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The 3 Biggest Risks Facing AstraZeneca

http://www.fool.com/investing/international/2012/11/28/the-3-biggest-risks-facing-astrazeneca.aspx

Malcolm Wheatley
November 28, 2012

LONDON -- The world's fifth-largest pharmaceutical company, with operations in more than a hundred countries worldwide, AstraZeneca (LSE: AZN.L  ) (NYSE: AZN  ) is a business with very definite attractions. A 36-billion-pound FTSE 100 constituent, last year the company earned a pre-tax profit of $12.4 billion on revenues of $34 billion.

And with margins like that, it's no wonder that this defensively-positioned business is popular with many investors. Today, with its shares changing hands at 2,892 pence, the company is rated on a cheap-looking prospective price-to-earnings ratio of 8, and offers income investors a very tempting forecast dividend yield of 6.4%.

But how safe is that share price? And -- of vital importance to income investors -- how safe is that dividend? In short, how could an investment in AstraZeneca adversely impact investors' wealth?

In this series, I set out to answer just these questions. My starting point: AstraZeneca's latest annual report, where the company's directors are obliged to address the issue of risk.

Risk management
One immediate thing that I'm looking for is an acknowledgement that risks do exist and that they need managing.

The good news? As you'd expect from a business of AstraZeneca's size and caliber, the company has in place a risk management policy, a system of regular reviews, and a number of high-level committees tasked with monitoring the risks that the business has identified.

But what, precisely, are those risks that the company faces?

Read the small print, and AstraZeneca identifies no fewer than 29 risks as having a significant prospective impact on the company's financial performance. They range from delayed regulatory approvals to taxation, and from illegal trade in its products to patent litigation.

So let's take a look at three of the biggest.

Failure to meet development targets
Fairly obviously, AstraZeneca's shares are cheap -- and the prime reason for this is to do with investors' worries over its product pipeline. In short, this is seen as weak, with insufficient new products coming on stream as patents expire on old ones. As AstraZeneca puts it:

The development of any pharmaceutical product candidate is a complex, risky and lengthy process involving significant financial, R&D and other resources, which may fail at any stage of the process due to a number of factors. A succession of negative drug project results and a failure to reduce development timelines effectively or produce new products that achieve commercial success could adversely affect the reputation of our R&D capabilities, and is likely to materially adversely affect our financial condition and results of operations.

In many ways, it was the perceived failure of former chief executive David Brennan to get to grips with this issue that led to his removal earlier this year. And there's no doubt that investors are worried: Sales during the three months to the end of September slid almost 20%, thanks to the patent expiries of treatments such as the antipsychotic Seroquel. That said, new chief executive Pascal Soriot -- who joined the company from Roche -- is well aware of the problem, as is the rest of the board.

Delay to new product launches
In the pharmaceutical business, patenting a new treatment is one thing, and bringing it to market in a timely manner quite another. As the company puts it:

The anticipated launch dates of major new products have a significant impact on a number of areas of our business, including investment in large clinical studies, the manufacture of pre‑launch product stocks, investment in marketing materials pre‑launch, sales force training and the timing of anticipated future revenue streams from new product sales. For example, for the launch of products that are   seasonal in nature, delays in regulatory approvals or manufacturing difficulties may delay launch to the next season which, in turn, may significantly reduce the return on costs incurred in preparing for the launch for that season.

In short, execution is everything -- as the company knows too well. One slip, and the hit to revenues is almost unavoidable. AstraZeneca knows the dangers, to be sure. But can it avoid them? Time will tell.

Price controls
In many countries, health care costs consume an increasing amount of