Like a number of big pharma players, Novartis (NYSE:NVS) is restructuring for greater specialization, focusing in on a few key areas in which they hope to excel. Offloading animal health and vaccine divisions, Novartis will zero in on generics, pharmaceuticals, and eye care.

Will the drug company's narrowed focus bear fruit? Healthcare analysts Michael Douglass and Kristine Harjes look at what Novartis is facing, from patent cliffs and commercialization risk to label expansion opportunities and exciting new drugs in the pipeline.

A full transcript follows the video.

Michael Douglass: All about Novartis; this is Industry Focus.


Hi Fools, health care analyst Michael Douglass. I'm here with our special guest, health care analyst Kristine Harjes from The Motley Fool. Kristine, how are you doing?

Kristine Harjes: Doing great, Michael. How are you?

Douglass: Fantastic, welcome to the show for your second appearance, I think it's been. We're definitely excited to have you here.

What we really wanted to do for listeners today was just walk through a big pharma, and how you can understand it. Big pharmas, at the end of the day, massive companies; most of them -- all of them? -- are dividend payers and they make up a huge amount of health care spending and health care development.

So we just really want to look at and understand how a big pharma works and how people should think about big pharmas, particularly given that if you're a new health care investor, I wouldn't necessarily go for the one-trick ponies in the biotech space. I'd probably go for really big, diverse companies like Novartis, for example, which we're talking about today. Sound good?

Harjes: Absolutely, sounds great.

Douglass: Fantastic, so let's first talk about last quarter. Earnings were just announced. What did you think?

Harjes: Great. As reported earlier this week, Novartis had a pretty good Q4. As reported, net sales were down 2%, but then when you take a look at it in constant currency, they were actually up 4%. Core operating income, up 9%. Things are looking pretty good.

Douglass: Yes, especially when you consider in the big pharma space, you're not usually going to see double-digit growth. It'll happen from time to time, but these are big companies.

Harjes: Yes, well established.

Douglass: Yes. It's hard for one drug to really move the needle for them. You always do want to see positive, but single digits isn't necessarily a red flag, unless the valuation has just really gotten high, which I think with Novartis it doesn't look terribly expensive, especially when you compare it to some of the more expensive big pharmas, like Novo Nordisk (NYSE:NVO) and Merck (NYSE:MRK), but we can talk about that some more later.

All right, let's talk a little bit about their strategy and what they've been doing to reposition. Big pharma of course has faced the patent cliff, they've faced a lot of challenges over the last few years. How is Novartis reacting?

Harjes: Novartis is restructuring. They've decided to really focus on having these three different core ends of their business, and getting rid of the stuff that was just excess on the side of it.

They had this deal with GlaxoSmithKline (NYSE:GSK) last year, which is still being completed this year, in which they basically swapped their vaccine business for Glaxo's oncology business. That's very much aligned with their strategy going forward, and building up their oncology portfolio.

Meanwhile, they got rid of their animal health portfolio, sold that to Eli Lilly (NYSE:LLY). That's something that we saw just earlier this month, and again is very much in line with this increased focus.

Douglass: Yes, definitely an interesting pair of deals there. Of course, then you add in the third one, which was the sale of the influenza vaccine to CSL. Certainly it's clear that they've decided that vaccines? Not their thing. Animal health? Not their thing.

And they did the consumer goods joint venture as well, which recognizes that GlaxoSmithKline maybe has a little bit more experience with this and they can hopefully help leverage that.

You're seeing this across a lot of big pharma, that a lot of them are saying, "Okay, listen. Here are the three or four things we're really good at. Let's focus in on those."

Harjes: Of course there's a fine line to walk there, where you don't want to be too specific because that's just a huge risk if somebody comes in and just knocks your market share out of the park.

Douglass: Right.

Harjes: But having a couple of core focuses is traditionally a good move.

Douglass: Yes, absolutely. Let's talk about each of those businesses a little bit first. Which one do you want to start with?

Harjes: Let's talk about generics first.

Douglass: All right, fantastic.

Harjes: They've got Sandoz, which is their generics unit. That I believe is 16% of their total net sales. It's number two among generic drug makers, and the leader in biosimilars which, let's talk about that a little bit because that could be huge.

Douglass: Yes, let's! As you point out, biosimilars could be huge. When you think about AbbVie's (NYSE:ABBV) Humira, which is a $10 billion-plus a year drug, if a biosimilar gets approved ...

Harjes: If and when.

Douglass: Probably when a biosimilar gets approved, that is a lot of money they can get, especially because it looks like probably they're not going to have the kind of markdown that you've seen in traditional small (model?) for generics.

Harjes: Exactly. It's not going to be quite as low-margin as your traditional generics.

Douglass: Right, which means that there's a lot of money to be made there, knocking off some of these humongous biologic drugs. Definitely, they have been at the forefront of that.

Harjes: Yes, they had the first-ever blockbuster generic. Going back to the biosimilars, they've got EP2006, which is a biosimilar of Amgen's (NASDAQ:AMGN) Neupogen. That seems to be closing in on regulatory approval, definitely something to keep an eye on.

Douglass: Yes, there's a lot there to be excited about. We talked about Sandoz. Do you want to go Alcon next?

Harjes: Sure.

Douglass: All right.

Harjes: This is the eye care division which is, I would say, definitely going to be boosted in the future due to an aging population, due to emerging markets, new technology. I see a lot of room for growth with Alcon.

Douglass: Yes, I think it's an exciting part of the business. You're seeing a lot of folks ... when Actavis (NYSE:AGN) bought up Allergan (UNKNOWN:AGN.DL), Allergan has some early stage eye care assets which could help accrete to that deal a little bit. You've seen Valeant Pharmaceuticals (NYSE:BHC) playing in that space a lot in eye care as well, so there's a lot of opportunity, particularly with Lucentis, their really big eye care drug.

Then finally, number three?

Harjes: Pharmaceuticals.

Douglass: Yes, the big one!

Harjes: The big daddy! There's a lot to talk about there. Let's start with Gleevec.

Douglass: Sure.

Harjes: That's their biggest drug. It's a chronic myeloid leukemia drug. It took in $4.7 billion in sales in 2013 -- this is really big -- and almost $5 in 2014, I want to say. Definitely a huge part of this company.

However, something that investors need to look out for is its patent expiration, which is coming up; 2015 and 2016 will be big years coming up in the United States and the European Union.

However, they have this drug Tasigna, which actually is showing better numbers in trials, better efficacy, than Gleevec and looks poised to come in and kind of save the day.

Douglass: Yes, definitely exciting when you see a pharma having trouble with a drug that's coming off the patent, and then they've got something that potentially could be a better standard.

You saw Teva's (NYSE:TEVA) trying to do this with Copaxone in multiple sclerosis, that they now have this new thrice-weekly formulation instead of once-daily formulation, that sort of thing, so you're always looking to see.

Sanofi's doing the same thing with Toujeo in diabetes.

Harjes: Even these little improvements, that can be just what you need in order to not totally lose all your sales.

Douglass: Right. Absolutely, so there's some cool opportunity there. What other drugs in their pipeline are interesting to you?

Harjes: One pipeline drug that has me really excited is this LCZ696.

Douglass: I'd say you and the rest of the world!

Harjes: Yes! That's a heart failure drug, and it's looking like it's going to have a lot of promise. We're expecting an FDA approval by the middle of this year, and it could potentially be a multi-billion dollar drug, for sure.

Douglass: Right, that could be a very exciting drug. Of course, there's always the question of exactly what the FDA is going to look for and what they're going to see, but certainly everything we've heard seems pretty darn good.

It seems like they're pretty excited about this drug, and certainly the peak sales numbers we've been seeing from a number of different analysts in the $1-6 billion range, but most of them closer to that $6 billion than the $1. That's a really potentially good sign.

Harjes: Yes, of course.

Douglass: Absolutely. Anything else in their pipeline?

Harjes: Let's see. Just recently we saw Cosentyx get approval, so that's pretty exciting to watch out for. It performs statistically better than Johnson & Johnson's (NYSE:JNJ) Stelara, which pulls $2 billion annually, so if we can see it stealing a bunch of that away then it's going to be a big mover for the company.

Douglass: That's the psoriasis.

Harjes: Psoriasis is a huge indication. It affects 125 million people worldwide, so definitely a lot of room for growth there.

Douglass: Yes. Certainly when you look at the autoimmune diseases, as we were talking about with Humira earlier, Humira is an autoimmune disease drug. There are a lot of opportunities in that area, particularly when you think about getting approved in one area, and then potentially there's psoriatic arthritis, rheumatoid arthritis ...

I'm not saying necessarily that Cosentyx is going to seek out all of these other indications, but certainly that's what a lot of other drugs have done.

Harjes: Sure, the label expansion there would not hurt!

Douglass: Yes, so we'll be wanting to watch really closely to see what they do with Cosentyx, what their strategy looks like, whether they do things like Celgene (NASDAQ:CELG) has, where they'll get an approval in one area and then just start going into others. That will be certainly very interesting for folks to watch.

Now, let's talk threats a little bit. You've of course already mentioned Gleevec is coming off patent, and so is Gilenya in the next, I want to say four years? U.S. 2018, I think?

Harjes: Right, 2018 and 2019. That certainly does seem like a threat to me. With some of their other drugs, we have seen them do a really good job of getting the next player in the game lined up at an appropriate time.

We're not seeing that yet with Gilenya. There is no obvious drug that's going to follow in its footsteps. That being said though, there's still plenty of time left. It would be nice to see something in the pipeline at all, even very early stage, but there are several years remaining, and who's to tell what will happen with the patent before then, or what sort of competitors will come out?

It's definitely something to watch, but I'm not particularly worried about it.

Douglass: Sure, that's fair enough.

Also, I think it's important to always throw in the fact that you're always going to have clinical trial risk, for any drug in the pipeline. Sometimes drugs in Phase III will suddenly come up with just massive safety concerns, or they'll fail to meet particular endpoints, so those can be a big concern. It's part of doing business in pharma, unfortunately, so that's always a possibility.

And of course there's always the possibility of commercialization failure. You get something through the FDA -- and we saw this with some of the anti-obesity drugs, Arena and Vivus and some of these other smaller cap biotechs have been pushing -- multi-billion blockbuster projections, a couple hundred million in sales, max, for the year right now.

I think that commercialization risk is just always something people have to keep in the back of their head. Even if something looks really good, it doesn't necessarily mean it's going to completely light the world on fire and just mint money for these pharmas.

But certainly we're hopeful, I think particularly for LCZ696. It would be wonderful, among other things, to get some new standards of care to really help people who are suffering from chronic cardiovascular conditions.

All right, Kristine, I think we've pretty much covered everything. Do you have anything else on your mind?

Harjes: I think we hit the big guys.

Douglass: All right, sounds good. In that case, thank you very much for our chat today. Folks, make sure you check back to for all of your health care and other investing needs, and Fool on!