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AstraZeneca - Multi-billion dollar bet on Japanese research

Nicholas Hyett | 29 March 2019 | A A A
AstraZeneca - Multi-billion dollar bet on Japanese research

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AstraZeneca plc Ordinary US$0.25

Sell: 10,726.00 | Buy: 10,728.00 | Change 206.00 (1.96%)
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AstraZeneca has announced a deal to work with Japanese pharmaceutical group Daiichi Sankyo on early stage cancer treatment Trastuzumab deruxtecan.

The deal will see Astra pay $1.35bn upfront, with future payments of up to $5.55bn dependent on hitting certain milestones. The deal is being financed by a $3.5bn equity placing.

Astra shares fell 4.1% in early trading.

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Our View

Astra's been thinning its portfolio as it looked to boost near term cash flows, and keep the dividend ticking over, while the pipeline matured. That strategy seems to have paid off, with product sales showing signs of long term growth last year, and revenue expected to turn positive this year.

Recently approved oncology drugs are a particular stand out and the decision to expand the geographic footprint is bearing fruit too. An increased presence in Emerging Markets and Japan means Astra's been able to make the most of new drugs, as and when they arrive, and has also helped boost sales of more mature treatments.

However, Astra clearly felt the pipeline needed another shot in the arm, hence the Daiichi Sankyo deal. It's a high risk bet. The drug in question hasn't been approved in any markets, so there's always the risk it falls at the final hurdle and ends up being worth nothing at all. But then that's a fundamental part of the pharmaceutical industry.

Despite the green shoots, organic free cash flow hasn't been strong enough to support the dividend. That means Astra will be relying on debt and externalisation deals, where it sells stakes in some of its smaller drugs for cash up front and is left with just a small ongoing interest, to fund the dividend for another year at least.

That's clearly unsustainable in the long run. Fortunately the pipeline has generally delivered well to date, albeit with a few notable exceptions. If all goes to plan, the decision to hold the dividend steady during the lean times will be more than vindicated.

Even once we're over the hump, the need to deal with the mounting debt pile means significant dividend growth could be years away. But with analysts forecasting a prospective yield of 3.3%, investors are at least being paid to wait as the baton passes from labs to sales reps.

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Daiichi Sankyo Deal

Trastuzumab deruxtecan is an antibody-drug conjugate (or ADC), which directly targets specific cancer cells.

Trials are taking place in North America, Europe and Asia for use in breast and gastric cancers, with earlier stage trials looking at colorectal, lung and bladder cancers. However, since safety and effectiveness have not yet been established the drug "has not been approved for any indication in any country".

The deal will be accompanied by a $3.5bn placing, more than half of which will be used to fund the deal, with remainder helping to reduce debt.

The deal isn't expected to affect earnings per share (EPS) l in 2019 but should boost EPS from 2020, rising significant contribution by 2023. Guidance for 2019 sales and EPS remains unchanged and the progressive dividend policy is unaffected.

Full Year Results (14 February 2019)

Full year product sales rose 4% at constant exchange rates (CER) to $21bn, although less income from disposals meant total revenue fell 2%. Astra enjoyed a bumper fourth quarter, with product sales up 8% thanks to a strong oncology performance.

2018's core operating profit was 17% lower year-on-year at $5.7bn. That reflects a slight decline in margins and lower externalisation revenues.

The full year dividend remains unchanged at $2.80.

The shares rose 2.7% in early trading.

Full year product sales were driven by a 49% increase in Oncology sales which now stand at $6bn. That was largely thanks to the success of lung cancer treatment Tagrisso, with other newly launched drugs including Imfinzi and Lyparza also delivering strong growth.

Astra's other two growth areas, New CVRM and Respiratory, saw sales rise 12% and 3% to $4bn and $4.9bn respectively.

The mature Other portfolio saw sales fall 23%. That included a 14% fall in sales of gastro-intestinal drug Nexium, AstraZeneca's third largest drug by sales.

Core operating expenses increased 4% to $14.2bn. That reflects a 9% increase in core SG&A (Sales General & Administrative) spending to support new drug launches and expansion into China, where sales grew by 25% in the year.

The group expects 29 major regulatory or trial deadlines in 2019, with over half coming from the growing oncology portfolio.

Core earnings per share (eps) were 19% lower than last year at $3.46, reflecting the lower externalisation revenue and decline in gross margin.

Net debt during the year increased 2.6% to $13bn.

Astra now expects 2019 to see high single-digit growth in product sales and report core eps of between $3.50 and $3.70.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.

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