Like so many other pharmaceutical stocks, Novartis (NYSE:NVS) has done pretty well for its shareholders over the past year and solidly beat the S&P 500. With that move, the multi-year discount in most Big Pharma shares has evaporated and Novartis is no exception. Novartis has a deep and high-potential pipeline, but threats from generic competition, competition to its branded drugs, margin pressure, and strategic uncertainties do mitigate some of that pipeline value.

SEE: Evaluating Pharmaceutical Companies

Decent Growth, Relatively Speaking
While Novartis's first quarter earnings report is pretty stale at this point, I think it's worth noting that the company is logging decent growth at a time when many of its peers are struggling to show much of any momentum.

Revenue was up 2% in the last quarter (or 4% in constant currency), with the core pharmaceutical business the weakest at 0% and 3% growth. Generics and consumer health are both growing at mid-single digit rates, while the small vaccine and diagnostics business logged a double-digit constant currency improvement. Alcon results are still a little sluggish, with growth on par with the pharmaceutical business.

Due in part to the revenue mix, Novartis's margins are not quite as impressive as some peers. Operating income rose 1% (or 6% in constant currency), but the 26% operating margin isn't so impressive relative to Pfizer (NYSE:PFE) at 42% or Roche (OTC:RHHBY) at 31%. This less impressive margin is due at least in part to the company's very large generics business, as well as the very low margins of the vaccines/diagnostics business.

SEE: Analyze Investments Quickly With Ratios

A Strong Pipeline, But Near-Term Competition
Novartis has a broad and deep pipeline, and this pipeline could deliver billions of dollars in new revenue over the next five years. Importantly, Novartis is diversified across many disease categories – the company is quite strong in ophthalmology and oncology, but has meaningful presences in other areas like metabolic/endocrine and auto-immune.

Affinitor is not exactly a pipeline drug, as it is on the market, but label and market extension opportunities should lead to multiple billions of sales in a few years. The company's COPD drug is going to be trailing Glaxo (NYSE:GSK) in terms of reaching the market, but still has multi-billion dollar potential. Investors will soon have Phase III clinical data on AIN457 in psoriasis and rheumatoid arthritis, and the much-delayed Bexsero meningitis vaccine could still be a multi-billion dollar product when it reaches the market.

Last and not least is the company's efforts in immunotherapy, specifically its CART-19 product. CARs (Chimeric antigen receptors) are starting to get more attention as high-potential options in multiple cancers, and this could be a major oncology platform for Novartis. While Bristol-Myers (NYSE:BMY) and Merck (NYSE:MRK) are getting well-deserved attention for their immunotherapy pipelines, I wouldn't sleep on Novartis.

The flip side to this pipeline potential is the risk of real competition to the existing business. Biogen Idec's (Nasdaq:BIIB) Tecfidera is the real deal and likely to seriously challenge Novartis's position in multiple sclerosis. Likewise, newer drugs in diabetes (particularly SGLT2 inhibitors) will likely pressure the company's diabetes business. Last and not least, there is no shortage of competition in oncology, with established players like Roche looking to increase their share and other rivals bringing new drugs to market.

It also doesn't help matters that Novartis is still facing one of the larger patent cliffs in the space. Competition to Diovan (over $4 billion in 2012 sales) has been slow to arrive, but Diovan, Zometa, and Femara are all vulnerable in the near term.

SEE: Pharmaceutical Phenoms: America’s Best-Selling Medicines

A Change In Capital?
There has been ample speculation about what Novartis will do with its stake in Roche. It is pretty clear that Roche has no interest in merging with Novartis and the ownership structure of Roche pretty much prevents Novartis from doing anything about it. With the market finally valuing Roche at a more appropriate level, now could be an opportunity to sell.

It's not quite that simple, though. Novartis has 33% voting control of Roche, but a share capital stake of 6%. The best situation (for Novartis, at least) would likely be Roche borrowing the funds and buying back that stake. It would be at least a partial “win” for Roche as well given the low cost of debt today and the boost to reported earnings, but Roche may be more interested in deploying capital towards growth projects. Should Novartis manage to monetize this stake, look for a dividend or share buyback.

The Bottom Line
As I said in the intro, the Street has basically caught up with most of the companies in this sector and Novartis is no exception. I actually expect Novartis to be one of the better growth stories in the space over the long term (3% revenue growth, nearly 5% free cash flow (FCF) growth), but that works out to about $72 per share today, or “fairly valued”. The ability to sell the Roche stake at a premium would add a bit to that sum, but not enough to really make Novartis a must-own stock today.

At the time of writing, Stephen D. Simpson owned shares of Roche.

Related Articles
  1. Economics

    Pharmaceutical Sector: Does The FDA Help Or Harm?

    We look at how the FDA affects the pharmaceutical industry, and how investors can avoid the pitfalls.
  2. Fundamental Analysis

    Evaluating Pharmaceutical Companies

    Learn how to find a healthy pharmaceutical investment in a market full of weak drugs.
  3. Personal Finance

    An Introduction To Capital Budgeting

    We look at three widely used valuation methods and figure out how companies justify spending.
  4. Markets

    How To Choose The Best Stock Valuation Method

    Don't be overwhelmed by the many valuation techniques out there - knowing a few characteristics about a company will help you pick the best one.
  5. Insurance

    Pharmaceutical Phenoms: America's Best-Selling Medicines

    These three drugs were the winners of their day. Find out what winning pharmaceuticals have in common.
  6. Markets

    Investment Valuation Ratios

    Learn about per share data, price/book value ratio, price/cash flow ratio, price/earnings ratio, price/sales ratio, dividend yield and the enterprise multiple.
  7. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  8. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraPro Nasdaq Biotech

    Obtain information about an ETF offerings that provides leveraged exposure to the biotechnology industry, the ProShares UltraPro Nasdaq Biotech Fund.
  9. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  10. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Medical Identity Theft

    Stealing another person’s health insurance information so that ...
  3. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  4. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  5. Case Management

    Planning, processing and monitoring the healthcare services given ...
  6. Medical Patent

    A legal protection against market competition that a government ...
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. What role does the agency problem play in the modern Health Care industry?

    Agency problems vary from health care system to health care system, and not all economists agree on the degree and desirability ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!