Nov 30 -
Summary analysis -- Novartis AG ----------------------------------- 30-Nov-2012
CREDIT RATING: AA-/Stable/A-1+ Country: Switzerland
Primary SIC: Pharmaceutical
Mult. CUSIP6: 66987V
Credit Rating History:
Local currency Foreign currency
07-Apr-2008 AA-/A-1+ AA-/A-1+
12-May-1999 AAA/A-1+ AAA/A-1+
The ratings on Switzerland-based pharmaceuticals group Novartis AG reflect Standard & Poor’s Ratings Services’ view of its “excellent” business position, founded on a portfolio of highly profitable drugs, and its “modest” financial risk profile.
In our view, Novartis’ key business strengths include a manageable patent expiry profile, an above-par representation of seven blockbuster products (that is, with sales of more than $1 billion), which is expected to increase to nine by year-end 2012, and an excellent track record with respect to innovation. Other strengths relate to a diversified structure, both as a group and inside the pharmaceuticals division, as well as the division’s resilience under generally more difficult economic and regulatory conditions. A relative weakness, in our view, is the group’s slight underrepresentation in the lucrative U.S. market.
Our view of Novartis’ financial risk profile takes into account its excellent free cash flow generation. It also incorporates management’s historically less conservative financial policy following the mainly debt-funded $51 billion acquisition of U.S.-based eye-care company Alcon Inc., and the group’s seemingly more shareholder-value-oriented approach.
Novartis continues to be a top-five player in the global pharmaceuticals market, in which critical mass is important to support high research and development (R&D) expenditures and marketing activities. For the quarter ended Sept. 30, 2012, Novartis’s gross financial debt was $20.8 billion.
S&P base-case operating scenario
We anticipate that Novartis will achieve temporarily lower sales growth in 2012-2013 on a like-for-like basis, as we believe that the effects of the patent expiry on its largest drug, Diovan (cardiovascular), could dilute satisfactory growth from new products such as Gilenya, Lucentis, Tasigna, and Afinitor. However, we believe Novartis’s strong product portfolio in oncology, eye care (Alcon), and cardiovascular, together with its promising non-oncology pipeline are likely to be further growth contributors in the longer-term future. Altogether, we therefore consider that Novartis has good chances to keep sales at least stable in 2012-2013, despite potential sizable patent erosion. For most peers, growth has turned slightly negative over the past two years because of increasing price regulation and patent expiries. Novartis’ above-average growth potential is, in our view, a direct consequence of its R&D productivity, which has enabled it to bring a comparatively high number of new drugs to market over the past two years. In addition, we believe that the group’s pharmaceuticals division’s late-stage pipeline is supportive of the ratings and for future growth, as there are no major patent expiries beyond Diovan.
Novartis’ EBITDA margin in the 12 months to Sept. 30, 2012, declined slightly on the same period in 2011 to 31%, due mainly to restructuring charges in its pharmaceuticals division, as well as a significantly lower result in its consumer health division. Our base-case scenario anticipates that Novartis could achieve 2012 EBITDA of about $17 billion, compared with more than $18.5 billion on an underlying basis in 2011. This would be reflective of an EBITDA margin contraction to about 30%, from about 32% in 2011, due to our assumptions that Diovan could lose more than $1 billion of revenues in 2012 in the wake of patent expiry, and that the company will need to spend more on R&D and marketing to distribute the company’s newly approved drugs.
Our assumption of lower 2012 margins also entails a potentially weaker full-year result in the consumer health division, following the temporary shutdown of its Lincoln production site in the U.S. after an FDA inspection uncovered quality issues. The shutdown led to a sharp decline in reported EBIT of $60 million in the first three quarters of 2012, compared with $700 million in a year-on-year comparison.
S&P base-case cash flow and capital-structure scenario
We forecast that Novartis will reach a Standard & Poor‘s-adjusted ratio of funds from operations (FFO) to net debt of about 70% in 2012, slightly up on 2011. This expected trend is based on our assumption of a slightly lower FFO of about $14.5 billion in 2012, following the expected profit trend outlined above, as well as on adjusted net debt of about $20 billion, about $2 billion lower than in 2011.
The group’s adjusted FFO-to-net-debt ratio decreased to about 62% as of Sept. 30, 2012, from 68% on Dec. 31, 2011, reflecting higher pension debt following an interest-rate adjustment and the effects from funding the group’s $6 billion dividend payment earlier in the year. As the latter has a recurring technical background, we think this will correct over the course of the year, and that credit measures are likely to recover to about 70% for full-year 2012.
Our base-case scenario assumes about $11 billion free cash flow generation in 2012, compared with more than $12 billion in 2011, to be more or less fully absorbed by a combination of shareholder remuneration and bolt-on acquisitions. A near-full distribution policy is in line with management’s revised financial policy, which focuses more on shareholder returns through dividends and share repurchases. Management’s decision to continue with opportunistic share buybacks in 2012 should not jeopardize the ratings, in our view, if there are no further larger legal requirements or any sizable debt-funded acquisitions.
For 2013, we assume a potentially larger impact on group profits and cash flow due to an expected stronger generic effect on Diovan. We are thus assuming a further decline in the group’s EBITDA margin to 29% in 2013, including a 28% EBIT margin for pharmaceuticals. We believe that part of the assumed profit erosion from Diovan in that year will be balanced by the existing maturing product portfolio, as well as a likely gradual profit recovery mainly in the consumer goods division, from very low levels in 2012.
The short-term rating on Novartis is ‘A-1+'. Our assessment of the group’s liquidity profile as “strong” reflects our belief that the group’s future liquidity uses are likely to be covered by its cash sources by a factor of 1.5x on average for the next two years. We base our assessment on the group’s being able to generate strong levels of FFO, totaling about $14 billion annually, coupled with surplus cash of more than $4.5 billion.
Novartis has a strong ability to generate FFO, which allows it to easily meet potential cash capital spending outflows of $3 billion, acquisitions of $2.5 billion, a minimum dividend of $6 billion, and even share repurchases as high as $2.5 billion. Its ample cash flow generation ability helps keep the short-term rating at ‘A-1+'.
As of Sept. 30, 2012, the group had more than $5.8 billion in cash and marketable securities available (stripping out $0.5 billion of restricted cash), and benefited from full availability of a $4.5 billion, committed bank line maturing in December 2016. In conjunction with the group’s ample expected free cash generation of $11 billion, Novartis’ short-term financial debt of about $5 billion was more than covered.
The stable outlook reflects our assumption that Novartis will maintain credit-protection measures commensurate with the ratings, meaning a pension- and lease-adjusted ratio of FFO to net debt of more than 50%, which we view as commensurate with the ratings. The outlook also reflects our view that Novartis is likely to maintain its excellent business positions and superior cash-generating ability, which should enable the group to further reduce debt strongly in the future, provided that management is willing to do so.
Given Novartis’ track record of returning excess cash to shareholders supported by its stated financial policy, we think a positive rating action is currently remote. However, it could be triggered by Novartis’ reaching and sustaining an FFO-to-net debt ratio of above 75%.
We could take a negative rating action if Novartis sustainably generated an FFO-to-net-debt ratio lower than 50%. This could be the consequence of either a sizable debt-funded acquisition of more than $10 billion, or share repurchases as high as $6 billion with a negative 5% revenue growth. However, we don’t expect this because we believe management’s focus is on integrating its recent Alcon acquisition.