Novartis AG (ADR) (NYSE:NVS)

MarginofSafetyIn (46.65) Submitted: 11/20/2010 9:05:33 PM : Start Price: $52.45 NVS Score: -1.83

Novartis Review: Could be a good pharma pick

Intro
Novartis is a “large Pharma” company with 5 major operating units: Branded pharmaceuticals, Generic pharmaceuticals, diagnostics, vaccines and following the recent acquisition of Alcon, eye-care. I put NVS in my idea pipeline as it was one of the 5-star wide moat rated stocks by Morningstar last time I looked at it.
NVS currently trades for $57-58

Click on this annotated Surfmark if you want to see the source data for this Quick Review.

1- Business Performance Risk (+) and intrinsic returns (=/-)
Metric
Status
FCF / Sales   Last twelve months: 25%, on the high end of historical performance, between 17% and 22%
ROE   LTM: 18.4%, in line with 5-year average of 19.3%
ROA   LTM: 10.8%, in line with 5-year average of 11.9%
Revenue Growth   Revenue growth for the last 5-10 years has been in the 7% – 10% range, including acquisitions. Interestingly, the year over year growth of Novartis is historically fairly stable between 5% to 12-13% almost every year
Cash distribution to shareholders   Dividend yield: 2.9% on a payout of ~40%
Buybacks: NVS has only bought 3% of its share back over the last 5 years

Novartis seems to have a strong business performance, with strong free cash flow generation and high returns. Contrary to some of its competitors (e.g. SNY) intangibles due to acquisitions have not become so large that they make ROE/ROA performance unappealing.
NVS has been able to grow nicely, although it is a bit hard to evaluate what is organic vs. acquisition driven. Nevertheless the long-term growth of the business has been strong and it seems that NVS’ drug pipeline may be in better shape than that of most of its competitors.

In terms of returns, NVS could deliver the following:
   - Dividend: 2.2% on payout of 40%
   - Growth: 5% using 35% of earnings (assuming 15% ROE)
   - Buybacks: up to 2% (25% of earnings on a current earnings yield of 7.4%)
Total returns: 9% which is not great and highly depends on NVS’ growth given that historically they have not really done buybacks

2- Balance Sheet Risk (+)
Metric
Status
LT Debt / Equity   0.24x
Current Ratio   2.2x
NVS’ total debt of $13B is slightly more than its annual free cash flow of $10B. Overall the debt risk is limited

3- Valuation Risk (+)
Metric
Status
Cash Return   9.5%
P/E   13.4x, which is higher than the industry as a whole in line with the S&P
Valuation for NVS appears to be reasonable with an interesting cash return and a P/E in line with the S&P 500 for a company with high cash generation and returns.

Conclusion
NVS is an interesting candidate with strong business performance, good B/S and possibly attractive valuation – although I’d probably prefer that the company be a bit cheaper (10% or so) to make sure we have a good margin of safety. I will however still perform a company analysis to get a better sense of an attractive entry price - with a margin of safety - on what seems to be a good company