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Summary

  • Nominal health care spending is expected to nearly double in the next decade due to the evolving pharmaceutical industry.
  • The drug developed by Novartis which reduced cardiovascular deaths by 20% improved Novartis’s chance to add a multi-billion dollar product to its pipeline.
  • Novartis is going to invest $35 million in Gamida cells in exchange for a 15% equity stake and the option to fully acquire the company.
  • Novartis is a company with a strong financial position and attractive valuation.

Novartis AG (NVS) is involved in the research, development, marketing and manufacturing of pharmaceuticals and health care products. In the evolving pharmaceutical industry, Novartis is well positioned with its diversified operating platforms and large number of potential blockbuster drugs. The world's population will be larger, older, and sicker and this will demand better health care. Healthcare spending is expected double in the next decade. Global health care spending is expected to grow at a CAGR of 6.4% in just over 10 years.

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Source: Novartis Management Presentation

Novartis's Heart Failure Drug Shows Big Promise

A cardiovascular drug developed by Novartis reduced cardiovascular deaths by 20%, when compared with its rival's treatment. A new study reports that it is one of the biggest potential advances against heart failure in a decade. The study involved nearly 8500 people in 47 countries and was the largest study ever done regarding heart failure. The drug cut the chances of dying by 20% and the risk of being hospitalized for heart failure by 21%. Such results could transform the treatment of this disease that afflicts more than 5 million people in the US and 26 million people worldwide.

Novartis will seek approval for this drug, dubbed LCZ696, by the end of this year in the US and early next year in Europe. The launch of this drug will create a multi-billion dollar sales opportunity. The profitability of this drug will be higher because the cost of marketing this product will be lower due to the specialized nature of the heart failure disease and will require a smaller sales force. According to analyst Timothy Anderson at Sanford C. Bernstein in New York, this drug may garner sales of as much as $8 billion per year. Novartis believes that this breakthrough drug could become the biggest product in the company's history. The current record holder is Diovan that has peak sales of $6 billion.

Further Developments in the Pipeline

In order to further enhance its pipeline and focus on its core pharmaceuticals portfolio Novartis has recently entered into an investment and option agreement with Israeli-based Gamida Cell, a company which focuses on stem cell expansion technologies and therapeutic products. According to this agreement Novartis will invest $35 million in exchange for a 15% equity stake in the company and an option to fully acquire the company following the achievement of certain milestones regarding the development of Nicord.

The company is currently evaluating Nicord for the treatment of hematological malignancies such as Leukemia and Lymphoma in Phase 1/2 study. These milestones are expected to be achieved during 2015and will require Novartis to pay $165 million to Gamida's shareholders upon exercise of option and a milestone payment of $435 million. Gamida Cell has proprietary technology for growing the number and density of stem cells within a blood sample as this is the basis for all stem cell activity. Novartis's acquisition of Gamida Cell will provide momentum to the company's growing pipeline.

Recent Performance At a Glance

Novartis maintained strong innovation momentum in the second quarter while reconfirming its full year guidance. The company reported 2% growth in revenues compared to the revenue figure reported in the second quarter of the previous year. The company also improved its earnings per share. The company's operating income improved by 6% leading to almost 33% growth in net operating cash flows compared to the figure reported in the same quarter last year. The net income growth of 1.6% has exceeded that of the S&P 500 and outperformed the pharmaceutical industry's average growth. The company's second quarter growth is attributed to the strong double digit growth in the company's pharmaceutical segment.

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Source: Company's Q2 Results Presentation.

In addition to innovation, growth, and productivity focus the company's strong capital structure and free cash flows will enable it to reward its shareholders handsomely. During the first half of 2014 the company distributed $6.8 billion in the form of dividends reflecting an increase of almost 7.5% compared to the dividends reported last year. In order to further reward its shareholders the company has repurchased 34.1 million ($2.9 billion) of its shares during the first half of 2014. The increase in dividends and share buyback program is backed by the company's strong financial health and excess free cash flows. The strong financial health can be seen in its low debt/equity ratio of 0.2 compared to the industry average of 0.4.

Analyst Opinion and Valuation

The consensus target price reveals that Novartis is undervalued at its current market price of $89.84. The mean target price estimate is $95.06 and presents an upside potential of almost 6%. The median target price is $98 presenting an upside of 9% at the current price. The most optimistic forecast is $105 presenting an upside potential of 17% if materialized. I think the company will achieve the most optimistic forecast because of the recent success of its new heart failure drug LCZ 696.

Source: Yahoo Finance

Novartis is currently trading at a price to earnings multiple of 24.2x compared to the industry multiple of 22.3x which makes the company slightly overvalued. However, after incorporating the future earnings growth impact, the forward price to earnings multiple is 15.2x which is way lower than the industry's multiple. The forward P/E suggests significant upside potential as confirmed by the other price multiples shown below.

Source: Morning Star

Conclusion

Novartis is well poised to grow in the evolving pharmaceutical industry given the recent success of its cardiovascular drug. The company seeks to improve the company's prospects by adding a new multi-billion dollar product to its portfolio. The recent agreement with Gamida Cell has shown that the company is focusing on boosting its pipeline and core business. The company is trading at a very impressive forward P/E multiple and the company has strong financial health so I am bullish regarding the future of the company.

Source: Time To Be Bullish On Novartis