A Drug Company with All the Right Stuff

07/17/2008 12:00 am EST

Focus: STOCKS

Paul Larson

Editor, Morningstar StockInvestor

Paul Larson, editor of Morningstar StockInvestor, says pharmaceutical giant Novartis has a rare combination of a strong new-drug pipeline and other thriving businesses.

In an industry plagued by stagnant growth, Novartis (NYSE: NVS) emerges as a juggernaut with diversified operating platforms and an industry-leading number of new potential blockbuster drugs. Strong intellectual property supporting multibillion-dollar products combined with a plethora of late-pipeline products create a wide economic moat for the firm.

Novartis develops and manufactures health-care products within its four main operating segments: branded pharmaceuticals, generic pharmaceuticals, diagnostic and vaccines, and consumer products.

Novartis derives its strength from a diversified operating platform. Although the majority of Novartis's competitors focus solely on the high-margin branded pharmaceutical segment, Novartis runs four complementary operations that reduce overall volatility and create cross-segment synergies.

For example, not only does its generic business, Sandoz, serve to grab a portion of the billions of dollars in competitive branded products losing patent protection during the next ten years, but it also extends the life cycle of in-house products as patents expire.

Also, the vaccine division (largely created by the 2006 acquisition of Chiron) offers the company a substantial footprint in an area where pricing power is increasing with innovative vaccines and fewer competitors. Further, the company's intentions to acquire a majority share of Alcon (ACL) by 2010 should greatly boost its consumer business with additional sales from the fast-growing eye-care business.

The pharmaceutical segment is poised for growth, driven by new pipeline products and existing drugs. Novartis differentiates itself from the pack because of the sheer number of potential blockbuster launches, including Galvus for diabetes, Aclasta for osteoporosis, and Exforge and Tekturna for hypertension. Also, the company has generated a superior late-stage pipeline and should file at least six new products in 2008 in both the United States and Europe. Further, existing products should continue to perform well. Leading products (Diovan for hypertension and Gleevec for cancer) continue to post strong growth because of favorable efficacy in large therapeutic populations.

Daniel Vasella has led the dynamic construction of Novartis as chief executive officer and chairman of the board. By restructuring operations and pursuing external acquisitions and divestures, Vasella's leadership has created a more tightly focused health-care company. Mindful of the high-margin US business, Vasella moved the global research facilities to Boston and doubled the US sales force, which increased the US contribution from 19% of total sales in 1998 to 36% in 2007.

We believe Novartis is worth $73 per share. (It closed above $56 Wednesday-Editor.)We project an average 6% annual sales growth rate during the next ten years. We expect a slight decrease in operating margins during the next ten years as the product mix shifts from high-margin pharmaceuticals to the lower-margin generic group. Additionally, the multiple operating segments should provide more stable and consistent growth versus branded-only pharmaceutical companies.

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