Morningstar is initiating credit coverage of AstraZeneca with a rating of AA, reflecting our positive view of this large drug firm's ability to repay debt obligations even in the face of significant threats to its existing product portfolio.
At Morningstar, we really like the pharmaceutical business. However, we think most large pharmaceutical firms, like AstraZeneca, are entering a tough decade of weak growth or even sales contraction, as many blockbusters are facing patent expiration in the next several years. AstraZeneca, in particular, faces one of the biggest patent cliffs in the pharmaceutical industry. Drugs representing about half of the firm's sales--including gastrointestinal drug Nexium, antipsychotic treatment Seroquel, cholesterol reducer Crestor, and respiratory agent Symbicort--are projected to succumb to generic competition between 2010 and 2016. Generic competition usually leads to a swift, steep decline in sales for most branded pharmaceutical products. While the key to any pharmaceutical firm's long-term success is its ability to reinvent itself by launching new products once old products face generic competition, we think the upcoming hurdle for AstraZeneca is very high. We don't think it will be able to completely replace expected product losses with existing pipeline candidates, and we project low-single-digit annual sales declines for the next 10 years. Restructuring efforts--such as pruning its salesforce, streamlining manufacturing operations, cutting administrative expenses, and outsourcing development efforts--should somewhat mitigate expected revenue declines on the bottom line. Even if those efforts are successful, however, we think profits could decline at AstraZeneca for the foreseeable future.
Debtholders should be comforted by the firm's limited default risk even with this weak outlook. The company's financial position remains very healthy; at the end of 2009, AstraZeneca held $9.9 billion in cash versus $11.0 billion of loans and other borrowings. Also, we think the firm's cash flow will cover interest expenses an average of 30 times in an improving trend during the next five years. Part of our improving interest coverage projection relates to our belief that the firm will repay some of its debt obligations in the next several years, though, so holders of AstraZeneca bonds with relatively high coupon rates should be aware of the call risks inherent in the firm's issues. In addition to reducing interest expenses, management may also attempt to boost earnings per share by repurchasing AstraZeneca shares. While shareholders may appreciate such capital allocation, this activity siphons cash away from interest and principal payments, which could be seen negatively by bondholders. However, even in a worst-case scenario, we don't think management will boost share repurchases so much that they would jeopardise repayment of the firm's debt investors.
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