It has been a good week for equities, as encouraging earnings reports and a flurry of merger and acquisition activity in the pharmaceutical sector enhanced sentiment among investors.
Pharmaceutical stocks drove equities higher after the sector benefited from reports that AstraZeneca had been the target of a tentative takeover approach from Pfizer of the US. Simultaneously, news of an asset swap between GlaxoSmithKline and Novartis, combined with a takeover battle for Allergan, the maker of Botox, drove equities higher.
Analysts expect this could lead to more asset swaps among large corporations and with many companies carrying healthy cash balances it increases the likelihood that we are finally going to see the merger and acquisition boom that the Federal Reserve’s quantitative easing was always destined to create.
The US earnings season got into full swing, with about a third of S&P 500 companies reporting this week and thus far the majority have managed to beat forecasts. Boeing and Apple were among other bellwethers to exceed first-quarter expectations.
Following a shortened Easter trading week, there was a lack of macro-economic influence, although the general theme points towards further recovery. Better economic news from the Eurozone helped move peripheral government bond yields lower, as the flash composite purchasing managers index for the region came in at a 35-month high. The composite output index rose to 54.0 in April from 53.1 in March, while the new orders element also grew at its fastest rate for three years.
Euro-area consumer confidence also unexpectedly increased to the highest in six and a half years this month, exceeding analysts’ expectations as the unemployment rate retreated from a record high. Household confidence in the Eurozone rose to minus 8.7, the highest since October 2007, beating forecasts of minus 9.3, while the German Ifo index also bettered expectations.
Meanwhile, Britain’s economic recovery continued to gain momentum, with retail sales bouncing back, helped by a late Easter. The Confederation of British Industry’s retail sales balance jumped to +30 from +13 in March, well above economists’ forecasts for a rise to +17. The Bank of England expect the economy to have grown by 1% in the first three months of this year, with evidence of a sustainable rise in real wages.
In Asia, China’s factory activity shrank for the fourth straight month in April, although the pace of decline eased, helped by policy steps to arrest the slowdown. The HSBC/Markit flash PMI for April rose to 48.3 from 48.0 in March, but analysts see initial signs of stabilisation in the economy due to the governments targeted measures to underpin growth.
US data remained upbeat, with durable goods orders rising more than expected in March, amid a surge in business capital spending plans, bolstering views of accelerating growth in the second quarter. Initial jobless claims also improved, although new home sales fell 14.5% in March, representing the lowest annual rate since last July, though the pace for January and February were revised higher.
Technical analysis of the FTSE 100 illustrates this week’s move to fresh short-term highs, suggesting a new uptrend could be underway, although trading volumes have remained thin over Easter. The oscillators are moving higher, indicating improved momentum behind the recent strength, with the 13-year high at 6860 seen as the next target. Meanwhile, support should come from the 50-day moving average at 6640 and 6525.
In conclusion, markets have benefited from a cocktail of strong earnings, corporate M&A and encouraging macro-economic data, with headwinds easing from China. A growing sense of unease over developments in Ukraine remains a risk, with Russia operating military exercises on its border with Ukraine in response to Kiev’s crackdown on armed pro-Moscow separatists. Technical analysis points towards further upside, but with the US indices fast-approaching their all-time highs, there could be some short term profit taking until the outlook for Ukraine is brighter.
AstraZeneca topped the blue-chip gainers this week amid takeover speculation from Pfizer, with the market choosing to ignore another disappointing update from the Anglo-Swedish multinational, despite neither company confirming the news. Given Pfizer’s extensive cash pile held outside the US, combined with the highly anticipated consolidation within the pharmaceutical sector, I can understand why a deal might be done.
Chief executive Pascal Soriot, however, declined to comment on the rumour and people familiar with the matter have said there are no talks or negotiations currently going on between the two companies. Market etiquette might also expect either company to have broadcast a statement confirming they are in talks.
Meanwhile, first quarter results revealed another sharp fall in profit, dented by generic competition to its drugs, higher research, development and sales expenses, and foreign exchange movements. AstraZeneca’s net profit for the quarter fell 50% to $504 million, from $1.01 billion in the same quarter of the previous year, while core earnings per share fell to $1.17 from $1.41 a year ago, below expectations of a drop to $1.20.
The company has been struggling from one of the industry’s worst “patent cliffs”, or lower-cost competition to its patented drugs, such as cholesterol treatment Crestor and antipsychotic Seroquel. Much work is being done to improve the pipeline, with 104 ongoing projects, of which 90 are in the clinical phase of development, including the launch of a late-stage trial in a much-anticipated lung-cancer drug.
An increase in both acquisitions and research costs are, however, squeezing profits lower, with many analysts forecasting both sales and profits will decline for the next three years and the company admits it doesn’t expect a recovery in revenue until 2017.
Following the recent spike in the share price, the company now trades on 16.5x earnings, falling to 17.5x in 2015, a significant premium to the sector and FTSE 100 peer GlaxoSmithKline that trades on 14x prospective earnings. Shareholders will receive a 4.1% yield, which looks safe with operating cash flow rising from $6.95 billion to $7.4 billion, comfortably covering the dividend payments totalling $3.46 billion.
The chart of AstraZeneca illustrates the recent spike to all-time highs and the subsequent jump in the oscillators, but further analysis is immaterial given this week’s speculation.
Year-on-year comparisons are likely to get tougher from the second quarter and without an official bid, shareholders will be left holding a highly-rated stock, offering a 4.1% income return. In addition, the drug pipeline bears no fruit for at least two and a half years.
At the time of writing the share price is 4175p, which I believe is too high given the weak fundamentals. Current shareholders might consider taking profits and the brave may contemplate shorting the stock. Downside targets are seen at 3966p and 3801p, while a stop-loss above the intraday peaks at 4342p offers protection should a bid transpire.
This report was written by Mark Allen – Head of Derivatives at Simple Investments Stockbrokers. The writer does not hold a position in AstraZeneca, but client accounts may. The material in this report has come from Simple Investments internal data sources, Simply Charts and AstraZeneca’s corporate website.