The pharmaceutical industry is among the most profitable in the entire investment universe. This is because drug patents give drugmakers practical monopolies for long periods of time before those patents expire and competition is allowed by regulators.
But that's not to say that the pharmaceutical industry is without its risks. Companies need to consistently launch new drugs to keep large and growing cash flows coming. Consider, for example, Switerland-based Novartis (NVS 0.72%). It's one of the largest drugmakers in the world, but can it continue turning out great products and rewarding investors?
Let's examine Novartis' fundamentals and valuation to decide.
A steadily growing business
Novartis' $224 billion market capitalization earns it the distinction of being the sixth-largest pharmaceutical company on the planet. As you'd expect from a mega-cap drugmaker, the Swiss company boasts an exceptional product portfolio. This is led by heart failure medicine Entresto, which is on pace to become a mega-blockbuster in 2023 (i.e., generate at least $5 billion in sales). Novartis' portfolio also includes 12 products on track to be blockbusters this year (e.g., generate $1 billion or more in sales).
The company recorded $13 billion in net sales for the fourth quarter ended March 31, which equates to a 3.4% year-over-year growth rate. On its face this may not seem like impressive top-line growth. But it is when considering that the exceptionally robust U.S. dollar was a 5% headwind to Novartis and its global operations. The company's constant-currency net sales growth rate was a respectable 8% during the quarter.
These results were driven by the fact that 10 out of Novartis' 14 medicines positioned to be blockbusters in 2023 produced constant-currency net sales growth in the first quarter. This ranged from low-single-digit growth from chemotherapy drug Tasigna to triple-digit growth from multiple sclerosis therapy Kesimpta.
| Q1 2022 Net Margin | Q1 2023 Net Margin |
|---|---|
| 25.9% | 27.9% |
Data source: Novartis Q1 2023 earnings press release
Novartis' non-GAAP (core) diluted earnings per share (EPS) soared 17.1% over the year-ago period to $1.71 for the first quarter. Disciplined handling of expenses fueled a nearly-200-basis-point rise in the company's net margin to 27.9% during the quarter. Along with a reduction in Novartis' share count, this explains how core diluted EPS grew at a faster rate than net sales in the quarter.
Looking ahead, the drugmaker has nearly 140 projects in different stages of clinical trials, like the potential rare disease blockbuster drug iptacopan. This is why analysts believe that Novartis' core diluted EPS will increase by 7.6% annually over the next five years. Putting this into perspective, that is well above the drug manufacturer industry average annual earnings growth forecast of 6%.
Image source: Getty Images.
The huge dividend is safe
Stacked against the S&P 500 index's 1.7% yield, Novartis' 3.5% dividend yield is quite appealing. Prospective shareholders seeking steady income can also rest assured that the payout isn't a yield trap.
Novartis' forward dividend payout ratio is expected to clock in just above 49%. Such a low payout ratio leaves the company with most of its earnings to execute acquisitions, repay debt, and repurchase shares. That builds a great deal of certainty into the assumption that the dividend can be maintained or grown further moving forward.
Novartis is undervalued
Novartis' shares have roared 15% higher in just the past month. Yet the stock still looks to be attractively valued for income investors.
The stock's forward price-to-earnings (P/E) ratio of 14.2 is only modestly above the drug manufacturer industry average forward P/E ratio of 13.5. Given that the company's earnings growth prospects are significantly better than the industry peer average, Novartis arguably deserves an even greater premium to its peers.
