Novartis RecoA Stock That Profits From
Nearly Every Threat Facing the Drug Industry
At the time, it was the largest corporate merger in history.
On March 7, 1996, two Swiss drug and chemical giants, Sandoz and Ciba-Geigy, finally ended a rivalry more than two centuries old. But for the long-standing competitors, bigger wasn't better...
The $41 billion behemoth had a difficult time integrating. The new executive team struggled as pre-merger rivalries persisted. Despite inheriting close to 5% of the worldwide pharmaceutical market, sales lagged with little to no growth. The new conglomerate's stock plummeted 13% in its first two years.
That all changed in 1999... Enter Dr. Daniel Vasella.
A native of Switzerland and a physician by training, Vasella joined the business world at the relatively late age of 35. After graduating from the executive management program at Harvard Business School, he took an entry-level sales position in the U.S. division of Sandoz. He became fluent in English (he speaks three languages) and absorbed the fast-paced American corporate culture.
Vasella quickly made a name for himself as product manager for a cancer drug with foundering sales. He pooled ideas from researchers, marketers, and salespeople and positioned the drug in new markets – sales quadrupled. Eight years later, executives tapped Vasella to engineer a turnaround strategy on a much larger scale.
Keenly aware that he had inherited a merger of weakness, Vasella immediately spun off stodgy, unprofitable parts of the company and cut 12,500 jobs. He broke ground on a huge research and development facility in Boston, much to the dismay of his Swiss colleagues. He poached a world-famous cardiologist and geneticist from nearby Harvard Medical School to run the new facility. Commenting on the controversial move, he said, "We go where the talent is; we don't ask them to come to us."
Vasella aimed to Americanize the company... He increased focus on the lucrative U.S. drug market. Financial results began reporting in U.S. dollars, not Swiss francs. And the U.S. sales force tripled. Novel advertisement tactics were launched under the direction of two top marketing executives who were recruited away from U.S. drug rivals Pfizer and Johnson & Johnson. Of the 13 U.S. executives in place at the time of the merger, only two survived Vasella's makeover.
Since 2000, Vasella's company has launched three times more drugs than its closest rival – at least 15 are due out within the next year.
Vasella managed to restructure and transform the business from a plodding, risk-averse giant with a barren drug pipeline to one of the most innovative and risk-taking drug companies in the world.
Its name is Novartis (NYSE: NVS).
The Glory Fades on Big Pharma
Big Pharma stocks were among the most lucrative investments during the late 1990's. The AMEX Pharmaceuticals Index, which tracks the world's largest drugmakers, returned more than 450% to investors. In recent years, however, much of that glory has faded. A gun-shy FDA, generic drug competition, and a shortage of innovation currently plague the sector.
From 2001 to 2005, while peers Merck and Pfizer struggled with losses of more than 40%, Novartis returned gains of more than over 50% to its shareholders. And its best days as an investment are just ahead...
With Vasella's direction, Novartis has positioned itself perfectly for the coming boom in generic drugs, has a fully stocked pipeline, is developing vaccines for the world's worst diseases, and owns a lucrative line of nonprescription health products.
If you invest in Novartis today, you can expect strong, safe, and consistent double-digit annual returns for at least the next five years.
Playing Both Sides of the Drug Divide
One of the largest black clouds hanging over the drug industry today is the threat of generic drugs.
Brand-name drugmakers invent and sell patented medications at high premiums. Generic drugmakers, on the other hand, often challenge those patents or wait until patent expiration to sell copycat drugs at steep discounts – usually 30% to 80% cheaper than their brand-name counterparts. Today, 53% of all drug prescriptions are generics, a number that's sure to grow as health insurers push patients to use cheap alternatives.
Here are some top blockbuster drugs that have lost patent protection in recent years:
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Cholesterol-drug Zocor, by Merck, with annual sales of $4.4 billion |
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The antidepressant Zoloft, by Pfizer, with annual sales of $3.3 billion |
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Antibiotic Zithromax, also sold by Pfizer, with annual sales of $2 billion |
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Allergy treatment Flonase, by GlaxoSmithKline, with annual sales of $700 million |
Patents on 11 more blockbuster drugs are expected to expire in the next two years, representing nearly $30 billion in sales. Indeed, nearly half of the 60 most commonly prescribed drugs will become available as generics in the next four years.
Big Pharma simply can't keep up. Sales are evaporating much quicker than the pipelines can be replenished. The steady loss of blockbuster drugs has resulted in lackluster returns for nearly all Big Pharma investors.
Novartis, on the other hand, is the only drug player that has a significant stake in both brand-name pharmaceuticals and generic drugs. Under Vasella's leadership, the company acquired leading generic manufacturers Hexal and Eon Labs. The bold takeovers created the world's second-largest generics maker. Today, this division is named Sandoz, after Vasella's pre-merger employer.
Immediately after the buyouts, doubts were raised whether brand-name and generic pharmaceutical divisions could coexist under the same roof. Vasella believes that generic drug sales will grow twice as fast as patented drugs in the next five years, from $50 million now to as much as $100 billion worldwide by 2010. Novartis is well positioned to capture a large market share. Commenting on generic competition, Vasella said, "On one side I feel very sorry for the [drug] industry; on the other side it's a great opportunity for our generics business."
Novartis is the only Big Pharma company with the ability to "double-dip" – raking in sales from both brand-name and generic drugs, simultaneously.
Already, the Sandoz division of Novartis collects sales from off-patent medicines with 2006 sales of $5.9 billion, a 27% increase from 2005 numbers and most certain to explode in the next four years. As its peers struggle to stave off generic competitors, Novartis – and its investors – will thrive.
An Even Bigger Generic Windfall
When we talk about generic drugs, generally we're referring to knock-offs of traditional pharmaceuticals, which are nothing more than various chemicals packaged as pills. But there's an entirely different class of drugs, developed in the biotech sector, called "biopharmaceuticals" or "biologics."
Unlike the typical pharmaceutical pills, biologics are drugs that mimic the body's natural processes. They're typically proteins or enzymes derived from some form of living material and, unlike pills, they are often injected or infused.
Biotech drugs have revolutionized the treatment of cancer, autoimmune disease, and many other medical maladies that were once untreatable. Today, worldwide sales of biotech drugs hover around $30 billion and are expected to reach $60 billion by 2010.
These drugs are eligible for the same types of patents given to traditional pharmaceutical drugs... and, just like the top-selling blockbuster pills, the patents on the earliest versions of biologic drugs have also expired.
Yet, despite the nearly $10 billion in sales that will be up for grabs over the next three years as the earliest biologics lose patent protection, there are no generic versions of these drugs – also known as "biogenerics" or "biosimilars" – lined up to capture this market. There are a few reasons why...
To begin with, most generic drugmakers don't have the expertise to produce biogenerics. Creating a copycat of a protein or enzyme is much more difficult and expensive than mimicking a chemical drug.
Secondly, the FDA has no guidelines in place to approve biogenerics. The regulatory agency doesn't have the expertise to evaluate such applications. It's likely that biogenerics will have to undergo some version of clinical testing, thus making the development process much more expensive. (Traditional generics are able to piggyback on the FDA applications of their brand-name counterparts, only needing to prove that they are chemically equivalent – a much lower and less expensive hurdle.)
There is one generic company capable of making biogeneric drugs – the Sandoz division at Novartis.
Thanks in large part to Vasella's vision, Novartis has, under one roof, the scientific prowess to create novel pharmaceuticals and biologics, as well as generic versions of both types of drugs. No other Big Pharma player has such capabilities.
Biotech drugs cost insurers and patients as much as $5,000 per month. So biogenerics promise to be a lucrative business. And recently, Novartis received the first-ever U.S. approval of a biogeneric from the FDA.
The Sandoz division introduced a generic version of the human growth hormone, which is used to treat various growth deficiencies. The drug, named Omnitrope, was approved on June 1, 2006. Importantly, though, the FDA went out of its way to avoid instituting guidelines for other biogenerics, labeling Omnitrope a "follow-on" product instead of a generic equivalent. However, it's likely that Congress will step up and force the FDA to address the biogeneric issue.
In 1984, U.S. Representative Henry Waxman (D-Calif.) teamed up with Senator Orrin Hatch (R-Utah) to create legislation paving the way for an approval system for generic versions of traditional pharmaceuticals. The duo is working together again to fashion similar legislation for biogenerics.
Such a system will allow Novartis, through its Sandoz division, to become the leader in this most profitable element of the generic drug business. We believe this promise isn't accurately reflected in Novartis' stock price – creating a valuable buying opportunity for potential investors.
Fully Stocked Innovative Drug Pipeline
Of course, the most lucrative resource of any Big Pharma company is the sale of new brand-name drugs. Novartis is no different – the innovative drug division currently accounts for 60% of the company's total revenue. Sales climbed 15% in 2006, reaching $37 billion. This growth is staggering compared to the 2% and 3% growth in drug sales at Pfizer and Merck, respectively.
Novartis leads the industry, with 14 product approvals since 2000. The company has an amazing drug pipeline, one of the best in Big Pharma, with 50 projects in the late stages of human clinical trials and a total of 138 projects in development.
To date, Novartis' most well-known drug is Gleevec, which is used to treat chronic myelogenous leukemia (CML), a type of blood cancer. More than 25,000 adults in the U.S. are diagnosed with CML each year. Before Gleevec was launched in 2001, the only cure for CML patients was a bone-marrow transplant. Yet, such transplants are deadly for approximately 25% of patients.
Gleevec sailed through regulatory hurdles at the FDA, receiving approval in just two and a half years – a record-setting pace. Gleevec changed CML from killer to chronic disease. Most CML patients now expect to live for decades after their diagnosis, versus less than five years before the introduction of Gleevec. Annual worldwide sales of Gleevec reached $2.5 billion in 2006, a 17% increase. The drug has been nothing short of amazing for Novartis. But it's just the beginning...
Here is a short list of the most Novartis' most promising drugs, which have just been launched or should gain FDA approval in the next one to two years:
Drug Name |
Indication |
Expected Annual Sales |
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Galvus |
Novel diabetes treatment |
$1 billion |
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Tasigna |
CML – for Gleevec-resistant patients |
$300 million |
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Lucentis |
Macular degeneration (wet version) |
$1 billion (sales outside of U.S.) |
|
Tekturna |
High blood pressure |
$1 billion |
|
Exjade |
Iron overload (chelator) |
$400 million to $700 million |
|
Aclasta |
Osteoporosis |
$750 million to $1 billion |
|
Exforge |
High blood pressure |
$500 million | | |
Beyond its own R&D efforts, Novartis is also extremely aggressive in licensing compounds and forming partnerships with biotech companies that have late-stage products.
Also, the company just announced plans for a $100 million plant in China, to ensure it remains competitive with recent global trends for research and development.
The drug pipeline and the partnerships will ensure Novartis' continued growth for the next five years, giving investors returns typical of Big Pharma's golden years.
Over-the-Counter Profits
Finally, like other Big Pharma companies, Novartis has a separate consumer health-products division. The division primarily sells over-the-counter medications and other nonprescription health products. This division also sells a host of animal-health products and the Gerber product line, which was just subject to a $2.5 billion acquisition bid by Swiss food company Nestle.
Here are some of the better-known brands in the Novartis consumer health division:
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Ciba Vision |
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Gas-X |
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Lamisil |
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Maalox |
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Theraflu |
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Excedrin |
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Ex-Lax |
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Triaminic |
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Consumer health sales were $6.5 billion in 2006, an 8% increase. This division, which makes up 17.5% of the company's total sales, is a strong component of the Novartis business.
Summary & Recommendation
Novartis is one of the few nonfinancial companies worldwide to have attained the highest credit rating – AAA – from Standard & Poor's, Moody's, and Fitch, the three benchmark rating agencies.
The company's year-end results for 2006 exceeded Wall Street expectations. Sales were up 15% to $37 billion, with earnings per share of $3.06, up 16%. This translates into a price-to-earnings ratio of around 17, which compares favorably with the company's peers. Moreover, Novartis has a 1.8% dividend, which has steadily increased around 10% per year since the 1996 merger.
Novartis has strong revenue and earnings growth, presence in the generics business, and the best pipeline in the industry. It's simply the safest and best investment in new drugs.
Action to take: Buy Novartis AG (NYSE: NVS) up to $63, with a 25% trailing stop.