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Novartis (NYSE:NVS) is the most valuable healthcare brand in Europe and the third largest in the world. The company specializes in research, development and manufacturing of a wide array of healthcare products, with pharmaceuticals contributing the largest share. NVS has five segments: Pharmaceuticals for patent-protected prescription medicines; Alcon (surgical, ophthalmic pharmaceutical and vision care products); Sandoz for generic pharmaceuticals; Vaccines and Diagnostics; and Consumer for OTC and animal health.

The company has healthy cash flows, a strong dividend payout (dividend yield of 4.1%) and is also diversified in the generics market, which positions it well to fight against the competition arising from a wide availability of generics. Given its strong position in the pharmaceuticals industry, we recommend the dividend paying stock as a buy.

Third Quarter:

Sales for the quarter were down by 7% and stood at $13.8 billion. The decline was 2% on a constant currencies basis. The core earnings per share declined by 6% and stood at $1.34 in line with consensus. Like all major pharmaceuticals around the world that we have covered, NVS too must cope with the menace of patent expirations. It lost protection for its Diovan two months back, which made its sales go down by 32% to $969 million. Sales of Dovian for the full year ending 2011 stood at $5,665 million.

The company is banking on its newly launched products to fill the gap in revenue due to the patent expiration of Diovan. These new products accounted for 36% of the net sales with their $2.8 billion contributions. The products launched since 2007 include Lucentis, Gilenya, Afinitor and Tasigna.

Tasigna is a drug currently approved for patients with Ph+ CML in the choric phase. Its market share expands both in the first line and second-line settings. Afinitor marched forward following approval from the FDA and EMA for advanced breast cancer. Multiple sclerosis drug Gilenya also showed growth with more than 46,000 patients prescribed with the medicine. Lucentis too showed resilient results. In the below table we show sales' figures of the aforementioned drugs.

Table 1: Sale figures

Sales (NYSE:MM)

Lucentis

$593

Gilenya

$316

Afinitor

$206

Tasinga

$261

Problems:

The generic competition also bogged down sales of Sandoz because of the introduction of a copycat version of blood thinner Lovenox of Sanofi (NYSE:SNY). Furthermore, friction at NVS' Lincoln manufacturing site slashed revenues by 6.2% and stood at $938 million. Last month Italy banned the sale of anti-influenza vaccines and waited for tests for possible side effects. Since the vaccines were made in Italy, other countries followed the suit and banned the usage. However, on November 12, the Italian Medicines Agency announced that a suspension on the Agrippal and Fluad flu vaccines was lifted. More encouraging news for the company came when the FDA indicated that the manufacturing plant Broomfield had attained a compliance status following a re-inspection in August.

The Power of Generics:

In our earlier article we evaluated the generics industry in the coming future. Big pharmaceuticals were expected to achieve a flat to 3% growth in their branded drug segment, while the generics industry will expand rapidly, especially in emerging economies. Unlike AstraZeneca, NVS manufactures generics as well which we believe provides it a significant hedge in the current turbulent times. Its generics department has provided some early benefits to NVS. Bloomberg reports that the company held up to 69% of Diovan prescriptions in the U.S. since the drug lost patent protection.

It achieved this by hitting the market with its own branded copy from Sandoz (the generic division). Since Mylan is the sole competitor in the market, NVS was stated as not intending to price the product aggressively. Exact pricing methodologies and how much NVS will gain from the introduction of its own generic haven't been disclosed yet. However, the introduction of a branded copy cannot reach the same sales of the original and the company must focus on its newly launched products to achieve the same heights. Also important is the evaluation of drugs in the pipeline.

Developments:

On November 20, 2012, the FDA approved a seasonal flu vaccine developed by NVS using animal cell culture rather than using conventional chicken eggs, a process which will help build stockpiles quickly to ward off a pandemic. NVS supplies the U.S. with 30 million doses of flu vaccine annually and has numerous products in the pipeline which can be found here.

Valuations:

Although NVS provides a healthy dividend yield of 4.1%, since the Swiss impose a tax on dividends paid to foreigners, the dividend is reduced and is comparable to many U.S.-based pharmaceuticals such as Pfizer (NYSE:PFE). On its balance sheet, it has a manageable debt (its debt/equity ratio is 31% with a healthy interest coverage ratio of 70x).

Chart 1: Dividend History

The stock is currently trading at 11x its forward earnings; analysts estimate a mean price target of $65. We are particularly optimistic about NVS's strong portfolio of drugs and a rich pipeline. Also worth mentioning is the fact that Novartis is aware of the competition from generics once patent for its products expires and is ready to counter the threat through its Sandoz division focused on the development of generics. In light of the recent developments, we hold a positive stance on the stock and recommend a buy position.

Source: Buy Novartis: A Dividend Gem In The Pharmaceutical Industry