AZNCF - AstraZeneca: Revenue Softening Possible Profits To Rise

2023-11-08 14:17:32 ET

Summary

• AstraZeneca's upcoming results have the potential of turning around its 8% price decline YTD as profit growth can be sustained, making its forward multiples attractive again.
• The outlook on revenues is less buoyant, on the expected decline in sales of COVID-19 medicines. Revenue ex-COVID-19 medicines can still be positive, especially with recent positive developments in the Chinese market.
• Recent litigation settlement costs that can hurt profits, if adequate provisions weren't made and speculation of management changes, however, downside risks remain for the stock and ADRs.

When I last wrote about the cancer treatment provider AstraZeneca ( AZN ) in July, it was fresh from the release of its first half (H1 2023) figures. While the numbers themselves were healthy, both its guidance and market valuations indicated little short-term upside, even though its medium to long-term prospects still looked good.

So it's unsurprising that the stock has softened by 11.6% since, with a smaller fall year-to-date [YTD] (see chart below). But with its third quarter (Q3 2023) results due out on November 9, it’s also worth exploring if the price decline has now tilted the scales enough to make it a short-term buy as well.

Some improvement in market multiples

With a price fall, AstraZeneca has indeed seen some improvement in its market multiples. Its trailing twelve months [TTM] non-GAAP price-to-earnings (P/E) ratio is now at 17.87x compared to the 20.37x it was at the last time I wrote about AZN. It’s also trading somewhat below its own five-year average of 19.36x as well. It has still, however, maintained its lead over the average for the Health Care sector which has now fallen to 16.74x from 19.34x earlier.

Similarly, forward non-GAAP P/E is now at 17.47x, down from 18.67x in July. It also remains below the five-year average of 19.22x. In this case, it's also below that for the Health Care sector at 18.35x. The key takeaway here is that while AstraZeneca’s market multiples are more subdued now, they aren't significantly lower to make it a sure buy with short-term upside.

What to expect from Q3 2023 numbers

But things can change, with its earnings numbers due out later this week. Here I look at what to expect for revenues and make an assessment of what's in store for profits.

Revenue expectations

In its full-year outlook (see page 2 of the link), the company sees total revenues ex-COVID-19 medicines at constant exchange rates [CER] growing at “a low double-digit percentage”, compared to 16% year-on-year (YoY) in H1 2023.

The softening is expected due to shrinking sales of COVID-19 medicines, which are also expected to dent total revenue growth to a "low-to-mid single-digit percentage". In H1 2023, we already saw just a 4% rise in total revenues at CER, much smaller than that for revenues ex-COVID-19 medicines, and a 1% rise at actual exchange rates.

Further, AstraZeneca also expects “a low single-digit adverse impact” from exchange rates even if they were to stay unchanged from June 2023 for the full year 2023. The already muted actual revenue growth in H1 2023, a drag from COVID-19 medicines' revenue and a potential unfavourable impact from exchange rates indicate that we can brace for a revenue decline in actual revenues in Q3 2023, or even if growth does happen it's unlikely to be more than the 1% seen in H1 2023. The signs for the first nine months [9M 2023] of the year are similarly not encouraging for revenues.

However, the true assessment of the company's growth is really from its ex-COVID-19 medicines revenue, which could continue to grow well. Only in estimating profits, the total revenues need to be considered.

Core earnings

For core earnings per share [EPS], the company expects an “increase by a high single-digit to low double-digit percentage” for the full year at CER. This implies that core EPS growth could also be lower than the 21% seen in H1 2023. In actual terms, core EPS grew by 13%.

According to my estimates, however, there's actually an upside to core EPS in Q3 2023 assuming that the core profit after tax [PAT] margin remains the same at 28.3% from H1 2023. There's little reason to expect otherwise considering that AstraZeneca expects core operating expenses to increase by a "low-to-mid single-digit percentage" for the full year 2023, which isn't very different from the 5% rise seen in H1 2023.

The core EPS in actual terms can grow by a much higher 20% year-on-year in Q3 2023. For 9M 2023, core EPS growth is slated to be higher at 15%.

The market multiples

These figures don’t change the P/E significantly though. If these earnings estimates come through, the TTM non-GAAP P/E after the release would correct to 17.1x based on these estimates, down from the current levels of 17.9x. This is still higher than the median for the Health Care sector.

However, extending the EPS estimates for the full year 2023 reveals that the forward non-GAAP P/E looks more attractive now. For the year 2023, the forward P/E could now be at 15.7x. This brings the multiples far lower than those for the sector median and its own past average as well.

Opportunities and risks

The catch of course is that the actual EPS figures have to come in in line with the forecasts. If revenues fall instead of increasing by 1%, the market multiples would look less favourable. There are also developments since the last results update that can move the stock either way.

Calquence approval in China

For instance, Calquence, its treatment for leukemia and lymphoma, has been approved in China. The treatment had a non-trivial share of 5% in the company’s total revenue in H1 2023. AstraZeneca’s China market already has a decent share of 13.6%, which is growing. In its last financial update, the company updated its forecast growth rate for the market to “low-to-mid single-digit” from the earlier expectation of low single-digit growth. This can be a positive for revenue growth.

Litigation settlement costs

There are risks to the downside, however, too. The company has recently settled lawsuits pertaining to its acidity related medications Nexium and Prilosec, which were claimed to cause kidney damage. The settlement amount was USD 425 million, which is 23.4% of the company's reported profit after tax in Q2 2023. If full provisions for the settlement haven't been made earlier, it can dent profit numbers.

Speculated management changes

There was also recent speculation of the company’s current CEO, Pascal Soriot stepping down. While he has denied the news , if the speculation continues to persist, it can be damaging to AstraZeneca’s price in the short term irrespective of how the earnings numbers turn out.

How to invest in AstraZeneca now

We don't know yet how the recent developments will impact the stock going forward. What we do know is that based on the company's forecasts, its performance in H1 2023 and my estimates of its upcoming earnings, the forward P/E looks attractive once more. I believe it's still a worthwhile investment once again, especially as profits could continue to grow at a healthy pace.

There are risks to the forecasts, with a recent settlement for the company’s acidity drugs and more could follow, which can dent profits. Recent speculation of management changes also works against the stock, but overall I think it’s a good time to start buying AstraZeneca again. With it being a good medium-to-long-term buy, in any case, every dip is a reason to buy more for now.

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