Novartis - Outstanding Strategic Initiatives Rendering The Sluggish Growth Irrelevant

May. 4.14 | About: Novartis AG (NVS)


Some of Novartis’ bestselling products under performed over the quarter as they lost patent protection.

The company is betting on its new multiple sclerosis drug Gilenya to propel the top line growth into the future.

Novartis’ Vaccines and Diagnostics division is to be sold to GlaxoSmithKline for $7.1 billion while Novartis intends to add GSK’s oncology department to its portfolio in exchange for $16 billion.

Novartis and GSK are to join hands and establish a leading consumer healthcare business.

Novartis is divesting its Animal Healthcare department to Eli Lilly for proceeds of $5.4 billion.

Novartis AG (NYSE:NVS) is a multinational health provider operating through a number of divisions with more than 60% of the operating earnings attributable to its pharmaceutical unit as of the recently ended quarter's report. The company derives 70% of its revenues from the developed world which includes the US and Europe. However, it is gradually establishing a strong position in the emerging markets. The following discussion encompasses the recently ended quarter's earnings in comparison with analyst estimates, re-strategizing efforts by Novartis, and the performance of its new drugs.

Comparing Actual Earnings with Analysts' Estimates

Although Novartis' top and bottom lines increased compared to the company's performance in the same quarter last year they fell short of analysts' estimates. The company's top line remained rather flattish and increased by only 1% YoY to $14.02 billion compared to $13.88 billion in the first quarter of FY2013. Analysts were hoping for a much better performance in the wake of the success of its newer medicines with their expectations set at $14.22 billion. The profits of the company increased by 24% YoY as the company sold some of its less profitable businesses. The bottom line stood at $2.97 billion at the end of the first three months of FY2014 compared to analysts' estimate of $3.05 billion. With this earnings performance the stock price of the company dropped by 1.31% to $85.43 in pre-market trading.

Overall, the drugs that were launched in 2009 and enjoyed patent protection up till 2018 contributed 31% to the top line of the company realizing a 17% growth rate compared to the same period last year. Some of the company's bestselling products underperformed over the quarter as they lost patent protection. Generic competition hurt the bone repair drug Zometa leading to a 69% YoY decline in sales whereas the company's blood pressure pill Diovan, which lost patent protection in 2012 is still safe from generic competition since Ranbaxy Laboratories Inc. failed to win FDA approval and come up with an equivalent or better pill. For this reason, Diovan continues to generate earnings for Novartis. However, since the drug has lost patent protection it cannot be relied upon to continue to generate future sales; a rival, cheaper drug shall be expected to beat Diovan soon.

The breast cancer drug Afinitor was negatively hit as well. The company blames shorter treatment times in the US since the drug is generally prescribed at a later stage of the disease. Sales projection for the drug underwent a downward revision to $1.5-1.7 billion compared to the previously forecasted figure of $2 billion. The drug's sales grew by 19% YoY over the quarter.

Going forward the company is betting on its new multiple sclerosis drug Gilenya to offset the negative performance suffered as a result of patent-expired drugs or the ones on course for expiry. Gilenya sales grew 31% YoY in terms of constant currencies to $14 billion compared to analysts' estimates of $14.2 billion.

Where the sales level increased as a function of higher product sales of its newer products they were offset due to weak currency translations in Japan and the emerging markets. In constant currencies, the sales figure grew 9% YoY.

Re-strategizing Efforts

Although the company reported a relatively weak top line performance for the recently ended quarter Novartis' future looks bright as it is enacting smart and strategic initiatives to strengthen its competitive position. The company sold its diagnostics unit to Spain-based Grifols towards the end of last year for $1.675 billion. The diagnostics unit was part of Novartis' Vaccines and Diagnostics division that will be sold to GlaxoSmithKline plc (NYSE:GSK) for $7.1 billion plus royalties. Moreover, the company intends to add GSK's oncology department to Novartis' portfolio in exchange for $16 billion. The divestment of the less profitable unit and investment in the core strength of the company would help Novartis strengthen its oncology portfolio, increasing its market share, adding R&D to its already strong portfolio, and making it better able to fight competition. The company enjoys leading position with its bestsellers like Afinitor, Exjade, Femara, Gleevec, and Jakavi. The company also maintains a very strong pipeline with 24 crucial trials underway.

The deal between GSK and Novartis does not end here. The two pharmaceutical giants will establish a leading consumer healthcare business. Furthermore, Novartis is divesting its Animal Healthcare department to Eli Lilly & Co (NYSE:LLY) for proceeds of $5.4 billion.

As a result of these efforts, Novartis' top line is expected to receive a significant boost in the future. However, the company maintains a conservative guidance for the current year with sales expected to grow within low single digits. However, the operating income might exceed sales growth as the company realigns and eliminates redundant operations. Novartis intends to consolidate its IT, financial reporting, and procurement services in this regard that are presently spread across its various divisions.

Shareholder Returns

Now let's take a look at the returns investors are getting. Dividend payments by the company have increased at a CAGR of 4% over the past five years. Novartis maintains an impressive dividend payout ratio of 66% compared to the roughly 18% payout ratio of its peers. The company's dividend yield hovers around almost 3.2% compared to an industry average of 1.67%. Take a look at the following figure showcasing the company's dividend yield against a few major pharmaceutical companies.

Click to enlarge

Source: Y-charts

Furthermore, the recent strategic moves taken by Novartis will significantly propel the top and bottom line growth of the company. As Novartis reports, "The transactions are expected to improve Novartis' sales and core operating income growth rates, while improving margins. Each of the transactions is projected to be value creating." Shareholders should expect better returns as the deals are finalized.

Concluding Remarks

Although the current and short term performance of the company is expected to remain slow the long term future outlook looks strong. The recent moves enacted by Novartis' management to realign, streamline, and strengthen its core businesses while letting go of relatively weaker divisions would significantly boost top and bottom line growth. As earnings increase so will the stock price. Hence, any weakness in price as of now shall be considered an ideal time to take a position in the company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.