Once a floundering big pharma with looming patent cliffs and a pitiful pipeline, CEO Pascal Soriot has remade AstraZeneca (AZN 0.41%) in a relatively short period of time. Patent cliffs are still likely to compress revenue for the next year, but AstraZeneca now boasts an appealing pipeline targeting a host of therapeutic classes, including an immuno-oncology pipeline that holds up pretty well to comparisons with Bristol-Myers (BMY 3.42%), Merck (MRK 1.01%), and Roche (RHHBY 0.84%) (Mr. Soriot's former employer).

Fourth quarter results are likely to be a sign of things to come
AstraZeneca had a pretty "blah" quarter in absolute terms. Revenue fell 6% as the sales of leading drugs Crestor and Nexium fell 10% and 5%, respectively, while Symbicort sales rose 10%. Gross margin fell about two points on mix, currency, and less sales leverage, and operating earnings dove 29%.

Shareholders should probably get used to this. With Crestor, Nexium, and Seroquel patents expiring in the coming years, it will be challenging (and quite likely impossible) for the company to show revenue growth absent a large deal. At the same time, the company will be investing heavily to support a deep Phase III and Phase II pipeline and those R&D expenditures are going to pressure profits.

A business undergoing metamorphosis
Assuming that AstraZeneca's operations evolve according to plan, the business is going to be quite a bit different in 2019. Today AstraZeneca has a large cardiovascular franchise (around one-third of sales), but the company has not joined the gold rush for PCSK9 inhibitors and has no particularly interesting cardiovascular drugs in late-stage studies.

Diabetes is also a changing market for AstraZeneca. Buying Bristol-Myers' share of their joint venture does not appear to be a particularly good use of cash, and it is unclear how committed AstraZeneca is to this area over the long term. Farxiga was only just recently approved by the FDA and the company appears committed to developing follow-on indications of Bydureon (including a longer long-acting once-a-month formulation), but it is unclear if the company wants to reinvest the cash flow into early stage development of novel compounds. Still, the deal that AstraZeneca agreed to with Bristol-Myers rankles; AstraZeneca likely could have driven a harder bargain and Bristol-Myers clearly wanted out.

AstraZeneca does appear to be interested in maintaining its place in the respiratory market. Tralokinumab and benralizumab target asthma in different ways and both could become $1 billion-plus drugs, even with ongoing competition from Novartis (NYSE: NVS) and Glaxo and emergent threats from companies like Roche.

The biggest change is a real repriortization of oncology and immunology. AstraZeneca has built an oncology pipeline that looks both broad and deep. Through a partnership with Amgen, the company has also acquired an interesting collection of immunology/autoimmune assets. Brodalumab, an anti-IL-17 antibody in Phase III trials, looks like a drug to watch in psoriasis though Novartis has its own IL-17 drug secukinumab that is looking quite strong. Amgen will get half of the economics here, as well as for other interesting earlier stage compounds under consideration for asthma, Crohn's, and ulcerative colitis.

Oncology will draw the eyeballs
Wall Street seems almost obsessed with immuno-oncology today, and it is not too hard to understand considering the multi-billion dollar potential per drug in areas like lung cancer, melanoma, and so on. Like Bristol-Myers, Merck, and Roche, AstraZeneca has compounds under development in the PD-1/PD-L1 space, with MEDI4736 as the focal point. Like Bristol-Myers and Roche, AstraZeneca is also committing to developing a wide collection of compounds as potential mono- and combo-therapies, including antibodies, antibody drug conjugates, and small molecules, and is definitely looking at dual checkpoint and checkpoint/agonist combinations.

Considering the long-term opportunity
It has taken a while, but AstraZeneca has developed the MedImmune acquisition to the point where MedImmune now accounts for about half of its pipeline. More important than where it came from is where the pipeline is going – the company is looking to start six Phase III studies in 2014 and possibly more than a dozen in 2015, all of which could support more than $9 billion in sales in 2020.

The problem with AstraZeneca from a valuation standpoint is that a lot of this exciting pipeline will go toward offsetting impending sales declines due to patent losses and competition. With that, I am looking for about 2% long-term revenue growth today and similar growth in free cash flow. Due to the way in which I model revenue (risk-adjusted sales), there is very definite upside to those growth rates as subsequent clinical data de-risk the revenue outlook, but there is also the risk of total wipe-outs of individual programs if the data are bad.

The Bottom Line
With shares currently fairly valued in my model, but a higher than normal dividend yield, I don't think AstraZeneca is particularly overpriced, nor much of a bargain. I do like the company's pipeline, which addresses large revenue opportunities like oncology but also offers more balance than Bristol-Myers is targeting at present. In a sector lacking many clear bargains, AstraZeneca is an OK candidate but the company must deliver good news on its late-stage pipeline to create value.