AstraZeneca to Justify its Current Price in the Long Term

Constantin Wells (University of St. Gallen), Ory Ratoviz (Cal Poly SLO - Orfalea College of Business), Spyros Maris (University of Glasgow), Luca Poschl (University of St. Gallen), Alvaro Bernal (King's College London)



Company Profile:


AstraZeneca PLC is a Swedish-British multinational pharmaceutical and biopharmaceutical company founded on April 6, 1999, through the merger of Sweden-based AstraAB and UK-based Zeneca PLC. Its global headquarters are based in Cambridge, United Kingdom. AstraZeneca (AZN) is a holding company, which engages in research, development, and manufacturing of pharmaceutical products. The company has been working extensively in therapy areas such as oncology, cardiovascular, renal, metabolism, and respiratory. Approximately, 80% of the firm’s shareholders are individuals.


  • The company falls under the sector of Healthcare Technology and under the Pharmaceutical Industry.

  • The company’s market capitalization is approximately USD 136.3 B.

  • As of 2019, the total number of employees employed by the company were approximately 70.6 K.

  • The company has manufacturing facilities in 19 different companies, 9 operating research and development sites and sales across 100+ countries worldwide.

  • Some of the most sold products of the company include Losec (marketed as Prilosec in the USA) and Seloken, - a leading cardiovascular beta-blocker.


Over the past three years AZN has completed over 150 strategically important business development transactions and the following are some of the groundbreaking transactions:


Daiichi Sankyo: AZN entered an alliance with Daichii Sankyo to develop and commercialize Enhertu for multiple cancer types. In markets where Daiichi Sankyo is selling this product, AZN is entitled to receive a royalty and this income is recognized as Collaboration revenue.


Innate Pharma: In 2018, AZN entered into a further multi-element transaction with Innate Pharma. Under this agreement, AZN decided to pay USD 50 million to collaborate on, and acquire an option to license IPH5201. Also, AZN licensed the EU and US rights to Lumoxiti to Innate Pharma for USD 50 million upfront alongside future milestone payments of up to USD 25 million.



Company Snapshot:


Important people, Management/Board of Directors




Pascal Soriot -Executive Director and Chief Executive Officer (MoB since Oct. 2012)

Previous Positions: COO Roche pharmaceuticals division

Education: École Nationale Vétérinaire d’Alfort (doctor of veterinary medicine); HEC Paris (MBA)




Marc Dunoyer - Executive Director and Chief Financial Officer (MoB since Nov. 2013)

Previous Positions: Global Head of Rare Diseases GSK

Education: Paris University (Bachelor of Law); HEC Paris (MBA)





Leif Johansson - Non-Executive Chairman of the Board (Chairman since June 2012)

Previous Positions: CEO AB Volvo, CEO AB Electrolux

Education: Chalmers University of Technology, Gothenburg (MSc in engineering)


Key Suppliers


The pharmaceutical industry is known for its strong reliance on APIs (Active Pharmaceutical Ingredients) and chemical suppliers. Supplier monitoring and management is even more critical for AstraZeneca than for some of its competitors. According to a report published by the European Parliament more than 50% of drugs to treat cancer and disorders of the nervous system account for more than half of those in short supply. Whilst the manufacturing procedure of cancer treatment relevant APIs is affected by tremendous manufacturing problems, industry quotas, legal parallel trades; AZN is a leading example for partnering up with European key suppliers to get away from the industry-standardized dependence on Asian suppliers.



AZN’s key suppliers are:


  • Swedish Orphan Biovitrum AB (Producer of therapeutic products to cure rare diseases)

  • FibroGen Inc (Therapeutics producer)

  • Gerresheimer AG (Producer of glass and plastic packaging)

  • Charles River Lab (Provider of laboratory services and R&D)

  • AptarGroup Inc (Industry-leading dispense systems producer)

  • Ionis Pharmaceuticals Inc (Producer of RNA-targeted therapeutics)

  • Pieris Pharmaceuticals Inc (Producer of immuno-oncology multi-specifics)



Competitive Landscape (Industry/Peer Overview)


Industry Overview


The worldwide pharmaceutical market is currently worth 1,204.8 billion USD. The Pharmaceutical sector is made up of three components: Research firms; the generic drug industry; and the biotech industry. The industry plays a significant role in developing medications and vaccines to reduce the incidence of diseases, to treat diseases, and enhance the quality of life of people.


The industry mostly contributes by engaging in technological advancements through innovative research to meet the healthcare demands of populations. Given huge capital at stake and the pace of technological disruption, the pharma industry is quick to adapt. Leading drug companies are re-investing up to 20.8% of drug sales into new drug development.


However, the pharma industry is known for high barriers to entry, especially in the U.S. but around the world as well. Regulatory organizations heavily regulate this market and regularly influence which drugs enter the market. Bringing new drugs to market costs an average of USD 2.8 billion and over 15 years, which creates an unfavorable environment for start-ups. Further, the global pharmaceutical contract development and manufacturing market is expected to expand at a compound annual growth rate (CAGR) of up to 7.1% in the next 5 years.

  • The S&P 500 Healthcare Index has returned a 1-yr annualised value of 17.45%

  • Some strong performers in the UK, as of 23/10/2020 (YTD) include AstraZeneca “AZN” (9.08%), Moderna “MRNA” (314.64%) and Hikma “HIK” (26.94%)

In the last few years, major pharmaceutical companies have been involved in sizable transactions, taking advantage of synergies to increase their market share and put more products in the market. Most notable examples include Bristol-Myers’ “BMY” USD 87.6 Bn acquisition of Celgene and AbbVie’s “ABBV” USD 83.8 Bn acquisition of Allergan in 2019. The large volume of the recent M&A deal underlines the dynamic nature of the sector. The trend of M&A activity is expected to continue and is an opportunity for AstraZeneca which has been involved in considerable deals and will be elaborated later on in the “Opportunities” section.


Main Competitors


AstraZeneca, being the 7th largest pharmaceutical company by revenue in the world, faces tough competition. Even though the market has many players, many of them operate along the entire supply chain from initial research to the production and manufacture of prescription drugs, which is counterintuitive at first due to their quantity. The sector's rapid growth is expected to continue, reaching a size of USD 1.5 trillion by 2023.


While AstraZeneca does not reach the heights of USD 300bn+ market cap giants like Johnson & Johnson “JNJ” or UnitedHealth Group “UNH” yet, it is not entirely fair to compare them to each other, as their approaches differ. Spending more than 20% of revenue on research and development (R&D), which is one of the key metrics in pharma, reaffirms the science-led and innovation-driven approach of AstraZeneca, which ranks them in the middle of their competitors in the sector. The large downside of this strategy however is the low net profit margin with roughly 8%, compared to rivals such as Amgen “AMGN” or Biogen “BIIB”, achieving more than 30% respectively.




The obvious outlier, in this case, is Gilead Sciences “GILD”, which spends nearly 40% on R&D, posing a rising threat to AstraZeneca once profitability is obtained, as Gilead operates in all of AstraZeneca’s focal sectors.


Oncology, which aims to produce cancer or hormonal therapy drugs, is a market expected to be worth more than USD 200bn in 2023, according to marketresearchreports. It was responsible for 37% of AstraZeneca’s sales in 2019 ranking them 8th in the industry, recording less than a quarter of market-dominating Roche’s revenue. Roche’s dominance through is expected to be challenged as a result of the 2019 acquisition of currently 2nd-placed Celgene by Bristol-Myers Squibb. As a result of fierce competition, AstraZeneca may face troubles to expand its current market share of 7%. The firm's growth potential mainly relies upon the Asia-Pacific region, with its predicted CAGR of 10% until 2025, potentially strengthening its focal region.


Cardiovascular, Renal, and Metabolism (CVRM), accounting for 29% of AstraZeneca’s 2019 revenue, is a market currently worth nearly USD 195bn, led by Sanofi, Bayer and Bristol-Myers Squibb, achieving more than twice as much revenue as AstraZeneca. AstraZeneca’s China expansion is currently the carthorse of its future growth expectations, aiming to provide 200 tertiary and secondary hospitals there with multi-year cardiovascular clinical programs, with the hope of expanding its market share of 3.6%.


Respiratory, which is a fragmented market, given that no big player really focuses on it apart from GlaxoSmithKline “GSK”, accounts for 23% of AstraZeneca’s total revenue, mainly achieved by Symbicort’s USD 2.5bn in sales. This leaves AstraZeneca sitting in 2nd place far behind GSK and above Roche “RHHBY” in product sales, holding 7.7% of the market. The industry however may face changes in the near future, given that it is likely to see new combinations and devices in the form of branded or generic products, which tests the efficiency of AstraZeneca’s high R&D spending in order to help patients suffering from asthma among other diseases.


The remaining 11% of AstraZeneca’s revenue are scattered amongst other markets, underlining its clear focus on three segments.



Industry Trends


What are the key trends within the sector and how do they affect the competitiveness of the target relative to the overall competition?


Several trends are reshaping the ever-changing pharmaceutical industry and may cause challenges for pharma companies in the future.


Drug-pricing concerns will exacerbate


There are fears about drug overcharging for generic drugs which is influencing international markets including Germany and Japan to establish tighter price controls on newly produced medicine. Pricing strategies depend on the company: big pharma players like Novo Nordisk and Eli Lilly are committed to voluntary price restraints while companies like Novartis and Roche favor value-based pricing. The need to be transparent with pricing is increasing given the trend of price overcharging.


This is especially the case given increased public scrutiny on the price and accessibility of pharmaceuticals worldwide; the potential of such concerns possibly amounting to the dismantling of long-standing pricing models such as Roche’s and other drug developers. The most cost-conscious companies will be those who increasingly outsource the production process of their products (excluding sales and research & development) to partners, thereby producing more alliances between packaging, transportation and contract manufacturing providers.


The conflicts surrounding prices charged for pharmaceuticals has most recently been demonstrated through biopharmaceutical companies such as Moderna. They predicted to hold the price of their coronavirus vaccine doses approximately USD 37 per dose. This is compared to the average priced vaccine likely to be charged by companies such as Johnson & Johnson and AstraZeneca pricing at USD 10 and USD 3- 4 a dose respectively.


Figure 1: Increasing Prescription Drug Costs (PGPF)

The Use of Artificial Intelligence


The adoption of artificial intelligence by the pharma industry is on the rise in all phases of drug discovery and development from assisting in target identification, predicting new drug properties and identifying risks. Combined with its use in clinical trials, more pharmaceutical start-ups are using AI to work on small molecule drug discovery programs which big pharma companies can take advantage of through partnerships, enhancing the industry’s innovation potential.


A key example is Atomwise, a company who is using its algorithm to perform drug research in developing a treatment for Ebola infections. The algorithm successfully predicted two drugs which could reduce the rate of infectivity; a process simplified and improved through the use of AI.


Technological innovation is also increasingly significant in the drug supply chain aspects of the industry in order to facilitate high tech distribution. AI can not only reduce the drug designing time, saving cost and time, but also reduce the length of the production cycle in order for drugs to reach patients faster. The use of robotics is further being integrated to shorten the production cycle. Robotics are usually in the form of exoskeletons and assist with manual labor and packaging lines to simplify the manufacturing process.


The landscape of disruption in pharmaceutical manufacturing is likely to draw more attention to the sector, resulting in an expected CAGR of more than 40% until 2025, valuing the healthcare artificial intelligence market at USD 31.3 billion.

Healthcare budgets are facing increasing pressure to the rising incidence of chronic disease


Currently, in countries like the U.S. chronic illnesses makeup over 86% of the USD 3.5 trillion in healthcare expenses annually. This number is increasing as more and more people are projected to suffer from chronic illnesses around the world. Chronic diseases are projected to increase expenses within the healthcare market exponentially, leading to a sort of “health care crisis” with less adequate care and higher costs. With patients and medical professionals relying heavily on prescription drugs, pharma companies are a colossal force in the healthcare industry. Chronic illness creates a significant burden on worldwide healthcare markets, which can have dual effects on pharma companies.


On one hand, it might increase sales or production of certain drugs that combat certain chronic illnesses. On the other hand, it might decrease sales or production as the medical community begins to more strongly embrace preventative medicine, like exercise or meal plans among patients. This would reduce the number of chronic diseases that could be prevented through various preventative services, as well as decrease the expenses associated with rising chronic illnesses. Since a significant proportion of pharmaceutical companies’ sales come from prescription drugs catering to chronic illness, the response to this chronic illness crisis is relevant.


Figure 2: Number of People with Chronic Conditions is Rapidly Increasing (Partnership to Fight Chronic Disease)



Key Success Factors


What are the key factors that drive financial success in the industry?


Research and Development


The development of new drugs, medications, and devices shapes the success of biopharmaceutical companies. Most firms spend around 20% of their sales on R&D because they know the long-term value of these investments, with GILD leading the pack at 39% of their sales in 2019. The company with the best drug wins -- in a world of exponential scientific progress, this process of innovation is one of the most important key success factors in this industry. However, too much R&D spending can be detrimental as too much of the firm’s resources go to this category.


Speed to market


First-mover advantage, an auxiliary of R&D, signifies the importance that firms have to release their drugs the fastest to materialize R&D spendings and secure valuable patents. Without the ability to streamline pharmaceutical companies’ supply chain and infrastructure, investment in innovative medicine is useless in a highly competitive landscape. According to MedicineNet, it takes 12 years on average from drug invention to market launch in the United States; any infrastructural advantage could enable a head start of years against competitors).


External Relationships and Collaboration


Achieving operational efficiency through biopharma collaboration is extremely important in the industry. By creating production and distribution relationships with other firms, pharmaceutical companies can compete better in the market and overcome a myriad of challenges. This allows companies to split costs and share experience in often never-seen-before scenarios, as Inova reports that pharma companies regularly pair to co-produce and co-market their products.


Government Support


Government support through subsidies is a major factor in how pharma companies are able to afford expensive R&D. Other98 reports that between 2010 and 2016, the U.S. government through the NIH has spent over USD 64 billion on research for first-in-class drugs.




Health Regulations and Scrutiny


Biopharmaceutical companies are bound to the strict regulations of the healthcare industry. Health regulations, led by organizations like the FDA, deem the viability and health risks of all new drugs that hope to come to market. These regulations are not always set in stone; many factors could cause more or less leniency when it comes to certain treatments produced by pharmaceutical companies.



Key Multiples


Figure 3: Key Multiples Comparables Analysis



Key Ratios


Figure 4: Key Ratios Comparables Analysis


At first glimpse, AZN seems expensive, and yes, probably due to AZN's over the top growth rates expectations, we find a trading price around the 75th percentile mark of our peer group multiples. Although seeing strong long-term growth rates on consensus estimates, we simply can't get excited about the valuation because of AZN's lack of margins compared to its peers. Not even the R&D spendings can justify the current market price (21.22% of AZN's rev compared to 20.68% industry average). We somehow miss this immense competitive advantage, that would back a GAAP P/E TTM trading multiple of 69x, compared to the peer group median of just 20x (same applies to Enterprise Value multiples).


When shifting focus towards comparable companies, tremendous discrepancies within the correlation of margins, growth rates, and market multiples can be recognized. Whilst AZN has proven its ability to generate notorious revenue and EBITDA growth rates the past year (1Y sales growth: 11.39%; 1Y EBITDA growth: 41.71%), competitors such as Merck, Bristol-Myers, and Abbvie have both: healthy margins and impressive growth rates. Higher multiples should be the result; however, exactly the opposite is the case and the market reflects a brighter future for AZN implied by the high EV/EBIT and EBITDA multiples as well as the P/E ratio.



COVID-19 Vaccine Implications



COVID-19 presents a unique opportunity to large-cap pharmaceutical companies, who can devote significant infrastructure like facilities and distribution channels to developing a vaccine while receiving significant sums of money from financial institutions and governments. Governments are rushing to subsidize the research and development of such a vaccine to bring their countries back to normal. The United States is a prominent example of this -- they pledged billions of dollars to firms in order to expedite the process through the CARES Act (a USD 2.2 trillion dollar stimulus bill) as well as multiple other deals with pharmaceutical companies including AstraZeneca, Moderna, and Pfizer. AstraZeneca received over USD 1.2 billion dollars to support the development of its late-phase AZD1222 vaccine in collaboration with Oxford University, according to Bloomberg.


The FDA is making it easier for pharmaceutical companies to achieve a functional vaccine. The United States even went as far as creating Operation Warp Speed (OWS) to accelerate manufacturing and development of potential vaccines. It is clear that the world is desperate for a successful vaccine, and regulatory organizations are inching towards international immunity. Further, Wall Street Journal published that several drugmakers like Pfizer and Moderna are pledging not to seek government approval until their vaccines are fully safe, marking an important development in the road to a vaccine.


In this particular crisis in which there is so much at stake, we need to help expedite vaccine development as much as we can… the agency is committed to thoroughly and expeditiously evaluating it all,” expressed Peter Marks, M.D., Ph.D., director of the FDA’s Center for Biologics Evaluation and Research.


Worldwide vaccine deals are already in place, with certain countries pre-ordering hundreds of millions of vaccines once they are ready to be supplied. Barron’s revealed that AstraZeneca recently reached a deal with the European Commission to supply over 400 million doses to members of the European Union (EU). Business Wire announced that the United States has reached an agreement with BioNTech and Pfizer to provide up to 600 million doses of their MRNA-based vaccine. Australia and China are also pursuing agreements with pharmaceutical companies to supply the vaccine to their populations.


However, companies that produce successful vaccines may not necessarily bring in record profits. Companies like Johnson & Johnson, AstraZeneca, and Pfizer have pledged to not take a profit from their COVID-19 vaccine revenue. The money brought in from subsidies will be used only to cover the costs of vaccine operations. AstraZeneca’s press release in June affirmed that “[the vaccine] is not anticipated to have any significant impact on the Company’s financial guidance for 2020; costs to manufacture the vaccine are anticipated to be offset by funding by governments.” Similar statements have been made by other major pharmaceutical companies. What seems on the surface to be a phenomenal profit-making opportunity is simply a break-even effort to supply the world with immunity.


It is also important to note that this is simply a pledge -- not only is there a grey area in regards to what constitutes a vaccine cost, but there's also the question of how long the companies will continue their not-for-profit vaccine distribution. After all, these companies exist to pursue profits, which means that a deep-diving analysis of the effects on companies providing a Covid-19 vaccine in the future remains to be seen. While positive image benefits could boost sales, high opportunity costs, regarding high amounts of R&D resources put into Covid-19 research, could cause vaccine-providing pharma companies to fall behind their competitors.



Opportunities

Demographics and Urbanisation


Figure 5 More People Living in Urban Areas


Two main underlying demographic trends are expected to highly increase the demand for medical treatment over the next decades. Firstly, the growth of the world’s population, which is predicted to nearly reach the 10 billion mark in 2050, according to the UN, means that more people will need access to medical treatment. Furthermore, the African population, expected to triple until 2050, largely has access to only primitive treatment, underlining the growing demand for pharma’s offerings in the future. Secondly, the world’s population is ageing, exemplified by the fact that the UN predicts 1 in 6 people being over the age of 65 in 2050, in contrast to 1 in 11 beings of that age now.


Additionally, the megatrend of urbanization, seeing so-called “Megalopolises” emerge, not only poses the great challenge of adapting logistically but also implies increasing metabolic and respiratory disease cases, which have scientifically been proven to relate to urban lifestyle choices and air pollution. While these factors may not be as tangible as the previous trends, a predicted 55% increase in annual cancer cases in 2040 and a predicted 47% increase in diabetes patients in 2045 are closely tied to urbanization. As a result, the pharmaceutical sector naturally has immense potential to expand its offerings to a broader target group and a more health issue-prone population.


Precision Medicine


The rise in demand for personalized medicine offers a lot of opportunities for the pharmaceutical industry. Personalized medicine is when medication is produced based on a patient’s specific diagnosis; genes, lifestyle, and environment. Over the past few decades, improvements in technology and development in Big Data have enabled more precise and customized treatments that increase efficiency, reduce costs, and minimize potential side effects. Furthermore, DaaP (Data as a Platform) opens up the possibility for pharma companies to identify disease trends subsequently exploring avenues for new products, which can potentially open up new revenue streams for those who position themselves correctly.


Precision medicine is mainly set to change the oncology, cardiology, respiratory, and immunology industries. Increasing demographics and urbanization play a big role in the growth of the precision medicine market, as global rising cancer cases open up strong demand for individual personalized treatment (as mentioned above, annual cancer cases are set to increase by 55% until 2040). Oncology is currently the biggest segment for precision medicine and is set to drive the latter’s double digit CAGR growth until 2025 as India and China fuel strong growth in population and cancer cases (mainly due to urbanization). However, research in non-oncology areas is also increasing giving further chances for firms who are more specialized