Novartis operates in five segments: Patented Pharmaceuticals ($30B in 2010 revenue), Vaccines and Diagnostics ($3B in 2010 revenue), Sandoz (generic pharmaceuticals, $8.5B in 2010 revenue), Consumer Health ($6.2B in 2010 revenue) and Alcon (77% stake, $2.4B in 2010 revenue). Alcon is an eye-care products company that Novartis recently purchased from Nestle and merged in to the Novartis group in April of this year.
Novartis appears on GuruFocus’ Undervalued screener and is broadly owned by a variety of gurus.
Like many pharmaceutical companies, Novartis is suffering from the twin problems of reduced pricing power throughout Europe due to austerity programs and expiring patents on best-selling drugs.
Exposure to Eurozone
As part of their austerity program, either forced or entered in to voluntarily, many countries are making cutbacks on healthcare expenditures. Last year Novartis faced 3% to 27% cuts in price in Greece, 6% to 16% cuts in Germany, 11% to 23% discounts in Turkey, and 7.5% discounts on brand name pharmaceuticals and 25% discounts on generics in Spain. Management (and indeed the whole world) expects forced price cuts to be in effect and perhaps deepen for the foreseeable future.
(Source: Novartis 10-K)
If the eurozone currency union were to break up Novartis is well situated from a debt perspective. It only has EUR 1.5B of its debt denominated in euros. The rest of the debt is primarily denominated in Swiss francs and U.S. dollars. While a break up would certainly wreak short-term havoc across Europe, Novartis’ solvency wouldn’t be in question.
Products and Pipeline
Like all pharmaceutical companies, Novartis is dealing with the loss of patents on some of its best-selling drugs. The largest loss is Diovan which expired in the EU and expires in the U.S. next year and in Japan in 2013. As one of the largest healthcare companies in the world, Novartis is able to absorb the blow better than most as Diovan only made up approximately 11% of NVS’ sales. Additionally, NVS's R&D efforts look to be paying off as recently launched products continue to offset losses to generics as shown below.
(Source: company presentation)
The continuing patent expiration issues and lower returns on R&D spending were also likely a driving force behind the decision to purchase Alcon.
Both ROA and ROC have been pretty steady over the past decade save for a large spike in 2007 and a deteriorating trend in ROA over the last few years.
With their days as heady growth stocks behind them, many pharmaceutical companies are finding a new shareholder base among investors seeking income, as most of these stocks pay a healthy dividend.
Novartis is no exception, paying a 3.5% dividend. However, since NVS is Swiss the dividend is paid in Swiss francs. Lately investors have been flocking to safe-haven currencies such as the Swiss franc causing the currency to rise.
(Source: Novartis 10-K)
The Swiss Central Bank has taken efforts to stop rise of franc so investors would wise to discount much if the recent foreign exchange effects that has made the dividend look more attractive. Also, if the euro situation is resolved (I can hear some of you laughing at the notion) the Swiss franc may fall as flight to currencies viewed as safe may stop.
Comparisons and Valuation
The table below shows how Novartis stacks up against several other large, global pharmaceutical firms.
|Company||ROA||R&D Spend||P/E||EV/EBITDA||Div. Yield||Payout Ratio|
|Johnson & Johnson (JNJ)||10.2%||11.4%||15.5||9.87||3.6%||44%|
|Abbott Labs (ABT)||7.6%||10.3%||19.0||12.77||3.5%||58%|
Novartis is trading at cheap levels compared to its historical multiples. Once the patent cliff issues began approaching in 2005 and 2006 many pharmaceutical companies began their slow decent to more reasonable valuation levels.
As you can tell by the disclosure we like NVS. This is due to its financial health, broad product line up, and commitment to in-house R&D. The current budgetary constraints in Europe and pipeline issues across the entire pharmaceutical industry mean that the days of the premium valuation multiples are likely gone but many pharmaceutical stocks offer large, well-covered dividends that might appeal to some types of investors.
Disclosure: Long NVS, GSK, JNJ, PFE
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