In a recessionary environment, it is quite fair to expect investors to get inclined towards stocks that offer assured returns. Consequently, those stocks which have better fundamentals but do not promise immediate assured returns are overlooked!.
A case in point is Novartis (NVS), which despite having the best fundamentals in the industry, is painfully undervalued. The stock has been overlooked all these years as it has failed to match the proactive stance of peer group companies to lure investors. As a result, Novartis stock trades at sector average P/E multiple (11.5x) on 2012 earnings. I believe it is inappropriate to benchmark valuations of a conglomerate like NVS to a pure branded prescription innovator company, as it fails to correctly appreciate or capture the growth potential of different businesses embedded in the conglomerate structure.
A better way to value NVS is to look at each business that is embedded in the conglomerate structure separately.
If you use the sum of parts valuation methodology, it would clearly show that Novartis is available at a deep discount to its intrinsic value. Investors can fetch up to 50-60% upside at current prices if NVS decides to hive off the different businesses embedded in Novartis group as separate listed entities.
Sum of Parts Valuation of NVS
NVS's presence spans across all major segments of pharmaceutical / healthcare business. Branded Prescriptions / Pharmaceuticals, Generics, Consumer Healthcare, Vaccine and Diagnostics, and Alcon (Ophthalmic business) are the major businesses which lie embedded within the conglomerate structure. Discussed below are valuations of each of this sub-sector separately.
Value of Innovation driven Branded Prescription Business - Large cap innovator pharma companies globally trade at an average valuation of 8.7x EV/EBITDA. I would assign a 15% premium to NVS to sector average for the following reasons.
1) NVS has one of the largest and fastest growing portfolio of recently launched products. In 2011, branded prescription business registered the highest growth rate (@ 29.5%) among peer group companies. NVS gained a market share of 0.8% in 2011, which as well is highest in the industry.
2) NVS is one of the highest R&D spenders and has one of the best R&D track records of getting new molecular entities on the market.
(click to enlarge)
Source - Novartis Company Presentation
3) NVS has the largest number of R&D Projects in pipeline. They had an impressive 130 projects listed in development at the end of 2011.
4) NVS has an unmatched growth platform - the recently launched product portfolio of NVS comprises 30% of branded prescription sales and is growing at 40% year over year. Afinitor which is among the growth drivers will further accelerate its growth momentum driven by recent indication of expansion in HR+ve breast cancer.
5) Despite patent expiry pressures, the pharma business will still grow in low-to-mid single digits over the next five years driven by recently launched products and a best in industry R&D pipeline.
At a 15% premium, the valuation of NVS pharma business comes at $120 billion.
Comparable Companies in Branded Prescription Space and Valuations
Company | Price | Dividend yield | 2011 EV/EBITDA |
AZN AstraZeneca | $47 | 6.10% | 6.5 |
BAYRY.PK Bayer | € 65 | 2.50% | 8.2 |
GSK GlaxoSmithKline | £14 | 5.10% | 8 |
NVS Novartis | $60 | 4.10% | 10.1 |
NVO Novo Nordisk | DKK 929 | 1.50% | 17.3 |
RHHBY.OB Roche | SFr 178 | 3.80% | 8.7 |
SNY Sanofi-Aventis | € 66 | 4.00% | 7.7 |
SHPG Shire | $31 | 1.50% | 11.4 |
ABT Abbott | $67 | 3.10% | 8.8 |
BMY Bristol-Myers Squibb | $33 | 4.10% | 12.1 |
JNJ Johnson & Johnson | $68 | 3.60% | 9.1 |
LLY Eli Lilly | $47 | 4.20% | 9 |
MRK Merck | $44 | 3.80% | 7.5 |
PFE Pfizer | $24 | 3.60% | 7.3 |
MEDIAN | 8.75 |
Value of Alcon
Alcon, which used to trade at 13.5 times EBITDA before acquisition, is now trading at 9.6x EV/EBITDA. Even prior to when NVS made an acquisition offer to Alcon shareholders and a public takeover speculation was triggered by a UBS research analyst report, Alcon was trading at $149.76 per share. Hence, $149.76 may appropriately be considered as unaffected share price of Alcon, or in other words it is the value of Alcon business from an investor perspective. At $149.76, Alcon shares traded at 13.5x EV/EBITDA. Assigning the same valuation multiple to Alcon current earnings, the implied value of Alcon business comes at $54 billion.
Value of Generic Business - Sandoz
Globally, generic business trade at an average valuation of 16.7x EV/EBITDA. Applying the global average to Sandoz earnings, the value of the business comes at $42 billion. Sandoz is a high end generic company with presence in areas which have high hurdles for competition. It also has made tremendous investment into Biosimilars and Respiratory generics, and has yet to reap the benefits.
Comparable Companies in Generic Space and Valuations
Price | M.Cap - $b | 2011 EV/EBITDA | |
UNITED STATES | |||
Impax | $24.05 | 1.6 | 12.5 |
Mylan | $23.95 | 9.7 | 7.9 |
Teva | $40.42 | 38.4 | 28.3 |
Watson | $83.59 | 10.7 | 10.7 |
Weighted Average | 60.5 | 21.5 | |
Weighted Average (Ex-Teva) | 22 | 9.6 | |
EUROPE | |||
Adcock Ingram | ZAR 59.5 | 1.3 | 8.3 |
Aspen | ZAR 138.1 | 7.7 | 16.8 |
EGIS | HUF 17,300 | 134.7 | 3.3 |
Gedeon Richter | HUF 38,950 | 725.9 | 8 |
Hikma | £7.15 | 2.3 | 14.2 |
Krka | € 44.21 | 2 | 5.6 |
Pharmstandard | $15.20 | 2.4 | 6 |
Stada | € 22.52 | 1.7 | 6.2 |
Weighted Average | 9.5 | ||
INDIA | |||
Aurobindo | INR 131 | 0.7 | 8.7 |
Biocon | INR 276 | 1 | 10.2 |
Cipla | INR 390 | 5.6 | 20.3 |
Dr Reddy's | INR 1,726 | 5.3 | 15.4 |
Lupin | INR 616 | 5 | 21 |
Ranbaxy | INR 560 | 4.3 | 15.6 |
Sun Pharma | INR 685 | 12.8 | 24.7 |
Weighted Average | 17.6 | ||
Global Generics | 16.7 | ||
US | 18.6 | ||
EMEA | 9.5 | ||
Indian | 17.6 | ||
Value of Vaccine and Diagnostic Business
The Vaccine and Diagnostic business is currently a drag on NVS value as it is not generating profits. But once it attains critical mass, the business will have a more than proportionate impact on the NVS value. There are no appropriate comparables that can be used as a benchmark to value this lucrative business. Most of the V&D business that NVS currently has is acquired. At cost, the business is worth $10 billion. On a discounted cash flow basis, if we discount average EBITDA of V&D business before R&D for last 3 years at a 6% cost of capital (assuming zero growth), the value comes to $14 billion.
Value of Consumer Healthcare Business
Comparable companies in the consumer healthcare space trade at a median EV/EBITDA of 12.65x 2011 earnings. Valuing Novartis consumer healthcare at 12.65x EBITDA, the value of the business is approximately $14 billion.
Comparable OTC companies and their valuations
Valuations | |
OTC Companies | EV/EBITDA |
Prestige | 12.64 |
Perrigo | 14.9 |
Colgate Palmolive | 12.37 |
GSK Consumer Healthcare India | 19.3 |
The Clorox company | 10.3 |
Median EV/EBITDA | 12.64 |
Value of 6.3% Stake in Roche
At the current price, the company's 6.3% stake in Roche (accounting for 33% voting rights) is valued at $10.6 billion.
NVS - SUM OF PARTS VALUATION
PARTS | EBITDA $b | Sector Average EV/EBITDA Multiple | Premium / Discount to Sector Average % | Business Value ($ billion) |
Sandoz | 2.5 | 16.7 | 42 | |
Consumer Healthcare | 1 | 12.65 | 12.7 | |
Vaccine and Diagnostics | 950* | 14** | ||
6.3% stake in Roche and other minority interests | 10.5 | |||
Pharmaceuticals | 12 | 8.7 | 15% | 120 |
Alcon | 4 | 13.5 | 55 | |
ENTERPRISE VALUE OF NVS | 255 | |||
CURRENT ENTERPRISE VALUE OF NVS | 162 | |||
POTENTIAL UPSIDE | 57% | |||
*EBITDA of Vaccine and Diagnostic business is fluctuating hence we have assumed an average for 2010, 2011 and 2012. To specifically value the existing business and not those that are in pipeline the R&D expenses on V&D business are added back. ** Value has been calculated assuming zero growth and 7% cost of capital | ||||
In Summary
The current price of Novartis offers a very attractive entry point for fundamental investors as it trades at a steep 57% discount to its intrinsic value. I understand that the intrinsic value attribute can be appreciated only by pension fund or long-term investors, while hedge funds or mutual funds which operate under tremendous pressure for generating near term returns may rather prefer to stay away from such stocks. For NVS to immediately harness this value, the company should think of splitting into different business as independent listed entities on the same lines as Abbott, Bristol-Myers or Pfizer have done in the recent past.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
