Novartis, a Medium-Term Opportunity
Novartis AG has an industry-leading late-stage pipeline that should boost long-term growth. The company is expected to launch several new chemical entities in the next few years in critical therapeutic areas such as neurology and oncology. In addition, it operates across multiple segments, which provides stability in earnings.
Novartis is permanently thinking about accessing new markets. Indeed, the acquisition of Chiron launched the company into the vaccine business.
The generic segment offers exposure to the billions of dollars in branded pharmaceuticals going off-patent during the next several years. Moreover, the company uses its cash beneficially for shareholders, as 100% of cash flow after acquisitions and dividends is used to buy back shares
Novartis has a diversified operating platform and an industry-leading number of new potential blockbuster drugs. This platform includes branded pharmaceuticals, generics, vaccines, diagnostics, and consumer products. Novartis runs four complementary operations that reduce overall volatility and create cross-segment synergies while the majority of Novartis' competitors focus solely on the high-margin branded pharmaceutical segment.
The pharmaceutical segment is going through the right track of growth driven by new pipeline products and existing drugs. Also, the company has generated a superior late-stage pipeline and should file several new products in both the United States and Europe. Further, existing products should continue to perform well.
The combination of relatively low near-term patent exposure and a diverse operating platform should translate into reliable growth during the next several years.
Novartis continues to make operational improvements and has announced reduction of job positions which will offset by the hiring of new people in low-cost countries. This action should help Novartis' ongoing productivity enhancements.
Joe Jimenez, its CEO has given an interview to Forbes where he has pointed out: “We continue to lead the industry in new product approvals, and 2 of the key approvals in the third quarter were the Gilenya approval in Japan, so we think this is a very important approval for us, and also Afinitor approval in Europe for pancreatic neuroendocrine tumors.”
“In terms of innovation, we're able to turn this innovation into profit growth and sales growth that hits the P&L (…) our newly launched products accounted for about 25% of group sales, up 31% versus a year ago,” he continued.
Novartis, however, also faces several headwinds, such as extended new drug approval times, pricing pressure from the managed-care industry, and political pressure to rein in drug costs.
Also, increasingly aggressive generic drug companies are attacking patents on branded drugs several years before expiration dates. Further, following several acquisitions, the company faces integration risk in bringing together all of the business lines.
Despite these risks, Novartis has shown sound third quarter results. Its sales were up 12% and they were able to show continued strong operating leverage with their core operating income up 15%. Free cash flow was very strong for the quarter at $3.7 billion, and it presented innovation in the quarter and 3 key approvals.
EPS grew 10% operationally from the prior-year period. Net sales in the company's top six emerging markets rose to $1.5 billion in the third quarter. In addition, sales have been particularly strong in China, where revenues grew 42 percent in the third quarter compared to the third quarter of 2010.
How are Novartis' estimates?
Novartis is trading at a 12.98 Price/Earnings Ratio and presents a 4.25 EPS. The fair value estimate is $71 per share.
It is expected that the company will have an average 5% annual sales growth rate during the next 10 years as Exforge, Tekturna and other new products launch.
Unfortunately, management foresees a slight decrease in gross margins during the next ten years as the product mix shifts from high-margin pharmaceuticals to the lower-margin generic group.
Additionally, the multiple operating segments should provide more stable and consistent growth.
In terms of management, in 2010, Joe Jimenez was appointed CEO.
Jimenez's experience as the recent head of Novartis' most important division, pharmaceuticals, should help him effectively lead the company.
Additionally, in early 2010, the retirement of the 25-year CFO veteran Raymond Brue opened the door for Jon Symonds to take over as CFO.
The company's corporate governance practices are good and the board is relatively independent. The board team has announced a "clawback provision" for incentive payments that allow the company to retract any unjustified payments if later facts determine employees' actions were based on financial misstatements or unethical behavior.