological and neurodegenerative diseases.
Looking ahead to the rest of 2016, management expects to advance a number of potential breakthrough therapies, including multiple Phase 3 clinical trials for treatments of early Alzheimer’s disease and spinal muscular atrophy. The company continues to focus on the rapid advancement of its pipeline, but will also look to maximize revenue by leveraging its commercial portfolio and pursuing inorganic growth opportunities. Biogen looks to build upon the cost control momentum it generated in the first quarter of the year, though it did not provide an update to its full-year non-GAAP diluted earnings per share guidance of $18.30-$18.60.
Eli Lilly (LLY) New Products Contributing
Eli Lilly reported an encouraging quarter to start 2016 April 26. Trulicity (diabetes), Cyramza (gastric cancer), and Erbutix (colorectal cancer) were key drivers of revenue growth of 5% from the year-ago period. Strong price performance in the US and solid volume growth across most regions were underlying factors in revenue growth as well. Gross margin improvements were partially offset by higher operating expenses, but lower acquired in-process research and development charges helped drive operating income growth of 36% in the quarter on a year-over-year basis.
However, the strong operating income growth was not passed through to the net income line of the income statement, which fell 17% from the year-ago period due to a ~$204 million dollar charge related to the impact of the Venezuelan financial crisis. Earnings per share decreased 18% from the first quarter of 2015. This pain was also felt in the firm’s cash flow generation, as cash from operations dropped significantly into negative territory and free cash flow deteriorated from the comparable period in 2015 as a result.
Nevertheless, management remains confident in Eli Lilly’s outlook. New products contributed 5.3% of the 7% volume growth realized in the first quarter of the year, and the pressure on the company’s bottom line is not expected to be a recurring theme. As a result, the firm revised its guidance for the full-year 2016. Revenue is now expected to be between $20.6-$21.1 billion, up from previous guidance of $20.2-$20.7 billion, and non-GAAP earnings per share are now expected to be in a range of $3.50-$3.60, compared to a previous guidance range of $3.45-$3.55. This is great news for a company that hopes to remain on the upswing after facing substantial revenue and earnings pressure in 2014 due to the expiration of patents.
Eli Lilly’s new products appear to have it back on track, but our fair value estimate of $73 includes an assumption of steady top-line revenue growth in the coming years, indicating that there may not be much valuation opportunity present at the moment.
GlaxoSmithKline (GSK) Expecting Double-Digit EPS Growth in 2016
GlaxoSmithKline’s 2016 got off to a solid start, as its Vaccines and Consumer Healthcare segments led sales growth of 8% at constant exchange rates. The firm’s Pharmaceutical segment, its largest segment in terms of sales, experienced a revenue decline of 1% in constant currency, though new product sales showed impressive momentum in the quarter and now make up ~20% of total pharmaceutical sales. After adjusting for the loss of revenue from the sale of its oncology business to Novatris (NVS) the segment reported pro-forma growth of 5%. This strong sales momentum, coupled with cost control and restructuring and integration benefits helped push improved operating leverage in the quarter as well. The company’s restructuring and integration program delivered material cost savings in the quarter, and it is on track to realize £3 billion in annual cost savings by the end of 2017.
The company’s strong operating performance helped it achieve core earnings per share growth of 8% on a constant currency basis from the year-ago period. This measure excludes one-time restructuring charges as well as non-cash transaction related charges incurred in the period, which materially reduced reported total earnings per share. Management was pleased by such operational success on its bottom line, and has increased its growth target to core earnings per share to a range of 10%-12%, compared to previous expectations for core earnings per share growth to reach double digits. Both targets ignore the impact of foreign exchange rates.
GlaxoSmithKline is also encouraged by the progress made in its pipeline in the first quarter of the year, particularly in core therapy areas such as respiratory, HIV, oncology, immune-inflammation and rare diseases. Though the company received multiple approvals for new products and positive data and opinions on a variety of drugs in its pipeline in the first quarter of the year, our fair value estimate of $35 is well below the current share price and already factors in growth assumptions consistent with that of management’s earnings per share guidance hike. We don’t see a great opportunity in shares at the moment.
2016 is a Big Year for Vertex Pharmaceuticals (VRTX)
2016 is an important year for Vertex following the launch of Orkambi (cystic fibrosis) in the US in July 2015. This, along with solid sales growth from Kalydeco (cystic fibrosis), led to revenue approximately tripling in the first quarter of the year from the year-ago period. The impressive jump in revenue in the quarter was not enough to keep the firm from reporting a GAAP loss, however. R&D expenses grew substantially in the period, as the company continues to invest in the progress of its portfolio of cystic fibrosis treatments, and selling, general and administrative expenses advanced from the first quarter of 2015 primarily due to support for the global launch of Orkambi.
On a non-GAAP basis, Vertex net income per diluted share swung to $0.09 from a loss of $0.62 in the comparable period of 2015. GAAP net income per diluted share remained at a loss in the quarter, albeit a much less significant loss compared to the year-ago period. A similar scenario took place in its free cash flow profile. Free cash flow remained negative, though it was far less substantial than the negative free cash flow reported in the first quarter of 2015.
These improvements further support the fact that 2016 is an important and transitional year for Vertex. The company has the opportunity in front of it to drive material improvements in its financial performance through its two primary cystic fibrosis treatments. It expects Orkambi product revenues to be in a range of $1-$1.1 billion, while Kalydeco is expected to bring in $685-$705 million in revenue. Continued uptake in both treatments, as well as ongoing approvals for different applications and in different regions of the world will help maintain strong growth in both products.
Shares appear attractive based on our fair value range of $97-$181, but investors should be aware of the risk that comes along with a company so concentrated in its revenue sources. This risk is what causes our fair value range to be so wide, and our estimates include significant revenue and profitability growth over the next 5 years. In any case, we would not consider a move in the firm until its technical indicators showed a material improvement.
Companion Animal Sales Driving Zoetis (ZTS)
Zoetis’ diverse portfolio of animal health products came through with strong top and bottom-line growth in the first quarter of 2016. On an as-reported basis, the company reported revenue growth of 5% from the year-ago period, and when excluding the impact of foreign currency, this growth rate jumps to 12%. The firm’s companion animal products were the primary driver of overall revenue growth, particularly in the US, where the division’s sales leapt 32% on a year-over-year basis. In its international markets, the acquisition of Pharmaq, global leader in health products in aquaculture, boosted livestock product revenue, particularly in Chile and Norway. This international livestock growth was partially offset by weakness in Venezuela and India, while international companion animal revenue growth was driven by increased sales of Apoquel (canine pruritus) in both new and existing markets.
The firm’s revenue growth, along with material improvements in SG&A spending, helped it grow adjusted net income and adjusted net income per diluted share 15% and 17%, respectively, on a year-over-year basis as reported. When ignoring the impact of currency headwinds, adjusted net income growth jumped to 28% from the year-ago period. The strong start to 2016 gave management material confidence that it is in great shape for the foreseeable future, and the company expects to deliver long-term revenue growth equal to or faster than the markets in which it participates.
Zoetis also increased its guidance ranges for both 2016 and 2017 after the first quarter of the year. The firm now expects 2016 revenue to be between $4.775-$4.875 billion, and adjusted diluted earnings per share to be in a range of $1.83-$1.90, compared to previous guidance ranges of $4.65-$4.775 billion and $1.71-$1.81. 2017 guidance has been upped to $5.075-$5.275 billion for revenue and $2.24-$2.38 for adjusted diluted earnings per share, compared to previous guidance of $4.95-$5.15 billion and $2.18-$2.32, respectively. Such increases are indicative of the company’s confidence that its first quarter performance is sustainable despite the potential for continued pressure from the global agriculture markets on its livestock segment.
Our projections for Zoetis are approximately in-line with management expectations, and our fair value estimate of $34 indicates that we feel shares are significantly overvalued at current price levels.