Weekly Stock Call

June 10, 2010
Current Price - US$47.01

Novartis is a diversified health care company comprised of four major divisions: Pharmaceuticals, Vaccines and Diagnostics, Sandoz (generics and biosimilars) and Consumer Health. Novartis sports a decent projected dividend yield (4.2%), a strong balance sheet and currently low price ratios relative to its industry and own historical levels. If there is a fly in the ointment, it’s that a fair portion their top selling drugs (representing 30% of current revenues) face patent expiration in the next two to five years. That having been said, Novartis is aggressively seeking to expand revenues through acquisitions (more than 7 since 2008 including the ongoing bid for Alcon), new product developments (more than 30 regulatory approvals received in 2009, 135 projects in the pipeline, more than 30 at phase III and 11 awaiting regulatory approval) , and through geographic expansion. Low reliance on debt thus far and growing free cash flows give Novartis a significant runway for launching new products and an aging demographic in industrialized countries bodes well for future product demand. In the meantime, they have a history of thirteen consecutive growing annual dividends to offer comfort if it takes the market a while to recognize the value in the company.

Valuation
Based on a blend of valuation methods (discounted cash flows, dividend discount model, and historical and industry price ratios) I arrive at current valuation for Novartis Ag – ADR of US$60.

Expected return should this price be realized in the markets within the next 12 months would be:

Price yield  27.6%
Dividend yield   4.2%
Total return  31.8%

Risks
Patent expirations – the previously discussed risk that Novartis will be unable to backfill lost revenues from expiring patents.
Currency risks arising particularly from downward pressure on the Euro due to sovereign debt worries. Europe is Novartis’ largest geographic revenue contributor.
Pricing pressure – drug companies may face increasing pressure as states institute health care reforms to cope with burgeoning national debts.
Legal – Novartis, like others in its industry, is subject to ongoing legal action from governments, corporations and consumers. While some provisions have been made, final liabilities can not be know in advance and may prove to be material.

The Numbers
Share Price  $47.01
Market Cap  $107B
No. Shares  2.2B
ROE  17.0%
ROA  9.8%
P/E Ratio   11.4
Price/Sales Ratio 2.2
Price/Book Value 1.9
Price/FCF   9.1
Price/Book (tang) 3.2
Current Ratio 2.1
Interest Coverage 27.5
Total Debt/Equity 0.32

Analyst: David Scollon



Disclosure - At publication of this analysis I hold no position in this security, but may take a long position in the future. I do not take short positions in any of the stocks reviewed on this site, nor do I receive any compensation from the companies studied for publication of my opinions.