Is FTSE 100 Stalwart AstraZeneca a Good Value?

LONDON -- Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If bought when the shares are cheap, two drivers could move the share price up:

• Growth in earnings
• An upward P/E re-rating

Highly successful fund manager Peter Lynch classified steady growers as Stalwarts, which he typically traded for 20% to 50% share-price gains. But whether buying for gains like that or holding for the longer term, we need to know if reliable earnings growth can continue, and whether the shares are cheap.

Seeking durable growth
Not all companies achieve stable growth, as you can see by the aggregate performance of those in London's premier FTSE 100 (INDEX: ^FTSE), where the compound annual earnings-growth rate has been just 0.7% over the last five years:

Consistent, cash-=flow-backed growth in profits is a promising characteristic in today's markets, so, for this series, I'm examining firms with annual earnings growth between 4% and 20%.

One contender is AstraZeneca (LSE: AZN.L), a pharmaceutical group, created in 1999 when Sweden's Astra was merged with the U.K.'s Zeneca. Zeneca demerged from chemicals group ICI in 1993.

This table summarizes the firm's recent financial progress:

Earnings have grown at an equivalent 13.5% compound annual growth rate, putting the company in the Stalwart category.

AstraZeneca describes itself as a global, innovation-driven, integrated biopharmaceutical company with a business aimed at discovering, developing, manufacturing, and marketing prescription medicines for six areas of health care: cancer, cardiovascular, gastrointestinal, infection, neuroscience, and respiratory and inflammation.

The firm employs around 57,200 employees in over 100 countries: 46% in Europe, 31% in the Americas, and 23% in Asia-Pacific. It has a growing presence in emerging markets like China, Brazil, Mexico, and Russia. To support its global operations, the company invests around $4 billion in research and development each year.

But according to the directors, pressures on the industry continue to mount. Drivers for long-term growth in demand like significant unmet medical need, growing and aging populations, and the desire for better access to health care in emerging markets are balanced by governments' and the private sector's ability to pay, and the company is seeing increased government intervention on pricing. Meanwhile, health care and R&D costs are rising faster than GDP, a trend exacerbated by ongoing global economic turmoil, and the decline in probability of success for bringing a product from pre-clinical testing to regulatory approval and launch.

AstraZeneca has a good record on profitable growth, but the directors see ongoing headwinds for years to come.

AstraZeneca's earnings growth and value score
I analyze five indicators to determine whether earnings growth can continue and if the shares offer good value:

1. Growth: Cash flow has been declining despite growth in revenue and profits. 2/5
2. Level of debt: Net gearing is around 19% including pension obligations. 4/5
3. Outlook and current trading: Recent trading shows a decline and the outlook is fair. 3/5
4. Enterprise value to free cash flow: Around six is below historic earnings growth rate. 3/5
5. Price to earnings: Around six on historic earnings and below earnings growth rate. 3/5

Overall, I score AstraZeneca 15 out of 25, so I think this stalwart may struggle to deliver earnings growth that outpaces that of the wider FTSE 100 over the next few years. However, when compared to the FTSE's price to earnings ratio of around 10, the firm looks reasonably priced despite its flat growth predictions.

Foolish summary
Although earnings have been growing well, forecasters expect them to decline. The company faces industry headwinds, and that shows up in the recent growth rate for revenue and cash flow. The company carries modest debt, which is encouraging, but the outlook is stilted.

Right now, there is a forecast earnings decline of 20% for 2012 and flat earnings for 2013. The forward P/E ratio is about 8 with the shares at 2,969 pence. Considering that and the other factors analyzed in this article, I think the shares fairly price AstraZeneca so it can stay on my watchlist for now.

AstraZeneca was a steady-earnings-growing stalwart whose problems may be temporary. It has the potential to deliver significant capital appreciation if a return to growth develops.

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