AstraZeneca or GlaxoSmithKline: Which is the better Big Pharma investment?

AstraZeneca and GlaxoSmithKline have both been in the news this week.  In fact, to some extent, they have been the news this week.

Investors flocked to buy AstraZeneca shares when a £60 billion takeover bid from Pfizer surfaced, and they stampeded into GlaxoSmithKline shares on the news of its three-part deal (one business sale, one acquisition and one joint venture) with Novartis AG.

So with AstraZeneca shares up 8% during the week and Glaxo shares up 5%, which one is now the better Big Pharma bet?

AstraZeneca – A potential turnaround

AstraZeneca has in many ways been the poster child for the patent cliff, which is a problem faced by many in the industry.  It’s where existing “blockbuster” drugs come to the end of their patent, with a steep fall off in profit margins expected as generic competitors move in.

Have a look at the chart below, which shows AstraZeneca’s revenues, earnings and dividends over the last few years, and try to spot the impact of the patent cliff:

Top marks if you spotted the big drop-off in revenues in the last couple of years and the even bigger fall in profits (although to be honest they’re pretty hard to miss).

The company is definitely struggling to maintain its size, and the best the CEO could offer in the most recent annual results was to say “I am confident that we can return to growth faster than anticipated and expect our 2017 revenues will be broadly in line with 2013”.

Personally, flat revenue over four years is not what I invest for.  However, the company has produced dividend growth of around 13% a year in the last decade.  If it can maintain the dividend at its current level, as it has managed so far through the patent cliff, then the current 4.3% dividend yield, with the shares at £40.80, should prove attractive once/if growth returns.

In comparison, reliable dividend-paying stocks yield just 3.1% on average.

Although AstraZeneca’s dividend growth rate has been high, the fall-off in earnings and revenues has dragged the company’s overall growth rate down to 7.2%, which is just above average for a consistent dividend payer (the average is 6.6% according to my database).

The Pfizer story adds a bit of excitement, but entering or exiting an investment based on a possible takeover is the opposite of the sort of long-term investing that I’m interested in, so the deal is of no consequence to me.

What should matter are the prospects for long-term growth, reliable dividends and a decent purchase price.

I think AstraZeneca shares, at £40.80, probably tick all three of those boxes, although that’s offset to some extent by the scale of the patent cliff problems and the reliance on an as-yet unproven, but potentially attractive, drugs pipeline.

The company also ranks at number 61 on the UKVI defensive value stock screen, which is based on a combination of an investment’s growth, income, quality and value.  A rank of 61 puts it in the second quintile out of almost 250 consistent dividend payers, a rank which I would generally call “attractive”, as opposed to the “very attractive” label I apply to the top 50 stocks.

GlaxoSmithKline – Slow and steady

Unlike AstraZeneca, Glaxo has been relatively unaffected by the patent cliff and doesn’t face anything like that company’s turnaround situation.  Instead, Glaxo is a picture of defensiveness, with astonishingly steady and progressive dividend growth, which you can see in the chart below:

If anything is guaranteed to warm the heart of a defensive investor it’s the sight of an arrow straight line of dividend growth.  In terms of speed, Glaxo’s dividend has grown by around 7% a year, but earnings growth has not been so forthcoming.  In fact, earnings haven’t really grown at all in the last decade.

This is a problem because, without earnings growth, dividend growth is not sustainable.  So there is a question mark over whether or not Glaxo will be able to turn things around and get earnings going in the right direction again, quickly enough so that the impressive run of dividend increases can continue unabated.

Sustained earnings growth requires revenue growth, and there again the company has been lagging.  Revenues have gone up by just 3% a year, although if you look at revenue growth per share it’s nearer 5% because the number of shares has declined over the years through various share buyback programs.

So Glaxo’s overall growth rate is somewhat less than inspiring at around 3.4% a year, which is better than the FTSE 100 (2.6%) but worse than other defensive dividend payers (6.6%).

In terms of valuation, with the shares at £16.55, the dividend yield is 4.7%, well above the FTSE 100’s 3.6%, AstraZeneca’s 4.3%, and the average of consistent dividend-paying companies which is 3.1%.

Overall, Glaxo appears to offer an above-average yield, combined with medium growth and low risk.

AstraZeneca or GlaxoSmithKline?

But let’s get back to that original question; Which is the better investment?

It’s not an easy question.

Glaxo has a higher yield at 4.7% compared to AstraZeneca’s 4.3%.  Glaxo’s dividend appears to be very safe while there is perhaps more risk around the AstraZeneca dividend.

On the other hand, AstraZeneca has a better record of growth, with overall growth at 7.2% and dividend growth at 12.9%, but both of those are likely to decline in the next few years.  Glaxo has had slower growth, but that growth rate is more likely to reflect what will happen in the future.

AstraZeneca is cheaper relative to its average earnings over the past decade, but those earnings are unlikely to be sustainable in the medium term.  However, if AstraZeneca can turn things around then its attractive pipeline means that there is a possibility of a sharp price increase in the future, which is something that seems unlikely for Glaxo.

This lack of an obvious winner is reflected in the two company’s rankings on my defensive value stock screen, where Glaxo comes in at number 56 out of 242 reliable dividend payers, and AstraZeneca is only slightly behind at number 61.

That’s close enough that there is virtually nothing to choose between them, and I think that’s true in general.

At their current valuations, I think both companies are attractive propositions, and I would be happy to own either of them.  One does not appear to be obviously better than the other, although if pushed I would probably say that for me, Glaxo offers the better mix of growth, income, quality and value at its current share price.

Disclosure:  I own shares in AstraZeneca and it is a holding in the UKVI Defensive Value Model Portfolio (which isn’t out of sync with my mild preference for Glaxo as the shares were purchased when they were significantly cheaper than they are today, and at the time were much more attractive than Glaxo’s shares).