NVSEF - Novartis: We Are Still Neutral

2023-06-08 07:39:39 ET

Summary

• We analyzed Novartis pipeline growth versus patent expiration.
• Positive adjuvant data for Kisqali could accelerate market share shifts.
• Novartis' equal weight rating is due to high margin sales lost to generics and risks from US healthcare reform, partially offset by new product launches.

Here at the Lab, we consider the pharmaceutical sector an evergreen investment. Even in a recessionary environment, over the long term (10 years) the MSCI World Health Care index returned to the investors an average of 11% per annum compared to the 9.2% achieved by the MSCI World . What is most important to report is the return-risk optimization. Indeed, during the sell-off phases, healthcare companies manage to give their best outcome, outperforming global equities thanks to the uncorrelated business.

In 2022, global equities fell by around 18%, compared to just -5% for pharmaceutical companies, and in 2018, the market dropped around 8%, while the sector gained 3%. The return-risk ratio is well supported by lower volatility. In this scenario, Novartis ( NVS , OTCPK:NVSEF ) could seem a good pick with a current P/E of 15.1x, a dividend yield of 3.38%, and a beta lower than 0.5. However, in our last publication, we emphasized how " Novartis's valuation seems fair " .

Why are we still neutral?

1. Novartis was not a beneficiary of COVID-19 such as Pfizer or Roche . In this new phase, most of the pharmaceutical giants are grappling with a significant problem. Many of their blockbuster drugs will lose their patent protection in the coming years and this will translate into another drastic drop in revenues. According to JP Morgan estimates, between 2023 and 2030, large pharmaceutical companies will lose almost a quarter (24%) of global sales (about $110 billion) to loss of patent exclusivity (LOE). Looking at the company's expiration date, in 2028, Tasigna, Promacta, and Entresto will compete with generic drugs. Therefore, Novartis executives are looking for promising new drugs to add to their portfolios, with the aim of beefing up sales in view of patent expirations.
2. In number, comparing Novartis pipeline growth versus patent expiries, we positively view adjuvant data for Kisqali and Pluvicto's new capacity approvals (Fig 1). Having participated in the recent ASCO investor meeting , we are more confident in Kisqali's sales potential evolution. Data are supportive and the drug is gaining share compared to Ibrance. We are now forecasting $5.5 billion in peak sales and this represents 6.5% of Novartis' future NPV. However, in our calculation, we are forecasting $11.8 billion lower sales from patent expiration until 2028. This includes $4.7 billion in high-margin oncology sales and a $3.8 billion turnover from Entresto.

Fig 1

3. This need could push toward a new season of consolidation in the sector and this will imply higher multiples. Indeed, after several years of intense activity, the big pharmaceutical companies had recently reduced their acquisitions. In 2022, according to EY, the total value of pharma M&A deals was about $88 billion with 75 biopharma companies involved, and was the lowest since 2017. This trend might reverse but pharma multiples are still pretty high (this was confirmed by Pfizer's latest acquisition - Seagen - an oncology company valued at $43 billion with sales at $2 billion). On the other hand, at March-end, Novartis' net debt evolution reached $15.1 billion compared to $7.2 billion at December-end. This was due to dividend payments and an ongoing buyback ($7.3 billion and $2.7 billion respectively). This was partially offset by FCF generation at $2.7 billion (Fig 2). To counterbalance LOE, Novartis could sustain new M&A; however, there is a valuation risk (given biotech/MedTech multiples) as well as a potential balance sheet constraint.

Fig 2

4. Another ongoing concern is CHF and US dollar evolution. As a US dollar reporter but with significant CHF costs, Novartis has a significant FX risk exposure.

Conclusion and Valuation

Looking at our forecast, netting off Novartis pipeline growth and patent expiration, we believe that the company will deliver an estimated 2.5% CAGR pharmaceutical sales growth with a plus 3.7% core operating growth until 2028. However, what is really driving Novartis' stock price performance is the ongoing buybacks. This increases the company's EPS growth by approximately 7%.

However, valuing the company in line with the EU peer's P/E, Novartis' rating is still an equal weight. Having raised sales and EPS estimates, we are now valuing the company at CHF 90 per share with a 2024 P/E of 14.5x and a 6% historical discount versus its peers. Here at the Lab, we see better opportunities elsewhere. Aside from the FX evolution and the usual risks associated with the pharmaceutical industry, we also include withdrawals and patent challenges, the Leqvio launch trajectory, and the risk from US healthcare reform combined with a lower top-line growth vs its peers.

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