Core Defensive – Pharmaceuticals

With the market at its current level and entering the traditional lacklustre summer months, we are relatively cautious on shares in the short-term and are favouring defensive stocks in general given that:

1) their current outperformance is relatively modest;

2) seasonal trends come into play (defensive stocks tend to outperform in the summer months);

3) defensives remain under-owned;

4) long-term earnings expectations for defensives are at a record low relative to cyclicals;

5) defensives trade at long-term valuation lows versus cyclicals on a variety of valuation metrics;

6) macro newsflow is likely to weigh on risk appetite.

With this in mind, we are advising investors to add some exposure to pharmaceuticals. Post poor long-term performance, the sector offers good value and any USD strength associated with the end of QE2 should offer support.

Our pick of the UK sector is Astrazeneca (see research note attached), trading on a low 2011E p/e multiple of 6.9x and yielding 5.26%. We see Astrazeneca as having a better chance of outperforming expectations than sector peer GlaxoSmithKline where the return to sustainable growth looks factored into the City’s forecasts and the 40% 2012e p/e premium to Astrazeneca.

For those invested in GlaxoSmithKline, we would take advantage of Glaxo’s recent strong performance and use this as an opportunity to switch into a higher yielding and better performing stock. For option traders the Astrazeneca September 2800 puts look good value at 48p (note the stock will go XD in August by a similar amount).