Novartis: The Value Creator


Novartis International AG (NVS) has one of the biggest and most promising pipelines in the industry. The company has a proven experience in getting value from its R&D activity. Novartiss stock won back its last year drop, but it is still far from the peak point level (around $106 as of 07/20/2015). According to Evaluategroups estimates, Novartis will save its leading positions as one of the top-3 companies by the worldwide prescription (Rx) and the OTC drug sales in the next five-year period. My valuation model shows that the current share price is in the fair price range and has a great potential for the new highs in the long-term run.


(Source: Nasdaq.com)

If we compare the price movement of Novartiss shares with another major Rx and OTC drug manufacturers (Roche (OTCQX:RHHBF), Pfizer (PFE), Sanofi (SNY), Johnson & Johnson (JNJ) and Merck & Co (MRK)), we can see that NVS was underperforming during the last year and only Pfizer has shown more disappointing result.


(Source: Morningstar.com)

The price is not justified from the position of the potential earnings, which are based on the current pipeline and the successful R&D activity (which is a crucial factor for the pharmaceutical industry).


As we can see from the table below, Novartis has the second largest and promising pipeline in the industry.

(Source: EvaluatePharma report)

Furthermore, this Swiss manufacturer has one of the most balanced pipelines, taking into account the value/risk relationship.


Value creation index: % 2022 WW sales coming from pipeline and recently launched products (Dec 2012+).

Value at risk index: % of 2022 WW sales at risk either because of generics or technical failure (pipeline products).


(Source: EvaluatePharma report)

Novartiss activity in the field of drug and therapies studies is overwhelming. You can see it from the list of the top-ten pharma companies arranged by the number of clinical studies:


(Source: ClinicalTrials.gov. Calculations by author)

The success of these studies should help Novartis market a dozen of blockbusters and improve its revenue growth.

Now, let us look at how such a generous R&D activity can influence the companys valuation. For this purpose, I built DCF model, which will be described below.

DCF Model

For the purpose of better revenue forecasting, I have divided the companys product portfolio into the following segments: Anti-Diabetics, Oncology, MS (multiple sclerosis) therapies, Cardiovascular Therapeutic Drugs, Anti-bacterials, Immunosuppressants, Anti-hypertensives, Bronchodilators, Ophthalmic Therapeutic Drugs, Other Rx drugs, CHC (Consumer Healthcare), Generics, Ophthalmic Devices and Vaccines.


Projected revenues do not include discontinued operations from the Vaccines business and the CHC due to the contribution of the former Novartis OTC Division into the GSK Consumer Healthcare joint venture.

I made my estimates about the probable revenue growth rates separately for each segment:

Oncology (excludes anti-emetics, anti-anaemics used in chemotherapy-induced anaemia, interferons, immunostimulants, immunosuppressants)

Oncology is a key segment for every major pharmaceutical company. On the report of the EvaluatePharma, Oncology is the largest and the most rapidly increasing segment in pharma industry. In FY2016, Oncology products constituted 26% of Novartiss total revenue.


Novartiss Oncology product portfolio and notable industry blockbusters (including potential ones) are summarized in the table below.


(Source: EvaluatePharma report; pharmaceutical companies annual reports)

Novartis is one of the top players in the Oncology segment. Its Oncology product portfolio is quite hefty with the focus on treatments for breast and blood cancers.


Among the negative factors for Novartis in this field we find:

Generic competition for Gleevec/Glivec (the main Oncology Novartiss blockbuster, which has faced a considerable competition due to the expiration of patent); Upcoming patent expiration for Afinitor (the first exclusivity expiration date is October 29, 2017).

There are also positive drivers for Novartis, which are stated in 2017 Q2 results:

The strong pipeline with a good progress on key 2017 milestones, including CAR-T cell therapy platform; FDAs approval of Ribociclib (Kisqali), which is a potential blockbuster with NPV aroud $6.4 bln.


Taking these facts into account, I estimated the following revenue CAGR for Novartiss Oncology segment (FY2017 – FY2021):

CAGR is conservatively set at the level of 2% in my Base Case Scenario (due to the fierce competition and the generics menace) and at 12.5% (at the industrys level) in the Optimistic Scenario. MS Therapies

This is not the biggest segment but is an important part of Novartis s sales (about ~7% of the total revenue in FY2016).

The main marketed drug of the Swiss manufacturer in this field is Gilenya. In the table below you can see that Gilenya has the market share about 14% (as of FY2015):


(Source: EvaluatePharma report; pharmaceutical companies annual reports)

Despite the good historical figures and the presence in the companys pipeline of the two promising drugs (OMB157 (ofatumumab) and BAF312 (siponimod)), my insight of the future sales in this segment is quite conservative.


The main reason for this opinion is an upcoming Gilenya’s patent expiration come with the generic competition in 2019. Gilenyas sales are currently accounted for almost 100% of total segment revenue.

Moreover, Roche’s Ocrevus will probably be market-ready at the end of 2017. Ocrevus is considered to be the most valuable R&D pharma project with NPV around $17 bln.

I estimate the following revenue CAGR for Novartiss MS therapies segment (FY2017 – FY2021):

CAGR is conservatively set at the level of 0% in my Base Case Scenario (due to the poor segments product portfolio diversification, an anticipation of the new strong rival and upcoming generic arrival) and at 2% (at the industrys level) in the Optimistic Scenario. Immunosuppressants


Another important niche for Novartis is the Immunosuppressants segment (about ~6% of the total revenue in FY2016).

Novartis traditionally pays a lot of attention to this segment. This results in a well-diversified drug portfolio, which consists of established medicines and the brand-new blockbuster Cosentyx. The potential of Cosentyx is still uncovered, and many additional studies for new indications are carried out.


(Source: EvaluatePharma report; pharmaceutical companies annual reports)

I estimate the following revenue CAGR for Novartiss Immunosuppressants segment (FY2017 – FY2021):

CAGR is conservatively set at the level of 4.5% in my Base Case Scenario (the level is based on the forecasted sales of Cosentyx only not taking into account possibilities of a launch of the new drugs) and at 11.3% (at the industrys level) in the Optimistic Scenario. Sandoz / Generics and biosimilars

Novartis is not only suffering from generics and biosimilars competition. It has also learned how to make money on patent expirations.


Novartiss division Sandoz is one of the global leaders in biosimilars and generic antibiotics, dermatology and transplantation medicines, cardiovascular, central nervous system (CNS), pain, ophthalmology, oncology, respiratory and hormonal therapeutics.

Sandozs revenue in FY2016 ($10.1 bln) was the second result among the generic pharmaceutical companies. Teva Pharmaceutical Industries keeps the first place in rating with the Generic Medicines revenue around $12 bln in FY2016 (Source: companys annual reports).

Sandoz is the only one Novartiss division which had shown sustained revenue growth in the period of FY2012 – FY2016. The share of Sandoz in Novartis Groups revenue reached the level of 21% in FY2016.


The main growth drivers of Sandoz in the near future are: Erelzi (etanercept) biosimilar of Amgen’s Enbrel; Rixathon (rituximab) – biosimilar of Roche’s Rituxan/MabThera; Adalimumab – biosimilar of AbbVie’s Humira; Infliximab – biosimilar of Johnson & Johnson’s Remicade; Omnitrope which is the first biosimilar to be approved in the global pharmaceutical space of Pfizers Genotropin (somatropin); Binocrit (epoetin alfa) – the reference medicines for Binocrit are Eprex/Erypo (Janssen), Procrit (Johnson & Johnson), Epogen (Amgen); Zarzio (filgrastim) – biosimilar of Amgens Neupogen.


I assume the following revenue CAGR for the Sandoz division (FY2017 – FY2021):

CAGR is set at the level of 3.9% in our Base Case Scenario (in line with the historical figures) and at 8.7% (in line with the global market for generic drugs in the Optimistic Scenario. Other Considerations

The EBITs forecast for the period of FY2017 – FY2021 is based on the average historical operating profitability separately for Innovative Medicines/Pharma and Alcon/Ophthalmic Devices divisions. For Sandoz/Generics it is set at the FY2016 historical level.


The rest of the forecast periods figures are calculated in-line with the historical numbers.

My DCF model shows that, after the inclusion of the above-described assumptions, the price sensitivity tables are as follows:

DCF Sensitivity: EBITDA Multiple Method

Value Per Share ($) Base Case Scenario


(Source: Author’s DCF Model)

DCF Sensitivity Perpetuity Growth Method

Value Per Share ($) Base Case Scenario

(Source: Author’s DCF Model)


DCF Sensitivity: EBITDA Multiple Method

Value Per Share ($) Optimistic Scenario

(Source: Author’s DCF Model)

DCF Sensitivity Perpetuity Growth Method

Value Per Share ($) Optimistic Scenario

(Source: Author’s DCF Model)

My target range per share is:

$80 – $94 in the Base Case Scenario; $107 – $126 in the Optimistic Scenario.

The market price was around $85 per share as of the time of writing, so there is an upside potential of around 10% in the conservative scenario and approximately 47% in the optimistic case.

Conclusion

If you are willing to invest in the pharmaceutical industry and looking for a good risk/return balance, then you should choose one of the major companies with well-diversified established drugs portfolio and the strong pipelines. Novartis is definitely one of them. This Swiss manufacturer has proven ability to get value from its pipeline. My valuation model shows a target price range of $80 – $94 per share in the Base Case Scenario and $107 – $126 per ADR in the Optimistic Scenario. In current market conditions, the potential upside can reach 10% – 47%. Hence, I recommend buying the stock ai ming at the exit price range in accordance with personal risk/return profiles.

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.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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