Novartis Is Surviving

On July 19, the $188 billion Swiss multinational pharmaceutical company delivered its first half fiscal year 2016 results. The company delivered constant currency sales and profit growth of 1% to $24 billion and -2% to $3.8 billion, respectively. Novartis (NVS, Financial) shares closed -0.62% that day, while the broader S&P 500 index closed -0.14%.

Valuations

According to GuruFocus data, Novartis had a price to earnings ratio of 27.8 times (industry median of 28.5), price to book value of 2.59 times (industry median of 3.08) and price to sales ratio of 3.78 times (industry median of 2.86). The pharmaceutical company also had a trailing 12 month dividend yield of 3.44% with a 98% payout ratio and 0.10% buyback ratio.

Market performance

Novartis had a total return of 10.55% in the past five years, while the broader index provided 16.37% (1). Year to date return figures were -5.07% and 7.84%, respectively.

(Novartis, Annual Filing)

Novartis

Novartis AG was incorporated on Feb. 29, 1996, under the laws of Switzerland as a stock corporation with an indefinite duration. On Dec. 20, 1996, its predecessor companies, Ciba-Geigy AG and Sandoz AG, merged into this new entity, creating Novartis.

Novartis is a multinational group of companies specializing in the research, development, manufacturing and marketing of a broad range of healthcare products led by innovative pharmaceuticals.

The company operates four segments: (a) Pharmaceuticals: Innovative patent-protected prescription medicines; (b) Alcon: Surgical, ophthalmic pharmaceutical and vision care products; (c) Sandoz: Generic pharmaceuticals and biosimilars; and (d) Corporate activities.

Pharmaceuticals segment

In Novartis' annual filing, the Pharmaceuticals segment researches, develops, manufactures, distributes and sells patented prescription medicines and is organized in the following franchises: Oncology, Cardio-metabolic, Immunology and Dermatology, Retina, Respiratory, Neuroscience and Established Medicines.

In 2015, Pharmaceuticals accounted for $30.4 billion, or 62%, of total sales, and $7.6 billion, or 81%, total operating income. Pharmaceuticals also delivered the highest operating margin among the segments with 25%.

Observably, Novartis discontinued several businesses involving the following: (a) Vaccines and Diagnostics; (b) Consumer Health: over-the-counter medicines and Animal Health.

Most of these divestments, acquisitions and joint venture agreements happened in 2014.

Divestments in 2014

1. On Jan. 9, 2014, Novartis completed the divestment of its blood transfusion diagnostics unit to the Spanish company Grifols S.A. (GRFS, Financial), for $1.7 billion in cash.
2. On April 22, 2014, Novartis entered into an agreement with Eli Lilly and Co. (LLY, Financial) to divest its Animal Health business to Lilly, for approximately $5.4 billion in gain. This transaction closed on Jan. 1, 2015, and will result in a pre-tax gain of approximately $4.6 billion instead.
3. On April 22, 2014, Novartis entered into the following divestment agreement with GlaxoSmithKline plc (GSK, Financial).
   1. Novartis has agreed to divest its Vaccines business to GlaxoSmithKline for up to $7.1 billion, plus royalties. The $7.1 billion consists of $5.25 billion to be paid on closing and up to $1.8 billion in future milestone payments. Novartis's Vaccines influenza business is excluded from the GlaxoSmithKline Vaccines business acquisition (2).
4. On Aug. 5, 2014, Merck & Co. (MRK, Financial) completed a tender offer for Idenix (Idenix) Pharmaceuticals Inc. shareholding. Novartis divested its 22% shareholding in Idenix, for approximately $0.8 billion gain.
5. On Oct. 26, 2014, Novartis entered into a transaction with CSL to sell its Vaccines influenza business to CSL for $275 million.
6. On Nov. 5, 2014, Novartis divested its 43% shareholding inLTS Lohmann Therapie-Systeme AG (LTS) shareholding, for approximately $0.4 billion gain.

Acquisitions in 2014

1. On Feb. 17, 2014, Novartis acquired all of the outstanding shares of CoStim Pharmaceuticals Inc., a Cambridge, Massachusetts, U.S.-based, privately held biotechnology company focused on harnessing the immune system to eliminate immune-blocking signals from cancer, for a total purchase consideration of $248 million (excluding cash acquired).
2. On April 22, 2014, Novartis entered into the following divestment agreement with GlaxoSmithKline.
   1. Novartis has agreed to acquire GlaxoSmithKline's oncology products for an aggregate cash consideration of $16 billion. For a period of 12.5 years, Novartis was granted a right of first negotiation over the co-development or commercialization of their current and future oncology R&D pipeline, excluding oncology vaccines.
3. On Oct. 16, 2014, Alcon acquired all of the outstanding shares of WaveTec, a privately held company, for $350 million in cash.

Joint venture in 2014

1. On April 22, 2014, Novartis entered into the following joint venture agreement with GlaxoSmithKline.
   1. Novartis and GlaxoSmithKline have agreed to create a combined consumer healthcare business through a joint venture between Novartis OTC and Glaxo's consumer healthcare. Upon completion, Novartis will own a 36.5% share of the joint venture.

Novartis and GlaxoSmithKline’s agreement was the most interesting part among the listed deals above. The approximately $20 billion deal between the two pharmaceutical giants, which closed in the first quarter of 2015, involved Novartis trading its vaccines for Glaxo’s cancer franchise.

As of mid-2016, Novartis still is undergoing its operational restructuring. Novartis’ head of pharmaceuticals, David Epstein, is expected to leave the company as the pharmaceutical segment would further be separated into cancer (oncology) and other drugs segments (3). According to Bloomberg, the oncology and drug segments will be led by Novartis’ Bruno Strigini and AstraZeneca’s (AZN, Financial) Paul Hudson, respectively.

According to the Wall Street Journal, Novartis is trying to battle its falling sales in its blockbuster cancer drug Gleevec, which lost exclusivity earlier this year, and the disappointing start of Novartis’ heart failure drug, Entresto. The eye-care Alcon segment also experienced increased competition.

Alcon segment

The Alcon Division researches, develops, manufactures, distributes and sells eye care products and technologies to serve the full life cycle of eye care needs. Further, Alcon offers a broad range of products to treat many eye diseases and conditions, and is organized into three franchises: Surgical, Ophthalmic Pharmaceuticals and Vision Care (4).

In 2015, Alcon accounted for $9.8 billion, or 20%, of total sales, and for $0.8 billion, or 9%, of total operating income. The segment also delivered an operating margin of 8.1% for that period.

As part of Novartis’ ongoing restructuring, Alcon’s drugs would be shifted to Novartis’ pharmaceutical segment, leaving behind surgical equipment and vision-care products, such as contact lenses (5).

Sandoz segment

Sandoz Division focuses primarily on developing, manufacturing, distributing and selling prescription medicines that are not protected by valid and enforceable third-party patents, and intermediary products including active pharmaceutical ingredients.

Sandoz is organized globally in three franchises: Retail Generics, Anti-Infectives and Biopharmaceuticals & Oncology Injectables (6).

In 2015, Sandoz accounted for $9.2 billion, or 18%, of total sales, and for $1.0 billion, or 11%, total operating income. The segment also delivered an 11% operating margin.

First half 2016 performance

Innovative Medicines (formerly the Pharmaceutical segment) delivered 0% constant currency growth to $16.1 billion, 66.8% of total first half sales. The segment also delivered 24.8% operating margin.

Alcon segment delivered -2% constant currency growth to $2.9 billion, 12.1% of total sales. The segment delivered a small operating margin of 1.3%.

Sandoz segment delivered +4% constant currency growth to $5 billion, 20.8% of total sales. The segment delivered an operating margin of 14.5%.

Outlook

“Barring unforeseen events

Group net sales are expected to be broadly in line with the prior year (cc), with Growth Products offsetting the impact of generic competition.

Based on the positive treatment guidelines on Entresto, we have made the decision to increase spending significantly in the second half of 2016 to build a US primary care field force, and add incremental medical support. We expect this to accelerate the uptake of Entresto and maximize future peak sales. As a consequence of this additional investment, and depending on the erosion curve of Gleevec, core operating income is expected to be broadly in line with the prior year or decline low-single digit (cc).

These comparisons are versus 2015 continuing operations.

If early July exchange rates prevail for the remainder of 2016, the currency impact for the year would be negative 1 percentage point on sales and negative 3 percentage points on core operating income.”

Novartis, Quarterly Filing

Net debt

As of June 30, Novartis’ net debt (total debt minus total cash) increased by $4.1 billion to $20.6 billion, compared to Dec. 31, 2015. Novartis had a book value of $72.46 billion and a debt to equity ratio of 0.36 (7).

Cash flow

(Novartis First Half 2016 Cash Flow, Quarterly Filing)

As of first half 2016, Novartis grew its free cash flow by 20% to $3.89 billion. Novartis also paid out $6.48 billion in dividends and $280 million in share repurchases (8). Net shareholder payouts, dividends and buybacks, were approximately 174% of its free cash flow.

In past three years (2013-2015), Novartis paid out 125% in net shareholder payouts.

Other information

In August, Novartis was reported to have disbanded its pioneering cell and gene therapy unit. The unit once carried the promise of the CAR-T therapy, in which a patient’s own T-cells are harvested an genetically altered into cancer fighting missiles.

According to Barron’s, Novartis was an early mover in the field, working via partnership with the University of Pennsylvania, and has been racing against smaller rivals Kite Pharmaceuticals (KITE, Financial) and Juno Therapeutics (JUNO, Financial) to launch the first of these cell therapies.

Nonetheless, Novartis confirmed that it remained committed to the possible breakthrough therapy.

“We are proud of the great strides we have made in manufacturing CART therapies, (Novartis’ manufacturing facility) has a strong foundation for implementing the CTL019 manufacturing process and future therapies.”

Novartis

According to FiercePharma, the CTL019 it refers to is Novartis’ CAR-T treatment that will first be offered for treating relapsed/refractory (r/r) pediatric acute lymphoblastic leukemia (ALL) patients, which early trials have shown to be quite effective in treating pediatric cases. Novartis said it still expects to present its application for the treatment to the Food and Drug Administration and European Medicines Agency in 2017.

Conclusion

There is not much to say as to what information I had found in Novartis’ filings and several articles, but it is trying to cope with the growing competitive market of the pharmaceutical industry.

(Annual filings having included discontinued operations)

Sales had observably reduced compared to previous years, and I think Novartis is critically looking forward to growing its oncology business segment, in addition to its Entresto medication. Meanwhile, the company was able to maintain its profitability.

For the past five years, Novartis had a sales and profit growth of -0.46% and 12.67%, respectively.

Meanwhile, both Morgan Stanley and Leerink Partners downgraded Novartis’ shares earlier this year. Multiplying its five-year earnings multiple with its trailing earnings would give a value of $50 a share.

In summary, Novartis would be a HOLD.

Notes

1. Morningstar data.
2. Annual filing: Novartis paid GSK a fee of $5 million in consideration for the grant of the Influenza Put Option.
3. Bloomberg: David Epstein, who has spent six years overseeing Novartis’s pharmaceutical business, has been rumored to be a potential candidate to succeed Glaxo CEO Andrew Witty when he leaves next year.
4. Annual filing: The Surgical portfolio includes technologies and devices for cataract, retinal, glaucoma and refractive surgery, as well as intraocular lenses to treat cataracts and refractive errors, like presbyopia and astigmatism.

Alcon also provides viscoelastics, surgical solutions, surgical packs and other disposable products for cataract and vitreoretinal surgery.

Ophthalmic Pharmaceuticals portfolio includes treatment options for elevated intraocular pressure caused by glaucoma, anti-infectives to aid in the treatment of bacterial infections and bacterial conjunctivitis, and ophthalmic solutions to treat inflammation and pain associated with ocular surgery, as well as an intravitreal injection for vitreomacular traction including macular hole.

Ophthalmic Pharmaceuticals portfolio also includes eye and nasal allergy treatments, as well as over-the-counter dry eye relief and ocular vitamins.

The Vision Care portfolio comprises daily disposable, monthly replacement and color-enhancing contact lenses, as well as a complete line of contact lens care products including multi-purpose and hydrogen-peroxide based solutions, rewetting drops and daily protein removers.

5. As per Wall Street Journal.

6. Annual Filing: Retail Generics franchise develops, manufactures and markets active ingredients and finished dosage forms of pharmaceuticals to third parties. Retail Generics includes the areas of dermatology, respiratory and ophthalmics, as well as the areas of cardiovascular, metabolism, central nervous system, pain, gastrointestinal, and hormonal therapies. Finished dosage form anti-infectives sold to third parties are also part of Retail Generics.

Anti-Infectives supplies generic antibiotics to a broad range of customers, as well as active pharmaceutical ingredients and intermediates to the pharmaceutical industry worldwide.

Biopharmaceuticals franchise develops, manufactures and markets protein or other biotechnology based products known as biosimilars and provides biotechnology manufacturing services to other companies.

Oncology Injectables franchise develops, manufactures and markets cytotoxic products for the hospital market.

7. GuruFocus data.

8. GuruFocus data.

Disclosure: I do not own shares in any of the companies mentioned in this article.

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