In Part 1 and Part 2 of our recent Novartis (NVS) reports, we laid out a five-year projection for the revenues from Novartis' existing drugs and newly approved drugs. In this section, we provide a forecast for Novartis financial projection and estimated earnings from 2013 to 2017 (see Table 1, Income Statement and Earnings Projection). Using the projected earnings and free cash flow numbers, we derive an estimated fair value for NVS around $76. NVS is currently trading at $72~$73. This price represents a less than 12x multiple to its 2013 adjusted EPS. With a 3.5% dividend yield, a sustainable 3.5% growth rate, and innovative product pipeline, NVS is appealing to both income and growth investors for the long-term.
Financial data before 2012 are based on the Novartis' 2012 annual 10K filing. The data from 2013 to 2017 are projections based on historical data or revenue estimates. Table 1 summarizes 5-year projected income statements.
Table 1: Projected Income Statement
As mentioned in Part 1 (Novartis: 5-Year Revenue Outlook), Diovan, Exforge, and Zometa will continue to decline in revenues as the result of patent expiration and generic competition. Gleevec, Sandostatin, and Exelon could maintain slow but steady growth. The combined sales of these pharmaceuticals with steady or declined growth are $25.8B in 2012. Our projection suggests that the revenues of these drugs will decline at a ~3.4% annual rate to $22B in 2017.
Alcon may maintain a steady growth due to demand for its eye care products. The Sandoz (generic, biosimilar), Vaccines, and Consumer health division sales had significant setbacks last year. Although their sales are likely to restore to normal levels, we still assign them a 3% declining rate by factoring in competition.
Sales from Novartis's new drugs approved since 2007 are expected to offset lost revenues from the products with declining sales. These drugs, such as Lucentis, Gilenya, Tasigna, Afinitor, and Galvus, are likely to generate high growth rate going forward. We estimate that the combined revenues of these drugs are $7.6B in 2013 and increase to $12B in 2017, which represents a 12.3% annual growth rate over next 5 years.
As described in Part 2, Novartis will file NDAs for 6 new drugs for oncology (LBH589, TKI258), hypertension and heart failure (LCZ696, RLX030), inflammation (AIN457), and COPD (QVA149). Together with Jakavi approved for myelofibrosis in 2012, these drugs will generate aggregate revenues of $1.4B, $2.2B, $3.1B, and $4.3B from 2014 to 2017, respectively. These new products will have a more meaningful impact on revenue growth after 2014. Some of these drugs could become blockbuster drugs for Novartis in the future.
Altogether, the estimated total revenues for NVS are $56.9B, $58.5B, $59.6B, $60.1B, and $60.4B from 2012 to 2017. It is important to note that 2013's revenues ($56.9B) will be slightly lower than $57.7B sales in 2012, primarily due to significant declines in Diovan's sales, but offset by newly approved drugs.
Figure 3: Revenues and Adjusted EPS
Other Income Statement Items
On the expense side, we used NVS' historical gross margin and EBIT margin as a guide. Its cost of goods sold (COGS) and selling and general administration (SG&A) expenses were about 32% and 47% of net sales, respectively. We also assumed its effective tax rate to be 14.5% going forward, similar to its 2012 rate.
Interest expenses were derived from our projected debt and interest schedules. Overall, NVS' long-term debt balance will be around $13B-15B. The average interest rate for NVS' debt is approximately 3.8%.
Our income statement projects EPS at $3.99 (2013), $4.28 (2014), $4.57 (2015), $4.87 (2016), and $5.23 (2017). NVS' adjusted earnings estimates will be approximately $6.04 (2013), $6.46 (2014), $6.85 (2015), $7.27 (2016), and $7.77 (2017). This suggests that NVS' earnings growth rate is ~5%-6% for the next 5 years.
Novartis's cash flows from operations (CFO) are estimated to be between $14.8B and $16B from 2013 to 2017. Capital expenditures are $2.5B, representing an average of 16% of CFO. After subtracting capital expenditures from its CFO, Novartis' free cash flows are in the range of $12.4B~$13.4B. The free cash flow numbers were used to derive NVS intrinsic value (see below).
NVS may pay $2.5 in dividends per share ($6B total) in 2013, a 2% increase from 2012. This amount is consistent with NVS' commitment to return 60% of its net income to shareholders. The company has not announced any future share repurchase program, although it has repurchased shares over the years at variable amounts.
Summary of financial ratios and growth rates
Based on its previous 3-year averages, NVS' gross profit margin, EBIT margin, and net profit margin are 67%, 20%, and 16.5% respectively. Its ROIC, ROE and ROA are 14%, 14%, and 8%, respectively. These ratios suggest that NVS' operating efficiencies and profitability based on return on investment are within the industry average.
Figure 4: Return on Investment Ratios
Novartis has a strong balance sheet. Its total debt will be around $14B. Over the next five years, its total debt to total capitalization will be at 19% and its debt to shareholder equity 23%, which are modest compared to its peers. Its interest coverage ratios are 16x to 22x, suggesting that the company can comfortably service its debt obligation with its operating income.
Figure 5: Credit Statistic
We utilized the Discounted Free Cash Flow model to derive NVS' intrinsic equity value. Based on the free cash flow numbers from 2013 to 2017 and a long-term growth rate of 3.5%, the estimated per share stock value is ~$76. The fair value is greatly impacted by long-term growth rates. For instance, a 3.75% growth rate would elevate the fair value to $78, whereas a 3.25% growth rate would bring down the fair value to $74. We believe NVS is capable of maintaining a 3.5% long-term growth rate, mostly attributed by the drugs approved since 2007 and a strong pipeline with supplies of new drugs in the future.
Figure 6: Intrinsic Share Price
NVS is currently trading at $72-$73 in June 2013. This price represents a less than 12x multiple to its 2013 adjusted EPS. With a 3.5% dividend yield, a sustainable 3.5% growth rate, and innovative product pipeline, NVS is appealing to both income and growth investors for the long-term.