(AZN) AstraZeneca Shares in Neutral Lane

We are maintaining our Neutral recommendation on AstraZeneca (AZN) with a target price of $49.00. The stock carries a Zacks #3 Rank (Hold rating) in the short run.

AstraZeneca performed disappointingly in the second quarter of 2012. The company’s second quarter 2012 earnings were down 6% year over year at constant exchange rates (CER) to $1.53 per American Depositary Share (ADS). Lower revenues (down 18% at CER) negatively impacted earnings during the quarter.

The generic competition that AstraZeneca is currently facing or expects to face for its various drugs has put significant pressure on the company. Generic competition was primarily responsible for the $2 billion loss of revenues in 2011. The genericization of key products will make it challenging for the company to drive the top line.

In addition to generic threats, AstraZeneca’s products already face intense competition from big companies. AstraZeneca’s lead drug, Crestor (cholesterol management), primarily competes with Merck’s (MRK) Zocor/Vytorin. With the entry of generic versions of Lipitor in November 2011, Crestor may find it challenging to grow market share. Nexium primarily competes with Pfizer’s (PFE) Protonix. Loss of market share due to intense competition will severely impact AstraZeneca’s top line.

AstraZeneca is laying emphasis on bolstering its pipeline through acquisitions and deals to counter the generic threat. In June 2012, AstraZeneca acquired Ardea Biosciences, thereby adding gout candidate lesinurad to its pipeline.

In addition to acquisitions, the company is targeting co-development deals. AstraZeneca inked a deal with Pfizer in August 2012 for the marketing of an over the counter (OTC) version of AstraZeneca‘s Nexium (gastroesophageal reflux disease and peptic ulcers). AstraZeneca will continue marketing the prescription product and also supply the OTC product to Pfizer. Subsequently, AstraZeneca raised its 2012 earnings guidance. AstraZeneca now expects 2012 adjusted earnings in the range of $6.00 – $6.30 (previous guidance: $5.85 – $6.15) per ADS. The guidance was raised as AstraZeneca expects to recognize $250 million as upfront payment from Pfizer for the Nexium OTC deal as other income in 2012. This will boost its balance sheet.

AstraZeneca is also focusing on emerging markets. Revenues from emerging markets climbed 10% year over year to $5.8 billion in 2011. Emerging markets represent significant commercial opportunities with factors like pricing pressure in the EU and intensifying generic competition affecting sales in large pharmaceutical markets. AstraZeneca strengthened its presence in the promising Chinese market with its global biologics division MedImmune joining forces with WuXi AppTech, a subsidiary of China-based WuXi PharmaTech Inc. (WX), to develop and commercialize MEDI5117 in the country. MEDI5117 is being developed for autoimmune and inflammatory diseases such as rheumatoid arthritis.

In view of the challenges facing AstraZeneca, we see limited upside from current levels.

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