Woodford: Setting the record straight

24 February 2011 12:35 pm | By Chris Salih

Invesco Perpetual income manager Neil Woodford believes poor current market valuations represent a once in a decade opportunity.

In an interview with Money Marketing at the Fund Strategy Investment Summit in Kitzbuhel, Austria last week, Woodford said his stock views are being drowned out by his macro-views in the media and that the pharmaceutical sector, in particular, represents one of the best investment opportunities in his entire career.

He said: “This is the best investment opportunity on the whole since the tech bubble in 2000. From time to time, stockmarkets get swept up by momentum that has nothing to do with fundamental valuations, which, in the long run, is the only thing that really matters.”

Woodford said the tech bubble is a good example of the stockmarket going through periods where valuations could not be more irrelevant.

He said: “In that case, the valuation attached to anything to do with a new economy was off the clock. The corollary of that was anything to do with old economy was perceived to be dead or prehistoric and that created a fantastic opportunity but, for a two-year period, the market was obsessed with this momentum investing philosophy and valuation became irrelevant. There are similarities to that situation now.”

Woodford acknowledges that pharmaceuticals have been the biggest negative contributor in his £7.9bn income and £10bn higher-income portfolios in the past two years. Despite this, Woodford has increased that weighting from 22 per cent to 25 per cent of his funds.

He said: “The market has completely misread the fundamentals of the industry. It has aligned a high-level concern on industry dynamics with stock prices. My job is not to invest in great businesses but undervalued ones.”

Woodford said a 25-year review of the tobacco sector shows it has produced a total shareholder return of over 9,000 per cent, way ahead of its nearest rival mining, at almost 5,900 per cent.

He said: “There has been a more attractive time for tobacco in my investment career but not pharmaceuticals. I think that sector represents the opportunity today that you may have seen in tobacco 25 years ago.”

Woodford said AstraZeneca is the perfect example of this opportunity, a stock which he has dubbed “the least loved stock in the least loved sector”.

Woodford points to a note from Citybank analyst Kevin Wilson which has a 10-year forecast that shows Astra Zeneca has a market cap of $65bn and $4bn of net cash on its balance sheet. Wilson’s figures show the company will create $134bn of free cashflow after tax over 10 years.

Woodford said: “That is genuine free cashflow, over twice its market cap. It also models the fact that, over that timeframe, the company will spend $50bn on research and development, $10bn on capital expenditure and around $73bn will come back to you in dividends of buybacks. More than the current market cap will come back to you in cash and dividends over the next 10 years after this company spends $50bn.”

Woodford said not only will investors get their money back over 10 years, the company will spend roughly the market cap of Tesco on research and development.
He said: “What this analyst is assuming is that this comp- any will build Tesco and then burn it to the ground and you will still get your money back over 10 years and retain your holding. You are not paying a bean for the pipeline of drugs which are effectively coming for free.

“It is worse than that because analysts are assuming you will spend $50bn in 10 years on the pipeline and get nothing back I have never seen valuations like this. These companies have spent a decade going nowhere with their prices being largely unchanged.”

Woodford also highlights Roche, which a few months ago was yielding more than 10-year government bonds in Gabon.

He said: “10-year government yields in Gabon at 5.4 per cent are bordering on insane but what is more insane is a 5.6 per cent dividend yield on Roche, one of the highest-quality, richest, best cashflow companies in the world.

“It tells you something is wrong when Gabon is deemed a lower piece of paper to hold while the yield on the pharmaceuticals stock is so high.”
Woodford said 25 per cent of his portfolio is currently in pharma stocks, up from 22 per cent at the start of the year, with AstraZeneca joined by the likes of GlaxoSmithKline, Novatis and Roche as well as a number of smaller biotech stocks.

He said: “I expect that holding will grow. There are natural limits for the sector you will bump into but in the 1990s I had 30 per cent in banks but I could envisage pharmaceuticals going up to and above 30 per cent.”

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