Thorny subject

The Federal Reserve disclosed on Wednesday in the release of their latest FOMC minutes, the subject of how and when to raise interest rates were discussed. What will happen to monetary policy around the globe continues to dominate investor thoughts. In the left hand corner we have Japan and the ECB, where speculation is about the possibility of increasing monetary stimulus. In the right hand corner the Federal Reserve and the Bank of England, whose next move is expected to be to tighten monetary policy, the question is when? The Federal Reserve has started the process in a modest way by winding down the bond purchase program.

In the UK the debate appears to focus on the strength of the housing market, on Wednesday the Deputy Governor of the Bank of England admitted the only way to cool the housing market in the UK may be to raise interest rates. In the US, according to BCA research, capacity utilisation rates are now at the same level as they were in 2004 when the Federal Reserve raised interest rates. Overnight on Tuesday, Federal Reserve member Prosser, in a speech in Washington, warned that interest rates may have to go up sooner in the US than expected. At present, investors expect the first rate rise to come approximately this time next year in the UK and US. Inflation has started to pick up in the US and the UK, and if that continues speculation may increase a rate rise could come sooner.

Back to the thorny issue of AstraZeneca, and what is the best outcome for the shareholders in the company. Neil Woodford has been vocal, in his view shareholders should reject the offer and trust the board to deliver value through its pipeline of drugs. Until the advent of Pfizer's interest, AstraZeneca was considered an income stock with a yield approaching 6% and analysts appeared to see limited value in this now much vaunted pipeline. Two major Investment banks over the past few days have come out recommending the company shares are worth approximately £50 based on its pipeline. The pipeline potential for AstraZeneca one assumes has not changed materially in the past few days, just the analyst’s view of it. As many papers have pointed out Pfizer's interest is as much a financial transaction as a belief in its pipeline. Drug pipelines are funny things, before a drug comes to the market there are many regulatory hurdles to go through as well as competition from innovative fast moving biotech companies. Unlike drug research, valuing pipelines is more of an art than a science.

AstraZeneca's shareholders only interest should be whether by accepting £55 from Pfizer now (if they get the chance) they could reinvest that capital and find a greater return elsewhere. One thing a shareholder might want to ponder, if they receive £55 now and invests it in an equity fund that gives a compound total return of 5% per annum, you would have approximately £70 in 5 years time. To take AstraZeneca's share price from the current level of £43 to £70 in the next 5 years, keeping it on the same valuation, this pipeline will have to deliver compound earnings growth circa 10% per annum in that period, something it has failed to do over the past 5 years.

Posted on May 22, 2014 .