Novartis: Big Pharma At A Discount
Growth At A Reasonable Price, Long-Term Horizon, Crypto, Tech
Seeking Alpha Analyst Since 2019
James Foord is an economist and financial writer with over five years of experience writing about stocks and crypto. His lifelong interest in monetary policy and innovative technologies led him to specialize in macroeconomics, crypto and technology. Given the current macro outlook, he is focused on commodities, real assets, international equities and value stocks.
- Novartis has succesfully reduced its assets and focused its operations.
- The company has a strong product pipeline and is cheaper than its peers.
- We believe Novartis will surprise investors next year in terms of growth.
Novartis AG (NVS) is the second-largest pharmaceutical company in the world. The company has been undergoing structural changes in the last few years, which have aided its profitability. Novartis has a strong and diversified product portfolio, upcoming growth catalysts, and we feel it is cheaply valued by the market. This provides a good entry point to own an established and dominant player in the lucrative field of pharmaceuticals.
Novartis is the second-largest pharmaceutical company in the world. As such, it has a wide portfolio of products in various market segments. However, the company has undergone significant transformation in the last couple of years. With the appointment of a new CEO in 2018, Novartis has undergone a strategic transformation aimed at making it leaner and more profitable.
The strategy looks to be paying off when we look at Novartis’ performance over the last nine months.
Source: Investor Presentation
Over the last three quarters, the company has achieved an increase in sales of 4% YoY. Furthermore, the operating income has increased by 16% compared to 2019. Despite what seems to be an overperformance compared to previous years, where revenues have remained almost flat, the stock still trades significantly below its pre-COVID level.
Financially, the company is also relatively solid. The company carries around $26 billion in long term debt, representing 30% of equity. However, the company is financed cheaply, and net interest expenses account for only 1.24% of revenues.
On the surface, Novartis looks like it has implemented some positive structural changes which the market has not recognized yet. This may allow us to purchase big pharma at a discount.
Lean and mean
Looking at the balance sheet and financial metrics, we can see some meaningful changes to Novartis’ business operations and overall “approach”. Since 2017, assets have gone down from $133 billion to $119 billion in 2019. As of the latest TTM figures, assets stand at around $129. Novartis has basically been refocusing its efforts, divesting from its more run of the mill consumer products, and investing in innovative medicines.
Since 2017, Novartis has sold its stake in GlaxoSmithKline and divested its eyecare business into Alcon (ALC). Meanwhile, it has acquired cancer specialist Advanced Accelerator Applications. Medicines Applications, and more recently, has acquired the privately owned Vedere Bio for an estimated $280 million. The results speak for themselves.
Over the last 3 years, the company has increased its profitability by most accounts, Operating margin is almost 3 points higher than in 2017. Asset turnover has also increased considerably during this time, showing that the divestments and acquisitions have achieved what Novartis wanted. The only issue left to resolve for Novartis now is growth.
Novartis has struggled to grow convincingly in the last 10 years, but we remain bullish on the upcoming quarters. We feel that Novartis has a good portfolio and some upcoming launches which could boost overall sales. While it is impossible to write about every single product/pharmaceutical Novartis has to offer, we can focus on some of the most relevant.
Entresto is one of the highest growing products for the company. The sales for this heart medication have grown 45% YoY and have shown promising prospects in Europe and China. Solargenix grew 75% and Kesimpta 95%. The latter is on track to become the 1st choice high efficacy DMT for physicians.
Beovu also looks like an encouraging growth opportunity, having now been approved in over 45 countries. In recent news, Kiskali and Aimovig have both recently shown encouraging data from their respective clinical studies. All in all, the company has a strong portfolio and upcoming pipeline
Source: Investor Presentation
On top of this, we could see higher growth come as a result of pent-up demand from the COVID pandemic. Dermatology and ophthalmology are areas that are still seeing weakness in Q3, but we expect this to normalize within the next year. Furthermore, the company acquired Xiidra, which expands its pharmaceutical offerings.
Lastly, the strongest growth prospects for the company come from China. Chinese sales grew at double digits n the last year, and the company expects them to double by 2024. In 2019, according to Statista, sales from "Asia/Africa/Australasia accounted for close to $10 billion in revenues in 2019. Novartis is pushing for growth in China on the back of new regulation which has eased constraints and limitations on drug manufacturing. Last year, Novartis applied for 15 new drugs in China, which now account for around $2 billion in sales.
Overall, we believe that Novartis can achieve positive growth over the next five years. This seems to coincide with analysts estimates, which put Novartis at $59 billion in revenue by January 2025
We are using our discounted free cash flow to common shareholders valuation method to value Novartis stock, currently priced at $86.52. For a better description of the method we use, check out this post. Calculations are based on a five-year forecast.
In terms of manual adjustments, we are looking at net asset turnover. By our estimate of net assets for operations, this reached a high point in 2019 after some balance sheet optimization. We expect this improvement to be sustained in the next few years, as you will see below, but not quite at the same level as in 2019, as new investments take some time to pay off. This turnover added to our estimates on investment led to a revenue CAGR of 4% in the five-year period from 2019 to 2024, which is in line with some of the consensus estimates we see on Seeking Alpha.
Operating margin is doing a little worse than average in 2020, but this measure has fluctuated over the years, so we are projecting an average performance for the next few years based on our automatic model.
As you can see in the summary below, (where items are in millions except per share items and percentages), we estimate a potential cash return above 9% for Novartis stock. This would suggest continued dividends and the possibility for good dividend growth in the coming years.
Source: Author’s work
Despite the attractive outlook, there are considerable risks to take into account. For starters, Novartis will have 8 patents expiring in the next year. This will certainly put a dampener on growth, but Novartis still has a large product portfolio and a strong pipeline. Furthermore, it is important to consider the new approach Novartis is taking can create more volatile earnings and revenues. Innovative medicines don’t always payout, and they are also subject to administrative and regulatory barriers, which can delay and reduce revenues. Novartis is changing the way it operates, so fat it has seen positive results, but this could change in the future.
Overall, we feel Novartis is cheaply priced given its increased profitability and growth outlook. This price offers a good chance to buy an established and dominant player in a generally lucrative field. The steady and growing dividend is the icing on the cake. Novartis is being overlooked by investors, and we expect it to outperform its rivals in the near future.
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Analyst's Disclosure: I/we 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.
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