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Novartis as a Core Holding

October 17, 2011 | About:
Chandan Dubey

Chandan Dubey

99 followers
A Brief History

1996 Sandoz and Ciba-Geigy merge to form Novartis.

1997 Spun-off Ciba Speciality chemical business.

1999 Spin-off agribusiness to Syngenta.

2001 Initial stake acquired in Roche, later increased to 33%.

2002 Acquisition of Lek, a generics company in $900 million.

2003 Acquisition of the worldwide adult medical nutrition business of Mead Johnson and Company, a subsidiary of BMY.

2005 Novartis acquires Hexal AG, a leading generics company based n Germany, and Eon Labs, an american generics company making Sandoz a world leader in generics.

2006 Entry into human vaccines through Chrion acquisition, also expanding its ocology franchise.

2007 Novartis completes divestment of medical nutrition business. Sale of medical nutrition and Gerber baby foods to Nestle to concentrate on pharmaceuticals.

2008 Agreement with Nestle to acquire 77% of Alcon.

2009 Sandoz completes acquisition of EBEWE pharma improving global patient access to affordable injectable cancer medicine.

2010 Novartis acquires Alcon, a major player in eye-care.

Key Figures

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II Mission

From the company annual report:

We want to discover, develop and successfully market innovative products to prevent and cure diseases, to ease suffering and to enhance the quality of life.

We also want to provide a shareholder return that reflects outstanding performance and to adequately reward those who invest ideas and work in our company.


III Business Segments



Pharmaceuticals division (60% of sales)

Novartis' pharmaceutical division is its largest. Oncology products are Novartis' largest business unit and give Novartis the second-largest market share in the oncology industry. Cardiovascular products are the second largest and the neuroscience division is the third. Following are the top products of Novartis, out of a $51.5 billion in sales in 2010.

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Generics division, Sandoz (17% of sales)

Novartis' generics division, Sandoz, is its second-largest division. Sandoz has two main areas: antibiotics, with Amoxicillin/Augmentin and anti-allergens such as Claritin.

Consumer Health (12.3% of sales)

Novartis' Consumer Health includes over-the-counter drugs (like Excedrin and CIBA contact lens cleaner). In 2010, Novartis purchased Nestle's (NSRGY) majority share in eye care product manufacturer, Alcon, and now is set to be a major player in the eye care industry.

Vaccines and Diagnostics (5.8% of sales)

These include vaccines for influenza and meningitis as well as pediatric immunizations.

IV Pipeline

Novartis' pipeline is among the best in terms of breadth and number of new products. There are more than 50 new drugs in the Phase II and Phase III. The following are the drugs which are going to be filed in the next few years.

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V Shares

Let us look at the number of shares of NVS in the last 10 years.

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Novartis started repurchasing its shares in 1999 and have completed five share repurchase programs since then, buying shares worth of CHF 19 billion. Most of these shares have been canceled.

In December 2010, the board of directors announced another share repurchase to buyback the shares which resulted due to the dilution which resulted from acquiring Alcon.



Ownership



  • Institutional holding 53%.
  • Daniel Vasella (chairman of BoD) owns 3.28m shares and 3.565m options.
  • Executive committee owns 1.6m shares and 3.5m options.
  • Novartis also owns 33% of the voting right in Roche Holding (RHHBY).


VI Analysis

Profitability and growth

It has very stable margins.

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And a good growth in Book value per share

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It has a good track record of growing sales and FCF (clocked in 11% in the last 10 years).1199328039.jpg

Balance sheet

Novartis has a very good balance sheet. It has done a phenomenal job of maintaining the LT debt well below its equity. The graph is the LT debt and Equity as a percentage of equity+liability.

1950830439.jpg

Dividend

Has a good dividend track record.

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VII Risks

Patent Expirations

Novartis will face major setbacks in the next five years, including its blockbuster drug Diovan and Lotrel. However, in comparison to its competitors such as Pfizer (PFE), El Lily (LLY), BristolMyers Squibb (BMY), Novartis has fewer patents which expire in the short term.

To make things better, Novartis also has a generic division (Sandoz). It has long owned Sandoz and has recently acquired Hexal and Eon Labs (see brief history). It has merged them to make a giant generic division. Because of this Novartis is in a unique position to compete in both the patented market and the generic market. Novartis can also take advantage of the competitors' drugs when their patents expire to offset some of the sales losses from its patent expiration.

Credit risks

The current ratio stands at 1.08 and the LT debt at 14.3b. With 12b in FCF, I see no reason to worry here.

VII Valuation Industry comparison on key ratios

CompanyRocheNovartisSanofi-Aventis
P/E14.513.917.2
P/S2.62.52.1
P/B13.92.21.3
PEG-1.83.7
P/CF8.310.67.2
Yield4.7%3.4%4.4%


Novartis clocked in the best graph in sales growth rate on a five-year average basis in the last seven years.

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It has the stablest Return-on-Invested-Capital.

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Cash flow

Let us look at the sales and the free cash flow. Novartis has a FCF of almost $11 billion in TTM. This is almost the same as Roche.

$m2001200220032004200520062007200820092010TTM
FCF3,6164,6445,3235,4566,8926,69613,6767,34810,30412,38910,874
Sales19,33523,15124,86428,24732,21236,03138,07242,58445,10351,56153,427


First of all, let us make sure that the free cash flow relates well with the income. For great companies, the FCF should outshine the income.

2001200220032004200520062007200820092010TTM
Free Cash Flow/Sales %18.7020.0621.4119.3221.4018.5835.9217.2622.8524.0320.35
Free Cash Flow/Net0.850.891.060.951.120.931.140.901.231.261.13


This seems to be the case with Novartis. Now, let us dig deeper into the valuation.

To be on the safe side, assuming that Novartis' FCF does not grow at all (ie., 0% growth). Following is the table of how much cash will be added into the coffers assuming different discount rates in five years. With 2.7 billion shares outstanding, the values this will add into the share price are as follows.

Discount rate8%10%12%15%
0% growth+47b+45.8b+44.4b+42.4b
+per share17.416.9616.4415.7


Starting from a book value of 28 (as above) the shares will have a book value between 43.7 and 45. With even a 1.5 multiple of book value (NVS sells for 2.2 at the moment) the shares will be worth at least $57. They currently trade for $57, which is a fair price to pay.

This may seem like a bad deal to you based on the conclusion, but notice that we have factored in no growth. So, to reiterate, the current price is fair if you expect no growth. Let us look at the growth in FCF that Novartis has managed in the last 10 years. The FCF has gone from $3.6 billion in 2001 to $12.38 billion in 2010. This is a growth rate of 13%. With even a 10% growth and 15% discount, this gets us $50.4 billion which translates to a share price of $69 with a book value multiple of 1.5 (very conservative again, in growth, discount and the multiple).

Let us now summarize the article with a few question one needs to ask about a long term holding.

Does the company have a moat? Will it be around here for another 100 years?

Yes.

Will the company grow?

It has done a good job in the year since its inception in 1996. Since 2001 the growth has been around 11%. It has a big generic division, which puts it in a unique position to fight at two fronts, in the patented market and in the generics field. I would put here a yes.

Are there significant risks associated with the company?

The patent cliff, yes. See patent risk section. The company has a new drug, Tasigna, which is often noted as a successor to Gleevec, that is losing its patent exclusivity in 2015. Tasigna demonstrated superior efficacy to Gleevec in chronic myeloid leukemia patients in head-to-head trials and was approved by the FDA in 2010. Furthermore, the generic division will offset some of the sales loss as Novartis will be able to market some of the blockbuster drugs from its competitors that are losing patent exclusivity in the near future.

When would I consider buying more?

I own around 5000 CHF worth of Novartis at the price of CHF52 a share. I will consider buying more if it falls below CHF45.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 3.6/5 (19 votes)

Comments

kefa
Kefa - 3 years ago
Since Novartis holds fairly big stake in Roche does it make sense to own both?
cdubey
Cdubey - 3 years ago
Roche has a bit weird shareholding structure. It has 160m voting shares and around 760m non-voting ones. Novartis owns 33% of the voting shares. Which is 5.7% of the total holding.

I would not buy more of either Novartis or Roche at the current prices. But if any of them fall around 20% I will consider it a very good entry point.

I like Novartis more because of its generic division and huge pipeline. Also, Novartis (as well as Roche) have been very shareholder friendly so far.

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