Novartis

Moat: 4/5

Understandability: 3/5

Balance Sheet Health: 4/5

A global pharmaceutical company that researches, develops, manufactures and sells innovative medicines and biosimilars.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Novartis AG is a global healthcare company headquartered in Switzerland and operates through two main divisions: Innovative Medicines and Sandoz.

Innovative Medicines: This division focuses on developing and commercializing patented innovative medicines. The key therapeutic areas within this division are Cardiovascular, Renal and Metabolism, Immunology, Neuroscience, Ophthalmology, and Oncology. In general, these products have long life cycles and face less competition due to their intellectual property protection. This division has generated the most revenues for Novartis at USD 41.9 billion for 2022.

This is generally a business model that yields great results for the long term. The innovative drugs protect the company and provide a great margin to be made even after patent expiry.

Oncology: The oncology franchise continues to be a major driver of growth for Novartis, with key products including Kisqali (breast cancer), Pluvicto (metastatic castration-resistant prostate cancer), Promacta/Revolade (immune thrombocytopenia) and Jakavi (myelofibrosis and polycythemia vera). Many drugs have indications across multiple lines and stages.
Cardiovascular, Renal and Metabolism: Entresto (heart failure) remains a core growth driver for Novartis.
Immunology, Hepatology and Dermatology: This division includes drugs that address different immunological disorders.
Neuroscience: Multiple sclerosis and spinal muscular atrophy are the main drivers here, with medications such as Kesimpta and Zolgensma.
Ophthalmology: This area includes drugs to treat eye conditions such as retinal disorders. A notable growth driver has been Beovu (age-related macular degeneration).

Sandoz: This business unit develops, manufactures, and markets generic medicines as well as biosimilars. Sandoz is focused on delivering more cost effective versions of complex molecules by creating more biosimilars and making generic medications. Sandoz is a standalone publicly traded company now and was formerly a Novartis company before being spun-off in 2023.

Trends in the Industry:

Drug Innovation: A constant need for developing innovative and better drugs as old ones are phased out either due to patent loss or for better results to combat a vast array of ailments.
Biosimilars: Biologics are becoming increasingly important as most big Pharma companies have their flagship products expire. Biosimilars are cheaper and help manage drug prices.
Personalized Medicine: As genetic analysis has become more prevalent, medicines and treatments are increasingly being tailored to individuals. This allows for a much higher success rate in treatment but also drives higher costs as the number of patients taking a specific type of drug decreases.
Growing Focus on Value: Patients, employers, and governments are focusing more on value and cost effectiveness when buying drugs, which often leads them to choose generics instead of name brands.
Global Expansion: Increasing access to medicines in emerging markets.

Financials

Revenue Streams:
- Innovative Medicines accounts for a substantial portion of revenue.
- Sandoz has substantial revenue and has a good market share in the generics and biosimilars business.
Gross Profit Margin: Generally, the gross profit margins are quite high across the board, but are particularly high in branded pharmaceuticals. This is mainly because of low marginal cost for each additional dosage of the drug. For new drugs, price gouging can lead to high margins.
- The Innovative Medicines division has a very high gross profit margin, while the Sandoz division has a relatively lower margin because of price competition. However, it is able to generate high revenues, albeit at lower profit margins.
Operating Margin: Novartis’s Operating margin has hovered around 20-24% level in the past few years with minor yearly fluctuations.
Profitability: Novartis typically invests heavily in R&D, which negatively impacts profitability. Despite this, the business still remains highly profitable and generates a huge sum of profits. The net income has varied significantly over the years.
Capital Efficiency: Novartis uses lots of capital and relies on intangible assets like R&D to improve its business. Because of this, capital turnover is lower. ROIC fluctuates between the 10-20% range.
Financial Statements: Novartis uses both GAAP and non-GAAP financial measures. Non-GAAP measures are adjusted to remove one-time or non-recurring charges, thus giving a better view of how the operational aspect of the business is performing.

Competitive Landscape

The pharmaceutical industry is extremely competitive and comprises many competitors:

Large Pharma Companies: These include companies like Roche, Pfizer, Johnson & Johnson, AbbVie, Merck, and Bristol-Myers Squibb.
Generic Drug Makers: Teva Pharmaceuticals, Viatris, and Mylan are some big competitors in this segment
Biosimilar Companies: Biocon and Amgen, among many others, dominate this market.
Biotech Companies: Companies like Regeneron, Gilead, and Vertex are major competitors in some fields.

Each of these competitors comes with unique competitive advantages of their own and have their own expertise areas.

What Makes Novartis Different:

Strong R&D Focus: Novartis invests heavily in R&D. That is evident through a large amount of drug candidates in different stages of development. The company has a track record of successful drug development in multiple therapeutic areas.
Diverse Product Portfolio: The diversification across various therapeutic areas serves as a cushion against problems like patent losses or unexpected failures in specific areas. Also, new approvals and a consistent stream of newer drugs helps the company in maintaining its revenues and also ensures future growth.
Global Presence: Novartis has a well established global presence and sells in over 150 countries. This also allows it to cater to a broader market base as well.

Recent News/Controversies and Problems

Sandoz Spin-off: Novartis completed the spin-off of Sandoz into a standalone, publicly traded company in October 2023, a move designed to allow the company to better focus on innovative medicines.
Restructuring: Novartis has undergone a restructuring program that has changed the company’s structure and has streamlined operations, which has caused a huge decline in the operating margin.
Acquisition of MorphoSys: Novartis is buying MorphoSys, a German company, for $2.7 billion in a deal expected to close in mid-2024. This is done to enhance their portfolio of cancer medicines.
Inflation: High inflation has been hurting drug prices and there is potential pushback for any price increases in a very high inflation market environment.
Regulatory Hurdles: Drug approvals are difficult and slow, particularly for companies trying to get their drugs approved in the US and Europe.

Moat Assessment: 4 / 5 Novartis has a reasonably wide moat stemming from the following:

Patent Protection: Pharmaceuticals, in general, depend on patents for their unique medicines. Patent protection on drugs serves as a barrier to entry and ensures the company that the revenues and profits can be earned for many years before generics are sold. The patent protection generally lasts for 20 years and can extend up to a few years more. This provides an opportunity for the companies to recoup R&D investments and make further investments in research and production.
Innovation: Continuous innovation is another aspect that is important for a pharmaceutical company like Novartis. As a company involved in pharmaceuticals, they have a strong track record of innovation. As they have newer drugs in their pipeline, they also get further protection as older patents expire, and it gives them higher profitability margins.

Risks that can hurt the moat:

Patent Expiration: Generic and biosimilar competition, can eat away a big chunk of the revenues and profits if new drugs are not launched or old patents are lost.
Disruptive Technology: New medicines may be developed that completely eradicate the need for current treatments for certain ailments, which would diminish the value of the company.
Regulatory Changes: The highly regulated environment can mean stricter approvals that may slow down the drug approvals. Unfavorable changes to existing regulations, especially for pricing, could also have a detrimental impact.
Price Competition: Pricing pressures in the healthcare industry can impact the profitability of branded drugs as government payers and insurance companies increasingly focus on cost containment and try to reduce the overall expenses of the healthcare systems.

Business Resilience: While Novartis faces potential risks, the company has multiple avenues of business which make it more resilient. Also, it is highly diversified geographically, and thus if they suffer in a particular country, they are still protected through sales from other markets. As pharmaceutical industry is mostly immune to recessions, they will do relatively well during economic downturns. Diversification of drug development and pipeline also leads to the company not being much dependent on one particular type of medicine.

Understandability: 3 / 5 The complexity of the pharmaceutical industry and the nature of the drugs that Novartis produces requires a bit of time and analysis to understand. The company’s financials can be easily understood with some basic understanding of finance. The various revenue segments and the drugs in different therapeutic areas requires some more scrutiny. Also the numerous clinical trials, and the uncertainty of approvals make it a bit more complicated.

Balance Sheet Health: 4 / 5 Novartis has a good balance sheet and maintains substantial liquidity and financial flexibility. Although the company has debt, the debt profile is very well manageable with good interest coverage ratios and debt maturities that are evenly spread. They have had a decent record of generating FCF, which also increases its ability to take on debt. The current liability to asset ratio is also well under 1.0 which makes it attractive. The company has a decent cash pile that it can use to pay off debt or invest further in innovation.

The Essays of Warren Buffett | Moat: N/A | Understandability: N/A | Balance Sheet Health: N/A

A collection of essays and speeches by Warren Buffett, selected and organized by Lawrence A. Cunningham.

This is a book that collects various writings, speeches, and letters from Warren Buffett that are mainly focused on value-investing and the principles that Warren Buffett uses. It is not a company and therefore doesn’t have a moat, balance sheet, or specific understandability rating. However, because of its content and how it focuses on understanding a company’s economic moat, it is worth analyzing in the context of the other resources that I’ve been provided.

Content of the book:

Corporate Governance: It stresses the importance of aligning management’s interest with shareholders. Managers should have an owner-oriented mindset and must act as a good steward of the business. It also highlights the importance of good board members and strong corporate cultures.
Corporate Finance & Investing: It emphasizes the concept of “intrinsic value” and buying companies at reasonable prices, with a good “margin of safety”. The book discusses the importance of a strong financial position, the use of debt and how it affects value, and avoiding speculation and the herd mentality.
Common Stock: It touches on a variety of important principles like the importance of a stable business with a good franchise, and long term competitive advantages. Also provides insights into a company’s dividend policies and how to make the most out of them.
Mergers and Acquisitions: Buffett is a staunch critic of overpaying for acquisitions and discusses that mergers should be done only to create value. He suggests that acquiring companies for stock should be done very cautiously and that it can destroy value if the acquirer’s stock is overvalued. It also warns of poor management motives behind acquisitions.
Accounting & Taxation: Buffett stresses the importance of clear accounting practices and how accounting rules can easily be manipulated to distort true profitability and performance. The emphasis is on focusing on actual performance and looking beyond accounting and reported earnings. Tax laws should be seen and evaluated from an economic perspective.

Key Takeaways Related to Moats:

Focus on Business Quality: Buffett stresses investing in businesses with good long-term characteristics, specifically those with unique products, established brands, and pricing power. Also that such businesses should have a wide moat or a strong durable competitive advantage that protects the businesses from being disrupted.
Management: Management is important but not a sole determining factor in profitability and sustainability of a business. The quality of management and if they are “owner-oriented” is very vital for long term success.
Value over Price: He emphasizes buying securities with the assumption that the price paid is less than the value of the company.
Market Behavior: He is quite critical of “the Market” and always prefers to see it as a “manic depressive” fellow whose actions are in stark contrast with logic.

Common Stocks and Uncommon Profits | Moat: N/A | Understandability: N/A | Balance Sheet Health: N/A

A guide for long-term growth-oriented stock investing written by Philip Fisher, a well-known author and investor.

Like the “Essays of Warren Buffett”, this is a book and not a company that we need to analyze, so I won’t be giving it a moat, understandability rating, or balance sheet rating. This book provides a good view of how a growth stock should be analyzed and why it is necessary for long term profits.

Key points related to moats and identifying a good company:

Fifteen Points for Investment: The book introduces 15 points that can be used to look at a company for determining whether that company is a good long term investment.

Potential Sales Growth: Products/services with significant market potential.
Management’s Determination: The company should not rest on old product lines, they need to be developing new and better lines for the future.
R&D Effectiveness: The company needs to be doing research, or engineering, to have better products as well as more efficient production methods.
Sales Organization: An outstanding sales organization is also a must-have criteria for long term success.
Profit Margin: Companies should have a healthy profit margin to enable higher profit growth.
Maintain or Improve Margins: Management needs to be keen on cutting costs and improving margins.
Labor and Personnel Relations: Good labor-management relations help foster an environment conducive for high productivity.
Outstanding Executive Relations: A very good top management should be at the helm.
Depth of Management: Companies must be capable of training a second generation of leaders for future growth.
Cost Controls: The cost controls and financial planning must be extremely meticulous.
Other Peculiar Aspects: There may be some other industry specific or unique advantages.
Long-Range Outlook: Short term profits are less important than the long term outlook. The company should also avoid focusing too much on short term profit gains.
Equity Financing: Future growth should not require large equity financing that might hurt the gains of existing stockholders.
Management Talk Freely to Investors: The management should also be ready to discuss the company’s positive and negative situations with its shareholders.
Integrity: Companies must have a management with high ethical standards to foster faith and build trust among its shareholders.

Scuttlebutt Method: It emphasizes a detailed understanding of the industry and the market, not just from reports but from people who have the knowledge. The author suggests to look for opinions from competitors, suppliers, and customers, rather than directly relying on reports or what company management says.
Focus on Growth Stocks: He prefers to concentrate on high quality and high growth stocks, and stresses about finding well managed companies that can provide outstanding growth and returns for the long term.

Key Takeaways Related to Moats The book emphasizes the importance of qualitative aspects of a company, rather than directly focusing on numbers. For good and profitable investing, it focuses on a company’s track record of continuous improvement, management’s business intelligence, and its long-term vision, which are all linked to the concept of moats. The book also stresses that finding out if a business has an inherent ability to keep growing is very vital to understanding if a company can be a long-term winner.

Morgan Stanley - Measuring the Moat | Moat: N/A | Understandability: N/A | Balance Sheet Health: N/A

A research paper released by Morgan Stanley which focuses on how to calculate and measure the magnitude and sustainability of value creation.

This paper isn’t an analysis of a company, but a guide on how to assess a company’s competitive advantages. This is therefore, a very useful document when we talk about a company’s moat as it provides a framework on how to assess and understand it.

Content of the Document:

Sustainable Value Creation: It describes a way to analyze how well a company can generate profits and the length it can sustain those profits. This is what they refer to as “sustainable value creation”. A company with a great ability to generate high returns on its capital and to continue doing so, has a large spread between the ROIC and the cost of capital. That spread is the key in identifying a company with a competitive advantage or “moat.” It also stresses that sustainable value creation requires a company to have the ability to differentiate itself from its peers in the same industry.
Company Life Cycle: The document describes different stages of a company’s life cycle, from introduction to growth, maturity, shake-out, and decline. At different stages, the companies often pursue different strategies.
The Microeconomics of Value Creation: It focuses on how a company can generate more willingness to pay for its product. It highlights the importance of price and value, consumer surplus, and supply-side economics.
Industry Analysis: To understand if a company has a moat, they focus on the structure of an industry, and the competitive advantages that a company can create in its market. They focus on a five forces analysis, barriers to entry, the nature of the business, and the influence of the government.
Firm-Specific Analysis: This section focuses on methods through which an individual firm may create value. The framework includes, value creation, value chain analysis, and adding value. The impact of the government and how it shapes the playing field is also covered in detail.
Firm Interaction, Competition, Cooperation, and Expanding Frontiers: This section deals with how companies interact with each other to have a better competitive position through different methods, ranging from game theory to linking and leveraging with other enterprises in their own industries.
Brands: A brand in and of itself doesn’t create an economic moat but may give an advantage if it creates loyalty or adds to the perception of quality.

Key Takeaways Related to Moats

Value Creation: They describe value creation as something that happens when the willingness to pay (WTP) for a product is greater than the company’s cost to produce and offer that product.
Sustainability: ROIC is highly emphasized, but for determining a company’s value it is crucial to determine the sustainability of returns and how long the company can continue its streak of profitability. This helps in separating the good businesses from businesses that are destined to fade away quickly.
Industry Structure: Porter’s five forces framework, focusing on the threat of new entrants, rivalry within the industry, the bargaining power of suppliers and buyers, and threat of substitutes, provides some insight into if a company will have any competitive advantages.
Competitive Advantage: The document identifies that a company can create competitive advantage in a number of ways, such as by lowering costs, providing a better product or service, and making customers feel that their needs are satisfied.

Common Takeaways from the Above Documents

Moats Are a Must: All the documents suggest that a business needs some sort of an economic moat, or some type of strong competitive advantage, to achieve long term success in profitability and shareholder returns.
Return On Capital: All the documents place huge importance on ROIC as a way to gauge if the business is successful or not. ROIC is also used to determine if the business is capable of creating long term value or if the excess profits might be temporary.
Management: All documents indicate that while management isn’t the sole defining aspect of the business, it’s role is very essential to align interests with shareholders and create a business environment conducive to higher productivity and greater efficiency.
Avoiding Speculation: These documents advocate a strategy of long term value-oriented investing rather than speculative methods, because they believe, in the long run, it is always the business that performs well and not the “market”.

Final Summary of all Resources

Based on my analysis of the provided resources, the book “Valuation” by McKinsey & Company provides an exhaustive framework for understanding and applying valuation methods, while also teaching about some basics of how to evaluate businesses. “The Essays of Warren Buffett” provides a look into his thought processes and investment mindset focusing on value and long term business characteristics. “Common Stocks and Uncommon Profits” acts as a framework for evaluating a growth stock from a fundamental level, with a focus on long term vision of a company. And the Morgan Stanley document provides a way to look at an industry structure and evaluate its sustainability through an economic perspective. All documents seem to point out that a business, that has a strong competitive advantage and produces solid returns for long term, with honest management and a good market, will be a good investment. These aspects tie into each other to create a full framework that could be used by an investor for proper investment decision.