Image Source: Taki Steve
Leadership change can often bring a great deal of uncertainty especially when a new leader is replacing a successful CEO. In the case of Novartis, we are witnessing a focused effort to streamline the business: a deliberate attempt to shift focus from a sprawling healthcare enterprise towards a more pure-play pharma/biotech powerhouse with an innovative, cutting-edge product portfolio.
By Alexander J. Poulos
Key Takeaways
We liked that Novartis divested its stake in its healthcare joint-venture with GlaxoSmithKline, and we were very pleased with the large sale price of $13 billion. The cash proceeds will offer increased financial flexibility at Novartis.
We’re not completely against the company’s near-$9 billion deal for AveXis, though this, too, had a high price tag. AveXis has a promising gene replacement therapy for spinal muscular atrophy (SMA) and further augments Novartis’ commitment to Neuroscience.
We remain pleased with Novartis’ performance during the first quarter of 2018, with mid-single-digit sales growth and solid core operating income expansion, even after adjusting for currency fluctuations. Quarterly net income and core earnings-per-share growth came in at 12% and 6%, respectively, adjusting for currency, and free cash flow advanced to $1.9 billion in the period (up 15% on a year-over-year basis in USD).
Cosentyx ($580 million in sales during the first quarter) remains the molecule that has been driving the nice top-line expansion at Novartis, as sales of the molecule increased ~35% over the comparable period in 2017.
At its current run-rate of $200 million per quarter and with payer resistance falling by the wayside as evidenced by an uptick in new prescriptions written for the product, we believe Entresto is well on its way to achieving blockbuster status (sales over $1 billion per year).
Novartis may spin-off its optic division Alcon, as evidenced by the distinct lack of near-term molecules for the treatment of various optic disease states.
Though Novartis’ portfolio continues to shift around given the JV sale, the acquisition of AveXis, and the potential spin off of Alcon, the company’s Dividend Cushion ratio still stands at a healthy 1.5. We continue to monitor the viability of Novartis’ clinical pipeline for clues regarding the long-term sustainability of the dividend, however, but the payout looks solid for the foreseeable future.
Leadership Change and Divestiture of Novartis’ JV Consumer Healthcare Stake
Vasant Narasimhan ascended into the CEO role at Novartis (NVS), effective February 1, 2018. We view Narasimhan as a change agent with a unique runway to dramatically alter Novartis into a more-nimble global operator through a series of moves to streamline the company. We have not been disappointed thus far in 2018, as Narasimhan has moved quickly and decisively to recast the business.
In our recent report titled “GlaxoSmithKline: Not All Dividends Are Created Equal,” we discussed our concerns about the strategic direction at pharma rival GlaxoSmithKline (GSK). We anticipated a purchase on the part of Glaxo of Novartis JV stake in the business, and we are pleasantly surprised at the speed of which the deal was announced. Novartis will divest its stake for a staggering $13 billion with the deal widely expected to close in the second quarter of 2018. We found the following quote for Narasimhan particularly enlightening:
Vas Narasimhan, CEO of Novartis, said: “While our consumer healthcare joint venture with GSK is progressing well, the time is right for Novartis to divest a non-core asset at an attractive price. This will strengthen our ability to allocate capital to grow our core businesses, drive shareholder returns, and execute value-creating bolt-on acquisitions as we continue to build the leading medicines company, powered by digital and data.
Quote Source: Novartis March 27, 2018 press release
Purchase of AveXis
Not to be outdone, Narasimhan followed up the bold move of selling the reliable, yet slow-growing consumer healthcare division with a masterstroke of a deal, assuming the product gains approval. Novartis reignited the feeding frenzy in junior biotechs with the audacious takeout of AveXis to gain control of its promising gene replacement therapy for spinal muscular atrophy (SMA). The price tag for AveXis came to a staggering $8.7 billion in cash with the treatment widely-expected to enter the US market in 2019. Novartis issued guidance of peak sales in the multi-billion-dollar range with an expectation the product will become accretive to earnings in 2020.
Spinal Muscular Atrophy is a genetic disorder caused by a defect in the SMN1 gene. We remain optimistic the treatment will gain widespread adoption as the potential for a lifetime fix for a deadly disease that kills off most infants before they reach the age of 2. We view the AveXis purchase as an excellent use of cash as it will further augment Novartis’ commitment to Neuroscience, as it pairs the treatment with top-selling Gilenya to form a potent franchise. We tend to have a more favorable stance to M&A targets that add to an existing franchise as the need to build out a sales staff is lessened. In the case of Novartis, the staff is firmly in place with significant long-term relationships with the specialists practicing in the field.
First Quarter 2018 Results
We remain pleased with Novartis’ performance during the first quarter of 2018, with mid-single-digit sales growth and solid core operating income expansion, even after adjusting for currency fluctuations. Quarterly net income and core earnings-per-share growth came in at 12% and 6%, respectively, adjusting for currency, and free cash flow advanced to $1.9 billion in the period (up 15% on a year-over-year basis in USD). Novartis has begun to improve from the decline emanating from the loss of patent protection of its key oncology franchise Gleevec in 2017. Let’s examine the various components of the “Innovative Medicines” group to gain a feel for how the various franchises are performing.
Immunology
Cosentyx ($580 million in sales during the first quarter) remains the molecule that has been driving the nice top-line expansion at Novartis as sales of the molecule increased ~35% over the comparable period in 2017. The sales expansion was viewed as a disappointment, however, as payers begin to push back over the exorbitant prices of such treatments. Cosentyx sales suffered from a destocking trend in specialty pharma coupled with a more-aggressive rebate, which management hopes will be offset by an increase in volume. Thus far, we are inclined to accept management’s assertion the destocking trend affected sales as overall share grew. However, if the trend does not reverse in the second quarter, we will view this as a negative not only for Cosentyx but the overall health of all the Immunology products.
Cardiovascular
We are pleased with the steady yet slow growth of Entresto ($200 million in sales during the first quarter), a novel new class of treatment for heart failure. Novartis continues to face an uphill battle in gaining widespread acceptance of the product. Entresto is mired in a widespread educational campaign to expand the overall market beset with numerous generic alternatives. At its current run-rate of $200 million per quarter and with payer resistance falling by the wayside as evidenced by an uptick in new prescriptions written for the product, we believe Entresto is well on its way to achieving blockbuster status (sales over $1 billion per year).
Oncology
The oncology division continues to grow at a brisk clip despite the lack of a market-defining blockbuster product such as PD-1 star Keytruda or the lymphoma leader in Imbruvica. The growth of the oncology division can now be viewed as a key growth driver for Novartis with the near-term product pipeline recently bolstered by new entrants such as Kisqali, Rydapt, and the Car-T treatment Kymriah. We view the oncology division as the premier area for additional R&D spend—we are very pleased with the recent approvals which underscore the productivity of Novartis clinical team unlike what is traditional witnessed in other big pharma peers.
The Alcon Spin Off
We are watching with particular interest the turnaround underway at Alcon, the optical division of Novartis. Novartis has issued guidance indicating it is contemplating a spin-off of the division in the first half of 2019, thus ensuring ample time to effect a turnaround in the division. We were impressed with the 7% top-line growth during the first quarter of 2018, coupled with core margin expansion (20.2% versus 16.2% in the prior-year quarter). In our opinion, Novartis may very well spin-off Alcon, as evidenced by the distinct lack of near-term molecules for the treatment of various optic disease states.
On the basis of our review of Novartis’ pipeline, the earliest new entry in the field of eye disease is UNR844 and ECF843, with a planned timeline for approval in 2021. We do not give much credence to the potential of the products, as we have yet to see detailed clinical data indicating the long-term potential of the molecules. A quick scan of the near-term pipeline underscores a strong trend: the focus remains on label expansion of current products along with a shift towards immunology and oncology as the key growth drivers.
Role of the Dividend
Though Novartis’ portfolio continues to shift around given the JV sale, the acquisition of AveXis, and the potential spin off of Alcon, the company’s Dividend Cushion ratio still stands at a healthy 1.5. We continue to monitor the viability of Novartis’ clinical pipeline for clues regarding the long-term sustainability of the dividend, however, but the payout looks solid for the foreseeable future. As is the norm for most European-based companies, Novartis pays out its dividend in an annual fashion. The annual dividend of $2.94 per share was paid on April 25, 2018, an 8% increase over the prior year’s payout. We remain comfortable with the financial outlook for Novartis in light of the productivity of its near-term portfolio coupled with the growth of its new product portfolio.
Concluding Thoughts
We remain impressed with the overall performance of Novartis in the recently-concluded quarter. We would like to highlight its growing trend towards more of a pure-play pharma company, with a burgeoning pipeline bolstered with an aggressive, yet intelligent tuck-in acquisition in areas of notable strength. We believe the sale of its consumer JV unit to Glaxo is the first step towards the transformation into a pure-play pharma entity. We will continue to monitor events at Novartis with timely updates posted when warranted. The company remains an idea in the simulated Dividend Growth Newsletter portfolio.
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Independent Healthcare Contributor Alexander Poulos has no disclosures to report. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.