Can Novartis Tide Over the Alcon Crisis?

Despite having financial strength, Novartis may decide to ride the trough with no new acquisitions

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Aug 26, 2016
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With Novartis (NVS, Financial) falling off the patent cliff with its blockbuster cancer drug Gleevec – which lost steam due to the impact of generics and sales declining during the year, an enormous amount of pressure was brought to bear on the stock.

Novartis is down nearly 11% since the start of the year; at 3.87 times price to sale the company looks like an attractive investment. For the sake of comparison, Pfizer (PFE, Financial), which saw a similar revenue decline this year, has been on an acquisition spree to bolster its top line, and the company is now trading at 4.08 times sales at the writing of this article.

Ironically, the biggest problem pharmaceutical companies face is their blockbuster drugs. At their peak these drugs bring in billions of dollars in growing revenues, positively impacting the stock price. But as they approach patent expiry – and sometimes even during the lifetime of the drug – competitors jump in and erode their sales. It’s extremely hard to develop a drug that can be a potential multibillion-dollar one, and it is even more difficult to replace it once it’s off the exclusivity list.

Big pharmaceutical companies have to resort to buying pipelines to compensate for the top-line loss that these erstwhile superstars cause. More often than not they end up paying a hefty premium for it, and this cycle keeps going on and on forever, making their income streams unpredictable.

This is the reason I prefer pharmaceutical companies that have a diversified income stream. Johnson & Johnson (JNJ, Financial), for example, has always taken pride in being a diversified player. GlaxoSmithKline (GSK, Financial) is also moving in that direction, and Novartis has been forced into such a situation to reduce its drug dependency, as it were. The company took nearly 20% of its 2015 sales from Alcon, its eye care unit, and Sandoz, its own generics company.

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Alcon sales, however, have been declining since 2014, putting even more pressure on the pharma division to perform. During the second quarter Alcon sales declined by 1%, pharma was down 1% and Sandoz posted 3% growth. The company expects to return to top-line growth during the second half of the year.

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With 62% coming from the pharmaceutical business, Novartis’ overall growth is extremely dependent on this segment. Sandoz is growing at a decent pace, and Alcon is going through a revamp, and the latter needs a lot more time to return to a period of stable growth.

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Though the rate at which Alcon’s sales have been declining has slowed, Alcon still needs lot more time to stabilize its sales and boost its operating profits. The twin impact Alcon struggling at one end and Novartis’ pharmaceutical business bracing for the impact of generics is hurting Novartis. As such, the company’s heart medicine Entresto is its only hope of recouping on sales numbers.

The company is in intense short-term pain and may have to resort to buying a pipeline drug to boost its top line. Novartis had $5.7 billion cash on hand at the end of the second quarter and holds a near $14 billion stake in Roche (XSWX:ROG, Financial), a rival Swiss pharmaceutical company. That’s a potentially salable asset that can fund a major acquisition.

The choice before Novartis is simple: either take the short-term pain and wait for Alcon to stabilize and ride out the pharma revenue slide or sell its Roche stake and buy a few blockbuster drugs. For now, it looks like the company is taking the short-term pain route. But with potentially $20 billion on hand, you never know.

Disclosure: I have no positions in any of the stocks mentioned above and no intention to initiate a position in the next 72 hours.

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