UK biotech and pharma heads into troubled waters

Early in 2010, Anglo Swedish group AstraZeneca (AZN) announced that it was closing its UK Research and Development centre in Loughborough by the end of 2011 with the loss of up to 1800 jobs.  In January, U.S. based Pfizer (PFE) announced the closure of the Sandwich research facility with the loss of 1300 jobs. The excuse has been the continued consolidation of research facilities and the loss of incentives to operate in the U.K. versus other developed markets.

It is true that a series of drug price cuts in the U.K. under the last Labour government under the PPRS (Pharmaceutical Profit Regulation Scheme) to try and offset the rising drugs bill, has given less incentive to spend millions of pounds on facilities such as Sandwich, and more incentive to use low cost operations in places like India or those with higher tax breaks such as the United States. As I wrote in a previous Contrarian Investor UK post, "Is the big pharma model broken for good?,  the major pharmaceutical companies are beset by rising drug development costs, yet with a less productive research system than ever and large numbers of big selling products going off patent (http://contrarianinvestoruk.blogspot.com/2011/01/is-big-pharma-drug-model-broken-for.html).

U.K. biotech is not fairing much better. Many of the hoped for stars of the industry have had major drug failures over the last few years highlighting the fact that as few as 16% of new drugs ever make it through clinical trials. Those companies with just one or two development products have significant risks. There are plenty of home grown examples to illustrate this point.

The most infamous is probably British Biotech, a company founded in 1986 and once close to membership of the FTSE 100. Peter McCullagh was ditched as Chief Executive in 1998 when a whistleblower, Andew Millar, alleged that investors were deceived with an over-optimistic view of its cancer drugs.

Its key product marimastat was touted as the "cure for cancer", but ultimately failed in clinical studies and Millar alleged that bad data was concealed. Co-founder, Brian Richards (now Sir Brian), went on to be Chairman of Alizyme, which would ultimately have it own problems.  In May 2006, British Biotech's shares peaked at just shy of £33 valuing it at £1.3 billion, when the company merged with Vernalis in 2003, it was worth around £50 million.

Alizyme (AZN) had several promising compounds in late stage development for obesity (cetilistat), ulcerative colitis (Colal-Pred) and irritable bowel syndrome (renzapride). It ultimately went into receivership at the end of 2009 when all its products failed late stage clinical trials. It was particularly unlucky for Alizyme given the drugs had passed through earlier stage clinical trials having reached their end points successfully and about 50% of drugs fail phase III testing. It was floated on AIM in 1996 and moved to the full list in 2000, before it folded in 2009.

Antisoma (ASM) once a promising company focused on anti-cancer drugs, has seen all of them fail human testing. A few years ago, Antisoma was trading close to 50p, now it is 3p! Antisoma's last hope, AS1413 in leukaemia recently had disappointing results after its lead product AS1404 for lung cancer (in partnership with Novartis) bombed in phase III trials. Its has £23 million of cash left but little else.

Ark Therapeutics (AKT) shares were once over 150p, now they are less than 5p, after the company had to withdraw its European filing for its brain cancer drug Cerepro (sitimagene ceradenovec) after a negative opinion from European regulators in December 2009 who requested additional clinical trial data.

Recently skin care specialist, Renovo (RNVO), lost nearly three-quarters of their value after the scar treatments developer admitted that its main treatment Juvista has failed to meet its goals in a phase III clinical trial in scar revision surgery. Unlike Antisoma, Renovo has £44 million in the bank and one product left in phase II trials, Prevascar, and results from this study are expected in the second half of 2011 for skin scarring reduction.

Not many examples of out and out successes come to mind from U.K. biotech, though we have major pharmaceutical players such as Glaxo Smithkline, Astra Zeneca and Shire pharmaceuticals. Compare this with the U.S., where they have Genentech (now part of Roche), Amgen, Genzyme (now part of Sanofi Aventis), Imclone (now owned by BMS), Medimmune (owned by Astra). Why the difference? - luck or judgement?

Is the big pharma drug model broken for good?

Is the traditional "big pharma"pharmaceutical company model broken? Certainly in terms of shareholder returns excluding dividends, their share price performance has been woeful. 

GlaxoSmithkline (GSK) (formed from the merger of Glaxo Wellcome of the U.K. and Smithkline Beecham of the U.S. in 2000) has seen its share price fall from around £21 at its inception to its current £11.43 (a decline of 46%).  U.S. giant Pfizer (PFE) which has been on an acquisition spree over the last 10 years or so with the purchase of Warner Lambert in 2000, Pharmacia in 2003 and more recently Wyeth in 2009 has also had a torrid time. Prior to the acquisition of the Warner Lambert business (owner of the cholesterol blockbuster Lipitor (atorvastatin) in 2000 its shares were over $46, they now stand at $18.15 ( a decline of 61%). Astra Zeneca (AZN) (formed from the merger of U.K. Zeneca and Sweden's Astra in 1999) has seen its shares oscillate between £29 and £35 for the last decade, and they now sell for £30.42, £5 less than in 2001.

AstraZeneca illustrates the problems faced by the big pharmaceutical players which have been formed from the merger of smaller players over the last 20 years. AZN is feeling the pain of generic competition as patents expire on some of its key drugs. Despite heavy R&D investment and acquisitions (e.g. MedImmune in 2007 for $15 billion), numerous failures in clinical trials have meant the company is increasingly reliant on some big bets in late stage clinical trials or regulatory approvals. Unfortunately the U.S. drug regulator, the FDA (the Food and Drug Administration), is becoming increasingly demanding of drug applications. Astra's anti clot drug, Brillianta, has been held up as the FDA has requested additional analysis of data.

Astra's 2010 revenue was flat at $33.6 billion and earnings per share (EPS) rose by 5% to $6.71 driven by cost cutting. But Quarter four revenue was down 3%. Growth in emerging markets is helping to offset patent expiry issues in the short term but there is more to come and cost cutting in areas such as sales has helped to drive profitability. To keep shareholders happy, the company increased the dividend by 11%,
and having bought back $2.2 billion of its shares in 2010 the company is targeting $4bn of share repurchases in 2011 to help drive the earnings per share growth into positive territory.

Pfizer has not had much better luck. Its acquisition of Pharmacia UpJohn (formed from the merger of U.S. Upjohn and Swedish Pharmacia in 1995) for $60 billion in an all share deal went badly wrong when two of its key blockbuster arthritis drugs called COX2 inhibitors were found to be associated with potentially serious side effects relating to increaed risk of heart attack and stroke. After an FDA review in 2005, Celebrex (celecoxib) had its labelling amended and second generation COX2 Bextra (valdecoxib) was withdrawn from sale. Bextra sales were expected to be in excess of $2 billon per year. In mid 2006, Pfizer made the decision to increase its reliance on the riskier prescription pharmaceutical business by selling its over-the-counter medicine business (including Listerine, Benylin, Sudafed) to Johnson & Johnson (McNeil). On a positive note it achieved a good price of $16 billion compared with sales of $3.7 billion as it was the one of the last crown jewel over-the-counter global businesses. J&J triumphed against other bidders such as GSK, Novartis and Reckitt Benckiser. The purchase (merger) with fellow U.S group, Wyeth (formerly American Home products which was due to merge with Warner Lambert in 2000 before Pfizer acquired Warner Lambert) is seen predominantly as a cost saving marriage, although Wyeth's vaccine and consumer health business help to diversify the group back from traditional prescription products.

Investors in pharmaceuticals have traditionally been income seeking through the high dividend yields they offer e.g. Astra 5.5%, Pfizer 4.3%, GSK 5.8%. As has been illustrated by the commentary, capital growth has certainly not been delivered. The series of mega-mergers has clearly failed to deliver shareholder value despite all the promises of increased R&D productivity and cost cutting. Tougher regulation and increasing R&D costs have not helped the sector as has increased pressure from ever more nimble generics companies e.g. Teva, Sandoz (owned by Swiss Pharma Novartis). Despite spending more and more on research, pipelines look anaemic. 

Part of the reason for the R&D problems is that centralisation has stifled creativity and innovation. Also easier molecular drug targets have been found and exploited. Biotechnology looks more fruitful but this is not without its problems and traditional pharmaceuticals companies have had to resort to takeovers to exploit this area in general e.g. Roche's takeover of Genentech in 2009. Although science continues to advance at an incredible pace, for example, the Human Genome project (HGP) was completed in 2003 after 13 years of work, the profit potential of these developments has yet to be truly felt by the pharmaceutical companies. New areas of science are themselves beset with issues such as how to test these new molecules on human subjects, particularly those that change the human gene to prevent or cure disease such as cancer. No doubt these problems and challenges will be solved but they will take time, maybe even decades before we see biological drugs which can prevent an at risk individual contracting a certain disease. If it could be cracked, the profit potential is incredible.

Big pharma needs to change to really deliver shareholder value. Forget the mega mergers (which have destroyed value in most cases). Companies like Novartis and GSK are ahead of the game with derisking their prescription businesses by moving into emerging markets, developing generic or over the counter divisions i.e. diversification. But even they are not going far enough. Development of a true biotechnology focus seems key in the new world. Reorganising R&D to drive true innovation rather than me-too's is also vital. I wonder how many CEO's in big pharma would be around if they were measured and remunerated on earnings per share growth (excluding share buy backs)? It is interesting that if you compare shareholder returns for an industry at polar opposite end of the spectrum such as tobacco but with similar high dividend yields, the differentials are astonishing. For example, British American Tobacco (BAT) has grown its share price from £3 to £23 since 2000. Household products company, Reckitt Benckiser (RB.) has grown its price from £8 in 2000 to £34. Enough said.

(NB. Historical earnings per share is not available but share price is used for illustrative purposes)

U.S. Healthcare bill passes House of Representatives

On Sunday evening President Obama scored a major personal victory, with the House of Representatives approving the Senate bill overhauling the U.S. health-care system with the aim of extending insurance coverage to about 32 million Americans. The margin of victory was narrow, with the vote in favour 219 to 212 to approve the bill. All Republicans and 34 Democrats opposing. It bans insurance company practices like denying care for pre-existing conditions, imposing lifetime caps on coverage, while providing subsidies to buy private insurance in newly-created marketplaces called “exchanges”.

This means its potentially bad news for the big pharmaceutical companies given pricing concerns for the new "exchange" insurance schemes which may create downward pressure on reimbursement prices for branded drug. On the flip side, the extra population covered by the scheme will drive additional volumes of prescriptions. Astra Zeneca (AZN)  generates half its earnings in the U.S., whilst GSK, Novartis and Roche generate over a 1/3 of their earnings in the American market. 

FIVE U.K. STOCKS WITH POTENTIAL FOR SHORTING

Contrarian Investor UK have been looking for stocks on the U.K. market which look overvalued and are candidates for a shorting strategy and here is my top 5 watch list. The FTSE All share is now up nearly 10% in the last month and 53% for the last 12 months and has tracked the move upwards on the U.S. Dow and S&P 500 (the S&P is up 10.5% in the last month). The strength in the overall market and generally bullish tone makes picking some overbought shares a tempting proposition as I feel that there is scope for a set back, albeit minor, in the next few weeks. Contrarian Investor UK uses Contracts for Difference (CFDs) through Igmarkets to enable stocks to be shorted i.e. with a hope that the price of a stock will go down in the future. However, spread betting using platforms such as IG index is also another easy potential online platform which allows buying as well as selling of individual shares and indices.

1. SSL International (SSL)
At £7.75 (52 week range £4.26- £7.89), health and personal care company, SSL trades on a price/earnings of 24 (based on earnings to year end March 2010) and a forward p/e for 2011 of 19 (based on earning of 40p per share in 2011). Garry Watts, its chief executive, has set a goal of increasing its earnings per share by 50pc over the three years to March 2012.

SSL's share price has been premium priced for years because of persistent rumours that Reckitt Benckiser will acquire the company to get its hands on its Durex and Scholl brands. But Reckitt's CEO Bart Becht is known for his prudence when its comes to acquisitions. Although Reckitt's paid a full price for both the Boots Healthcare International and Adams Therapeutics businesses, a takover of SSL for £9-10 would be difficult to justify given 1)it is unlikely that RB could accelerate the growth of SSL power brands too much faster given SSL has done a good job in delivering strong growth over the last 5 years 2) there is a portfolio of second line brands which were acquired during the 1990's particularly in Over the Counter (OTC) medicines which add significant complexity to the business and limited earnings e.g. Meltus, Cuprofen. Though these could be sold on, why pay a premium price for these brands? 3) SSL's organisation is relatively lean and therefore unlike the Boots acquisition, cost saving measures would not come as easily.

SSL has been busy beefing up its East European presence and now has strong growth prospects in Russia and other markets. It increased its presence in the Russian condom market by raising its stake in its BLBV joint venture in February. The company now generates about 85pc of its revenues from outside the UK. However, there are still significant risks in these markets as economic growth is still muted. The share price does not have the benefit of a good dividend, currently SSL yields 1.3%.

Although SSL's management has been doing a lot of the rights things over the last 5 years e.g. focusing growth on brands like Durex, emerging markets expansion, the high expectations for earnings growth in 2011 and 2011 and takeover rumours which justify the premium rating can easily fall apart if there is a glitch in any of its key markets. Investor's Chronicle featured SSL as a sell this week, and I agree with their assessment.

2. Reckitt Benckiser Group (RB.)
I have covered my reservations about healthcare and household company, Reckitt on a previous Contrarian Investor UK article published on Sunday 14th February (http://contrarianinvestoruk.blogspot.com/2010/02/reckitt-benckiser-certainly-not-good.html). At £35.11 (52 week range £24.96-35.45), the p/e is relatively undemanding at 18 and has a 2.9% dividend yield but my key concern remains the earnings impact of a generic competitor to opoid abuse drug, Subuxone in the U.S.. Suboxone accounts for 18% of group operating profits and around 10 percent of group profits. In the U.S. the drug accounts for half of the pharmaceutical divisions earnings and the North American operation represents two-thirds of total pharma sales.

3. ARM Holdings (ARM)
Chip designer, ARM (ARM or NASDAQ ARMH) currently trades at £2.27 (52 week range £0.98-2.32), rising from £1.95 over the last month alone as rumours have swirled around that Qualcomm (QCOM) is considering a bid. The company trades on a demanding 2010 p/e of 32.7 and 2011 of 27.5 as the company is seen to be geared to the huge growth in smart phone demand. The Cambridge-based firm had at least one of its chips in 90pc of all smartphones sold last year.

But directors have recently been selling the stock. For example, Tudor Brown (Chief Technical Officer and one of the founders) sold over £1 million of stock on March 9th. On March 11, RBS downgraded the stock despite the positive outllook for semiconductor stocks on valuation grounds and the Qualcomm rumours seem unlikely given competition concerns and a negative reaction from mobile manufacturers. Despite the positive fundamentals of the business, the share price seems to have gone a little over board and ARM therefore represents a good short at anything close to £2.30.

4. Rightmove 
Online estate agency, Rightmove (RMV) has had a tremendous share price move, rising from a low of £2.25 in March 2009 to its current £6.58, a rise of nearly 300% and not far from its 52 week high of £6.77. A renewed positive sentiment in the U.K. housing market has helped lift the shares and driven revenues back up as properties come onto the market for sale and hence Estate agents to use Rightmove as an advertising vehicle. It trades on a forward p/e of 19.7 and yields about 2%. Underlying operating profit for the 12 months to 31 December rose 2% to £41.9m on revenue down 6% to £69.4m. Pre-tax profit fell 1% to £37.8m from £38.2m.
Revenues for the second half of 2009 were 7% higher than in the first half and, by the end of 2009, monthly revenues had moved back toward their pre-crash peak. Costs were slashed by 17% to £27.5m as the company cut 16% of its admin staff during 2009. Broker Numis has upgraded full-year 2010 profit estimate to £52m from £50m and 2011 forecasts rise to £60m from £55m. Giving a 2011 forward p/e of around 16.

Of course these earnings estimates are dependent on a continued turn around in the U.K. housing market.The number of first-time buyers who expect to enter the housing market in 2010 has declined, which is concerning. The company's Q1 2010 Consumer Confidence Survey, which measures the public's property market views, revealed that the number of projected first-time buyers for the 12 months ahead has dropped for the third consecutive quarter. Only 26% of those who expect to buy in the next 12 months will be first-time buyers, a drop from 28% in Q4 2009 and 31% in Q3 2009. 

5. Astra Zeneca (AZN)
I have written about my negative stance on Astra Zeneca back in January (http://contrarianinvestoruk.blogspot.com/2010/01/astra-zeneca-azn-cheap-or-not.html) and my thoughts have not turned for the better after the failure of Recentin (cediranib) to reach its primary end point in the Horizon III clinical trial. Eight patents on drugs that represent 60 percent of Astra Zeneca's current sales are due to expire by 2016 and drugs like Recentin are desperately needed to fill the whole left by major patent losses on drugs such as Crestor and Pulmicort. Altough Astra trades on a forward p/e of only 7 and has a 5% dividend yield, patent expiries make earnings in 2011 and beyond hazy and the company has said as much. Heavyweight cost cutting is being done to try and stem the tide but success in the laboratory is needed and unfortunately Astra has been plagued by clinical trial failures on promising new molecules over the last 10 years. If AZN moves much beyond £30 (currently £29.22), this represents a good short opportunity and a move back towards its highs of £31 would make it an excellent shorting trade.

Horizon III clinicial trial failure puts further pressure on future AstraZeneca earnings

AstraZeneca (AZN) had yet another piece of bad news on Monday from its R&D pipeline with the news that cancer drug, Recentin (cediranib), failed to meet the primary endpoint in the Horizon III study. The company was evaluating the effectiveness of Recentin in a phase II/III study compared with Roche’s Avastin (bevacizumab), both in combination with chemotherapy in patients with first-line metastatic colorectal cancer (mCRC). As reported in a previous Contrarian Investor UK article, Horizon III was identifed as a high-risk study for Astra. The company also reiterated its financial guidance for 2010 and announced further cost cutting measures including site closures. The company guided for 2010 earnings of £3.80 ($5.75) to £4.10 ($6.15) , lower than the £4.20 ($6.32) reported in 2009 and putting the company on a forward price/earnings (p/e) of just over 7. With the loss of patent proection on cancer drug, Arimidex, and asthma drug, Pulmicort, in the US, the company expects a mid single-digit decline in revenue in 2010.

The pressure for Astra Zeneca to deliver on its R&D pipeline is signficant given the large number of patent expiries over the next 3-4 years. The failure of Horizon III puts the risks ahead for Astra into perspective and although the company trades on an undemanding forward p/e of 7 (compared to sector peers of 10 or so), the picture into 2011 and beyond is hazy. Although the company is focused on earnings growth through cost cutting, the scale of the patent expiries ahead means this will not be enough to sustain earnings per share. Astra has been plagued by bad luck in clinical trials, they need this luck to change quickly before Contrarian Investor UK advises this stock above other more diversified pharma stocks.

Doubts about Recentin and ex dividend hits Astra Zeneca

Astra Zeneca (AZN) was down over 3% this morning to £28.32 as concerns about whether its bowel cancer drug, Recentin (cediranib) in a head to head phase III clinical against Roche's Avastin would be positive when results are released in the first half of 2010 (Horizon III trial). The stock also went ex-dividend today. Recentin failed a final stage clinical in lung cancer in 2008 and focus is now on colo-rectal cancer.

Contrarian Investor believes a good entry point for AZN would be around the £25 mark.

Astra Zeneca news today supports negative view on the company

AstraZeneca (AZN.L) disappointed the markets today with downbeat forecast for 2010 and failed to hit fourth quarter earnings estimates. EPS (earnings per share for 2010) would be in a range of $5.75 to $6.15, down from $6.32 in 2009. Astra's core pretax profit rose 10 percent to 2.88 billion in the fourth quarter, giving earnings per share of $1.42 on sales up 9.0 percent at $8.95 billion. Analyst estimates for earnings, which exclude certain restructuring costs and charges, to come in at $1.57 per share and sales at $8.85 billion. Sales of cholesterol-lowering drug Crestor rose 20 percent to $1.26 billion, while gastrointestonal product Nexium fell 7 percent to $1.28 billion.

 Astra said that "The next five years will be challenging for the industry and for the company, as its revenue base transitions through a period of exclusivity losses and new product launches," Revenue for 2010 will be hit by the expected loss of U.S patent protection for breast cancer drug. Arimidex and asthma drug, Pulmicort.


Astra said it expected a fall in sales of up to the "mid-single-digit" in 2010 as benefits from H1N1 swine flu vaccines and unexpected revenue from heart drug Toprol XL, thanks to market withdrawal of generic competitors, wash out.


In order to mitigate the impact of patent expiries and previous failures in the R&D pipeline on future earnings, Astra said it would buy back up to to $1 billion in shares in 2010 and would cut an additional 8,000 jobs as it seeks to cut costs.


As I wrote a couple of weeks ago, Astra’s relatively low P/E (2011 forward P/E of 8) versus its industry peer group is enticing but the news today’s supports the hypothesis that there is much risk in the company’s future earnings stream. The shares are down 3% today to £29.60.

ASTRA ZENECA (AZN) - cheap or not?

BACKGROUND

AstraZeneca is one of the world's largest pharmaceutical companies, with 2008 sales of $31.6 billion and $6.1 billion in profits. 2009 sales are expected to top $32 billion.


It is interesting to note Astra Zeneca's (AZN) relatively low forward price/earnings ratio (around 8 for 2010 and 2011) versus its peer group and healthy dividend (4.1%). This appears to make it attractive versus other companies in the pharmaceutical space who generally trade on p/e ratio's above 10.  But before buying the stock "hand over fist" it is worth considering that the company formed from the merger of Astra of Sweden and Zeneca of the U.K. in 1999 has experienced a run of failures of drugs in late-stage clinical trials which makes the earnings picture hazy from 2014 onwards. Despite substantial R&D investment, the company's development pipeline has failed to produce a strong stream of future blockbuster drugs. Phase III clinical trial failures over the last 5 years include Galida for diabetes, Exanta to prevent thrombosis (blood clots), NXY-059 for stroke, Iressa for lung cancer, and AGI-1067 for prevention of atherosclerosis (hardening of the arteries).


After this long run of failed late-stage clinical trials, in order to boost its pipeline, AstraZeneca completed the acquisition of vaccine maker MedImmune in June 2007, paying $15.2 billion, a significant price premium to what analysts considered a good buy. Subsequently, AstraZeneca consolidated its biologics portfolio in MedImmune having also acquired Cambridge Antibody Technology (CAT) in 2007 again at a premium price.


AstraZeneca has eleven blockbuster drugs (with $1 billion or more in annual sales) in five different therapeutic categories. The strong performance of these drugs has driven earnings growth in recent years. These are (based on 2008 sales):

• Nexium $5.2 bn- gastro intestinal
• Seroquel $4.2 bn - anti psychotic
• Crestor $3.6 bn - cholesterol lowering
• Symbicort $2.0 bn - respiratory
• Arimidex $1.8 bn - cancer
• Pulmicort $1.5 bn - respiratory
• Atacand $1.5 bn - cardiovascular
• Casodex $1.3bn - cancer
• Synagis $1.2 bn - infection
• Zoladex $1.1 bn - cancer
• Prilosec $1.0 bn - gastrointestinal

POTENTIAL NEGATIVE DRIVERS
Litigation
AstraZeneca's most successful drug for the treatment of psychiatric disorders is Seroquel. Seroquel competes in the antipsychotic drug market, and can be used to treat  conditions such as schizophrenia.  However, the drug may significantly increase the risk of diabetes and the company is facing several thousand lawsuits involving 15,000 patients alleging that the company knowingly downplayed weight gain and diabetes risks. In mid 2008, AstraZeneca won a U.S. patent battle against generics manufacturers, securing its exclusivity to Seroquel until at least 2011.Sales of the drug were $4.45 billion in 2008.


Patent Expiry
Patent expiry issues are the largest drag on AZ's earnings outlook. Pharmaceutical patents generally last about 20 years during which a pharmaceutical company has an exclusive right to manufacture a particular drug (it can take well over 10 years to bring a new drug to market from discovery). After the patent expires, generic versions of the product can be produced and sold by competitors. Generic medication is cheaper than brand medication, undercutting the pricing power of the original pharmaceutical producer. Generally speaking the loss of patent protection for brand named drugs may reduce sales by close to 90%.


Eight patents on drugs that represent 60 percent of Astra Zeneca's current sales are due to expire by 2016. The company also has eight products near the end of its product pipeline and launch. However, it is not clear whether all of these drugs will receive regulatory approval or whether they can replace sales lost to generics.

AstraZeneca's Pulmicort was the subject of a patent infringement settlement in late 2008. Israel-based Teva Pharmaceutical Industries had released and been selling a generic version of the drug in the United States, but AstraZeneca threatened with a law suit and successfully forced a settlement. Teva will cease sales of the drug until December 2009, when it will pay AstraZeneca royalties.Nexium, which treats stomach ulcers and heartburn, is one of the world's biggest selling prescription medicines with annual sales of around 2.6 billion pounds. AZ has reached an agreement with Ranbaxy to produce a generic version from May 2014, delaying introduction of competition by several years.

POTENTIAL POSITIVE DRIVERS

New drug indications
AstraZeneca's anti-cholesterol drug, Crestor had $3.6 billion in sales in 2008 with its patent due to expire in 2016.. In December 2009, the U.S. FDA panel backed an expansion of Crestor's labelling to treat patients with relatively low cholesterol levels who are otherwise at risk for heart disease. This expansion could open the market for Crestor significantly, the FDA estimates by an additional 6.5 million patients, and 2012 projections for the drug now reach $6.75 billion, almost double 2008 sales.


New products

One promising drug for AstraZeneca is Brilinta, a late-stage development drug which thins blood and helps prevent complications after surgery or in those patients at risk from stroke or heart disease. The drug, also known as ticagrelor, has been shown in a study to have lower death rates than competitor Bristol-Myers Squibb Company (BMY)'s Plavix.

During 2009, data from the PLATO trial of 18,600 patients with acute coronary syndromes (ACS) demonstrated a 16% relative risk reduction in death from cardiovascular causes, myocardial infarction (MI) or stroke and a 22% risk reduction of death from any cause, compared to current market leader,Sanofi Aventis' Plavix.The extent of this benefit in favour of Brilinta was at the top end of analyst expectations' and even outshone Effient in terms of efficacy, Eli Lilly’s (LLY) antiplatelet agent which received regulatory approval in 2009.. However, while Effient’s improved efficacy over Plavix comes at a significant cost of an increased risk of major bleeding, the Plato data showed no overall difference between Brilinta and Plavix in major bleeding rates.

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There were some concerning safety and efficacy signals from the PLATO data. Although Brilinta was similar to Plavix looking at the risk of major bleeding events, AstraZeneca's drug did cause significantly higher rates of minor bleeding, as well as showing a trend for increased intracranial bleeding and strokes, although these were not statistically significant. In addition, Brilinta caused a higher rate of breathlessness and increased blood levels of uric acid and creatinine, side-effects that have not previously been observed with either Plavix or Effient. However, most analysts and experts do not expect these more minor safety issues to be a barrier to approval, although clearly they will attract particular regulator scrutiny and will be part of any post-approval risk management programme. What was attracting slightly more concern was sub-group analysis which revealed an anomaly in the U.S., the biggest commercial market for Brilinta. The Plato trial was divided into 66 sub-groups, 33 covering safety and 33 over efficacy. Of the 33 efficacy sub-groups, 30 were consistent with the overall trial results, however two groups in North America showed no benefit with Brilinta with a trend towards a worse outcome. Trial investigators are so far at a loss to explain this anomaly, having already re-examined the data for clues. The negative result could be down to regional differences in patient populations or practice patterns, or just a “statistical fluke”.

Whilst clearly a risk, and of specific concern for FDA approval, given the overwhelming nature of the overall positive data, the drug is likely to be approved, but the regulators may well request  additional studies in the U.S.  which may put back approval 12 months or more.

One of AstraZeneca's largest new products is Onglyza (saxagliptin), a diabetes drug co-developed with Bristol-Myers Squibb and approved in the U.S. in mid-2009. However, even before its launch in 2009, competitor Novartis has developed a drug called Galvus. The two drugs share significantly similarities in chemical structure and pharmaceutical action, so it is unclear how Onglyza will perform in the market


Dividend Yield
Astra Zeneca has a commitment to paying a good dividend. Currently the stock is yielding 4.2%.


SUMMARY
The firm faces many challenges in the mid to long term.  AstraZeneca's prospects after the year 2010 are unclear. Despite a 28% increase in research and development spending in 2007 to $5 Bn and another $5 Bn in 2008, it has failed to produce any truly ground breaking drugs to complement its portfolio largely due to bad luck with late stage clinical trial failures. Brilinta is a vital component of AZ's patent expiry protection plan.


BUY OR AVOID?
Positive news on Crestor and Brilinta is a solid start to cover the $20 billion plus of patent expiries due over the next 5 years. But much remains to be done in terms of new products and as the company knows only too well, commercialisation of drug discovery doesn't always go to plan.


AZ is purely focused on pharmaceuticals unlike competitors like GlaxoSmithkline, Johnson and Johnson and Novartis which means that drug failures have a disproportionate impact on future earnings growth. In addition the patent expiry situation will hit earnings hard if new products of a signficant size are not delivered consistently.

The company may also embark on another round of acquisitions to strengthen the R&D pipeline and they have a history of paying top prices. On the other hand, AZ itself may be target of a takeover but at close to £46 billion market capitalisation, it would be difficult particularly in this environment where bank funding of debt is still not normalised. A friendly merger, perhaps with the likes of Novartis is a more likely scenario.


Although the company is not expensive based on classical valuation metrics, the risk appears signficant that things may not go to plan due to the usual uncertainty with clinical trial success and regulatory scrutiny. I am avoiding Astra Zeneca for now, especially with price going over £30 with the pharmeceutical sector being upgraded over the last few days. AZ seems a share to buy on a set back rather than now after its very strong run from close to £27 at the end of 2009 to its current £31 (52 week range £21.47-£31.08). Amgen remains a favourite for Contrarian Investor in this sector.