Analysis of Novartis AG (NOVN:VTX)

Novartis is a flagship of the Swiss economy and one of the largest pharmaceutical companies in the world. It was born from the merger of Ciba-Geigy and Sandoz in 1996 and has a whopping 125,000 employees.

Valuation & dividend

As they say, quality has a price. Novartis is no exception to this rule. Indeed, the Basel pharmaceutical company is traded at:

• 24.86 times current recurring earnings
• 23.05 times average recurring earnings
• 2.56 times book value
• 15.3 times tangible assets
• 3.79 times sales
• 19.24 times current free cash flow
• 20.15 times the average free cash flow

Not only is it expensive, but with a price-to-sales ratio above three, it becomes a downright sell signal. If we look at the EBIT side, we can see that it only represents 4.13% of the enterprise value (4.23% for EBITDA), which confirms the excessive valuation of the stock.

On the dividend side, it is apparently much better, with a yield of 3.5%. But this generosity comes at the cost of a slightly too large distribution of income. Indeed, the dividend represents:

• 87.02% of current profit
• 80.66% of average profit
• 67.34% of current free cash flow
• 70.51% of average free cash flow

With such figures, the future development of the dividend is compromised. It has only increased by 0.78% per year on average over the last five years. A decrease is even possible, as was the case between 2013 and 2014.

Balance sheet & result

If the dividend is struggling to take off, it is because profits themselves have stagnated, or even slightly declined over the last five years. The value of assets and cash reserves have, on the other hand, increased very slightly. Novartis is therefore having some difficulty creating value for its shareholders, which is reflected in a modest increase in the share price, of only 51.7% over the last ten years.

The company's cash reserves are sufficient, with a current ratio of 1.21 (increasing), but for a quick ratio of only 0.91. Even if this situation is not ideal, there is no reason to panic either. We quite often come across large, renowned companies that display immediately available cash that is lower than their current obligations. These companies have little difficulty in raising current credits from financial institutions. Novartis, with a Z-Score (Altman) of 3.4, is far from going bankrupt!

This is all the more true since the fundamentals of the Basel giant are really very solid. Indeed, the gross margin is really comfortable, with 66.2% (up), for a free cash flow margin of 19.7% and a net margin of 15.24%. Impressive. The profitability is not too bad either, with an ROA of 5.74%, CFROA of 5.74% and an ROE of 10.3%.

The long-term debt-to-asset ratio is quite high, at 17.45% (and increasing). However, thanks to its exceptional cash-generating capabilities, Novartis would be able to pay off its entire debt in just three years using its free cash flow. Furthermore, even though it has been growing for several years, debt still only represents 0.38 times equity.

It should also be noted that the number of shares in circulation has been falling regularly for several years, which is obviously a good thing for the shareholder who sees his share of the pie increase at the same time.

Conclusion

Novartis is a pharmaceutical giant. Not only is it protected from the first competitor that comes along due to its size, but its sector of activity protects it from economic and financial upheavals. We always need to take care of ourselves, even when times are tough. Especially when they are tough! NOVN shares can therefore boast of being a good defensive value, with a volatility of only 8.4%, even if the beta still amounts to 1.12.

Above all, what is striking about Novartis is its ability to generate cash. The company is a real cash cow, with typical franchise characteristics. Margins are really very strong, overheads are under control, goodwill is up, debt is relatively low and capital expenditure needs are correct.

The F-Score (Piotroski) of 7 confirms these excellent predispositions and the solidity of Novartis. We are certainly dealing here with a value of very high quality, even if the profit has had difficulty in progressing for several years. That being said, as we have seen above, the title is really too expensive at the moment, especially since the price/sales ratio is higher than three. I would therefore rather wait for a future big correction of the markets, before becoming the owner of this beautiful slot machine.