Novartis: A healthy dividend tonic?

Novartis is a European giant of the pharmaceutical industry, headquartered in Switzerland. With a portfolio of drugs that treats conditions of the heart, brain, eye and respiratory system, Novartis has a solid in market portfolio and provides a good dividend yield to match (almost 4%). Is the Novartis yield sustainable, and can we expect good growth in the dividend going forward? 

 

Core Business 

Novartis (NVS) manufactures a variety of health care products including both branded and generic pharmaceticals, diagnostics, vaccines and eye care products. It generates close to USD $60B revenue annually across its business units at gross margins approaching 70%, with net income of nearly $10B annually.

The Novartis branded pharmacuticals business accounts for the majority revenue (over 50%), with Alcon (eye care business) the second major portion of revenue (around 20%). The generics, vaccines and consumer health business are relatively minor contributors and account for the rest of the revenue.

Like many other large pharmaceutical companies, Novartis has been exposed to some key drugs coming off patent and continuing to come of patent. Diovan, one of the Novartis blockbuster drugs (lowers high blood pressure) came off patent in late 2012. The drug which has contributed as much as $5B in sales to Novartis is already facing sales pressure from generics.

However unlike many other big pharma companies, Novartis has a relatively robust pipeline and a number of recently released drugs which are performing quite well. So while the loss of Diovan will hurt company sales through 2013, increasing contributions from late stage drugs in the Novartis pipeline should start to make up some of the revenue shortfall from the loss of Diovan patent exclusivity.

Where’s the growth? 

Key to Novartis future growth is the performance of some of its new to market drugs and the robustness of its pipeline. Some of its new to market drugs such as Gilyena (multiple sclerosis drug) and Lucentis (eye drug) have so far surpassed analyst expectations and will help to close the revenue gap that Diovan leaves. Novartis has also been hard at work building a robust pipeline of drugs

So how does the Novartis pipeline look? While Novartis has greater than 100 projects in clinical development, more critical is the number of late stage pipeline projects that can secure FDA approval for launch. Novartis has some 10-15 late stage pipeline projects that it expects to seek FDA approval for over the course of the next 12 months. Many of these are oncology drugs designed to treat cancer.

While the success of these drugs is still dependent on clinical data to prove out effectiveness of the drug, the presence of a full late stage pipeline with many potential drugs being submitted for approval holds promise for the companies future prospects.

What do the numbers say?

Note for this analysis I normalized 2007 operating cash flow, which appears to be abnormally high due to the sale of a business and not in trend.

10yr /5yr revenue

NVS compound revenue growth over the 10 year period (2002-2011) has been a modest 11% p.a, quite respectable for a company its size.

Both “halves” of the period have had roughly similar revenue growth  2002-2007 revenue growth was 10% p.a while 2007 to 2011 has been a similar 12% pa.

10 yr / 5 year operating cash flow growth

NVS growth in operating cashflow over the period has also been a comparable 10.5 % p,a.

2002-2007 increase in yearly cashflow was 9.5% p.a for the period. while 2007-2011 was 11.5% p.a. Again, fairly consistent throughout both periods.

Dividend Growth Rates

Novartis dividend has increased from $0.44 in 2002 to roughly $2.00 in 2011. Dividend growth rate has averaged an impressive 18% p.a over the period.

This is higher than what we’d expect from NVS given its operating cash flow growth at a more modest 11% p.a over the 10 years. And in the last 5 years? NVS’s dividend growth from 2007 to 2011 has increase 16% p.a over this period, again a little higher than what we’d expect given its cash flow growth.

This suggests to me that NVS has been steadily increasing its payout ratio over time.

A review of the payout ratio reveals a steady increase  from 30% in 2002 up to 55.5% in 2011. In fact, 2012 TTM seems to suggest a payout ratio of close to 70% (largely due to lower revenues and cashflow from loss of patent exclusivity.

In my view, NVS will struggle to increase payout much beyond these current levels (I’d be concerned if it went much higher) Unlike the situation at JNJ however, my belief is that is newly released drugs, plus some success with its late stage pipeline should overcome the revenue and cashflow drop off that 2012 -2013 will see for the company from the loss of Dioxan.

Wrap Up 

Novartis is a big pharma giant with an impressive range of in market drugs. Like its other big pharma peers, its in the midst of revenue declines from a loss of patent exclusivity. What augers well for Novartis is some of the new drugs that Novartis has recently brought to market as well as its impressive late stage pipeline. While dividend growth of greater than 10% is unlikely to occur in my view (at least until some of these newly released drugs become blockbusters), I expect slowly increasing revenue, cashflow and dividends from NVS over a period of time.

Exchange Rate Conversion

One final factor to be aware of with any investment in NVS is the fact that dividends are paid annually and in CHF (Swiss francs). The Swiss Franc has generally been viewed as a safe haven currency which benefits from appreciation vs USD during periods of volatility or economic turmoil.

In looking at dividends from foreign companies, having a view of currency performance can be important to ensure your dividend isn’t diminished with declines in the currency. Unlike the euro, I am comfortable with the general level stability of the Swiss Franc and do not expect major depreciation in the currency in the near to medium term.

Adding a Position

I am adding an initial $7000 position to the Integrator 50k fund at $64 at roughly a 4% yield,. I may  add more should the NVS price decline below $60.

 

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