2023-09-26 07:17:48 ET
Summary
- Novartis' core EPS payout ratio is poised to come in at around 51% in 2023.
- The Swiss drugmaker grew at a solid clip in the first half of this year.
- The company enjoys an AA- credit rating from ratings agency S&P.
- My inputs into the discounted cash flows model have Novartis trading at a 16% discount to fair value.
- The stock's 3.5% dividend yield and mid- to upper-single-digit annual earnings growth make it an interesting pick for dividend-focused investors.
The companies that I find to be the most amazing as a dividend investor are those that remain in business for hundreds of years. That is because such an achievement requires a company to repeatedly innovate and adapt to change as the torch is passed from one generation to another.
Few companies can match the lengthy track record of Novartis (NVS): The giant Swiss pharmaceutical company can trace its roots back nearly 300 years to the mid-18th century . Since the merger between Ciba-Geigy and Sandoz in 1996 to form the company we know today, Novartis has raised its annual dividend for 26 consecutive years .
Income investors looking for a decent starting dividend and modest growth should consider buying Novartis stock. Let's further examine why.
The Generous Dividend Can Be Sustained
Novartis' 3.5% dividend yield is significantly higher than the healthcare sector's average yield of 1.7%. That is why the Seeking Alpha Quant system awards Novartis with an A- dividend yield grade. As you'd anticipate for a higher starting dividend yield, there is one obvious tradeoff: Novartis' 10-year annual dividend growth rate of 3.7% is about half of the healthcare sector average of 8%. This explains the C dividend growth grade from the Seeking Alpha Quant system for the drugmaker.
Overall, investors who want a strong starting income and the chance for their dividend income to keep pace with inflation should consider Novartis. This is especially true when considering how viable the dividend is moving forward.
The analyst consensus is that Novartis will post $6.86 in core EPS in 2023. Compared to the $3.50 in dividends per share that were paid this year, that works out to a 51% core EPS payout ratio. If that wasn't enough, Novartis' free cash flow also easily covers the dividend: The company anticipates that its free cash flow payout ratio will clock in at approximately 61% in 2023. These payout ratios leave Novartis with the funds needed to execute bolt-on acquisitions, repay debt, and repurchase shares.
Novartis Is A Flourishing Business
Novartis has had a wonderful start to 2023. Through the first half of this year, the company's net sales have edged 5% higher over the year-ago period to $26.6 billion. When accounting for a 3% foreign currency translation headwind stemming from a robust U.S. dollar, Novartis' constant currency net sales grew by 8% during the first half.
This admirable performance can be explained by the fact that the company's portfolio is loaded with 13 medicines each on pace to surpass $1 billion in 2023 net sales. This is led by Novartis' heart failure therapy Entresto and immunology treatment Cosentyx. Of the company's 13 blockbuster products, 10 put up constant currency net sales growth in the first half of 2023. These constant currency growth rates ranged from 1% for chronic myeloid leukemia medicine Tasigna to 103% for multiple sclerosis drug Kesimpta.
Novartis' core EPS ripped 17.2% higher year over year to $3.54 during the first half of 2023. Factoring out foreign currency headwinds, core EPS was up an even more remarkable 25%. Thanks to smart management of costs, the company's profit margin expanded by 150 basis points to 27.9% for the first half.
Looking forward, future growth should be decent. Aside from the exceptional existing product portfolio, Novartis has well over 100 projects currently in development within its pipeline across a variety of therapeutic areas. This is why analysts believe the company's core EPS will grow by 7.4% annually for the next five years.
The cherry on top is that Novartis is also a financially sturdy business. Analysts predict that the company's debt-to-EBITDA ratio will be around 0.6 in 2023. This serves as the rationale for why S&P awards Novartis with an AA- credit rating. That translates into a minimal risk of bankruptcy for the company in the decades to come (unless otherwise linked, all details sourced from Novartis Q2 2023 earnings press release ).
Risks To Consider
Novartis is doing well from a fundamentals' standpoint. But like any business, it still has risks that investors must know.
As is the case with all pharmaceutical companies, Novartis can be adversely impacted by patent expirations and increased competition on top-selling drugs. This is why it is imperative that the company must innovate to keep growing. Fortunately, Entresto made up just 11% of Novartis' total net sales in the first half of 2023. Not to mention that the company's pipeline looks to be adequate to replace eventual lost revenue from the drug.
Novartis could also be impacted by unfavorable regulatory developments. If regulators around the world impose price limits on its products, the company's net sales and core EPS growth could be put under pressure.
An Undervalued Blue-Chip Stock
Based on an examination of the business, Novartis is a company worth owning for income investors. But that comes with the caveat of buying it at the right valuation. My inputs into a valuation model show the stock to be trading at an enticing discount to fair value.
The valuation model that I'm going to be using to value Novartis' shares is the discounted cash flows or DCF model.
The first input into the DCF model is the last 12 months of core EPS. For Novartis, that figure is $6.64.
The second input for the DCF model is growth forecasts. Building some conservatism into our assumption, I will use a 5% annual core EPS growth rate for the first five years of this calculation. I'll then assume a deceleration to 4% in the years thereafter.
The third input into the DCF model is the discount rate, which is an investor's required annual total return rate. Since my personal preference is for 10% annual total returns, that is what I will be using.
My inputs for the DCF model helped me to arrive at a fair value of $120.15 for shares of Novartis. This indicates that Novartis' shares are priced 15.8% below fair value and offer an 18.8% upside from the current price of $101.12 a share (as of September 25, 2023).
Summary: Novartis Is A Great Pick For Income
It's hard to imagine Novartis not paying a dividend in some capacity for many more decades. This is due to several reasons, such as the longevity of Novartis as a business, its safe payout ratios, and its development pipeline that affords it many future growth opportunities.
As we alluded to earlier, Novartis' valuation seals the buy case for income investors. That is why I believe the stock is a smart fit within a dividend stock-oriented portfolio.
For further details see:
Novartis: Buy This Dividend Aristocrat For Consistent Income