Novartis On The Right Track

It has taken longer than some analysts predicted, but it looks like Novartis' (NYSE:NVS) strategy is finally paying off. It was not that long ago that Novartis looked like a just another floundering drug company with a weak pipeline. When the Sandoz acquisition failed to immediately produce results, more people wrote off the company and sold the stock. Now, though, Novartis looks like one of the more dynamic names in big-cap pharma.

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The Quarter That Was
Novartis produced a very good June quarter. Sales were up 12% to nearly $12 billion, as pharmaceutical sales rose 8% and Sandoz (the company's generics business) saw revenue rise 13%. Oncology and cardiology drugs make more than half of the company's pharmaceutical revenue base, and these were up 11% and 8%, respectively, as major contributors like Diovan and Gleevec continue to grow.

Novartis leveraged that sales growth into operating profit growth of about 23%. This, though, is where I have some issues. The company held administrative expenses flat, and that is great. Sales and marketing expenses rose 5% and that is certainly fine if the company has figured out how to be more efficient. What troubles me, though, is the 5% increase in R&D spending. I realize that R&D can wobble from quarter to quarter on the basis of clinical trial timing, but I tend to be very sensitive to R&D spending by Big Pharma - if you do not spend on R&D, you ultimately have to spend on partnerships and M&A, and that can carry a hefty price tag. (For related reading, see Playing Big Pharma With CROs.)

Looking Strong for the Near Term
Luckily for Novartis, the company's roster of newly-launched and late-stage drugs is very solid. Gilenia looks to be the first oral multiple sclerosis drug on the market, and the company is clearly hoping that Tasigna can maintain the momentum in the oncology franchise even when Gleevec goes off patent in the near-term. Elsewhere in the pipeline, I do not see a lot of blockbusters about to be filed, but the company has a number of follow-on indications in the works and those are generally good sources of incremental profit. This is one of the areas where Novartis stands out in comparison to a company like AstraZeneca (NYSE:AZN) where the near-term pipeline is not so strong.

Unlike Bristol-Myers Squibb (NYSE:BMY) or Pfizer (NYSE:PFE), Novartis does not have a big near-term generics risk beyond Diovan. Moreover, the company continues to look for ways to restock itself - the acquisition of Alcon (NYSE:ACL) for instance. Novartis is still moving forward with the acquisition of this leading eye-care company, even though Alcon shareholders are howling about Novartis' attempt to pay Nestle more for its stake than it is willing to pay the shareholders for their shares. I understand that there has always been a difference between what is legal and what is fair, but I find this process intriguing and I am very curious to see whether Novartis can be forced to give everybody the same deal.

The Bottom Line
I have never been an enthusiastic advocate for Novartis shares, but I have to admit that I am warming up to them at least a little. The company does not have the dividend yield of AstraZeneca or Lilly (NYSE:LLY), nor the diverse business array of Abbott (NYSE:ABT) or Roche (Nasdaq:RHHBY). Nevertheless, Novartis is a good version of what it is - an integrated producer of branded, generic and OTC pharmaceuticals.

I still think that there are better ideas elsewhere, but not very many and not all that much better. With several major drugs growing more than 20% a year, new drugs making up more than one-fifth of sales, and both a solid pipeline and good reputation as a partner, Novartis deserves a spot on the watchlist of anybody looking at Big Pharma. (For more on investing in pharmaceuticals, read Stocks On Drugs: What It Takes To Get High.)

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