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Morningstar | Novartis Posts Solid 1Q Driven by Innovative Drugs, but Increasing Generic Competition Is Looming

Novartis reported first-quarter results slightly higher than our expectations, but we don't expect any significant changes to our fair value estimate based on the minor outperformance. We continue to view the stock as slightly undervalued, with strong sales growth from recently launched drugs and expected new drug approvals offsetting generic competition over the next several years. This favorable balance in outlook helps support our wide moat rating for the firm. Further, with the recent divestiture of the eye care company Alcon and the expected sale of the oral U.S. generic business later in 2019, the company's increased focus on branded drugs should reinforce its competitive advantage position by focusing on the widest moat segment of patent protected pharmaceuticals that carry strong pricing power.

Overall, the quarter's strong growth (up 7% operationally for the core business) was buoyed by the innovative drug segment (up 10%), leading to a slight increase in guidance for 2019, but we expect generic competition to slow growth later in the year. Exceptionally high growth from immunology drug Cosentyx, cardiology drug Entresto and cancer drug Lutathera helped offset declines from more mature drugs. We expect continued growth from these drugs based on strong clinical data, new indications, and limited competition in the case of Entresto. The strong growth of innovative drugs is also driving a positive amplified impact on the bottom line, as this segment of drugs carries higher margins than the generic Sandoz segment. However, we expect generic competition for cancer drugs Exjade and Afinitor to increase later in the year and potential generic competition for multiple sclerosis drug Gilenya (second largest product) and cancer drug Sandostatin (fifth largest drug) could also weigh on growth in late 2019 and 2020.

Longer term, Novartis is making strong strides in bringing forward next-generation drugs. The recent launches of Lutathera, cancer drugs Kisqali and Kymriah, and migraine drug Aimovig should all contribute meaningful sales over the next decade. Further, the likely near-term approvals of gene therapy Zolgensma, ophthalmology drug brolucizumab, and breast cancer drug BYL719 along with the recent approval of Mayzent across a wide range of multiple sclerosis patients should add four key drugs, all with peak annual sales potential well over $1 billion.

For a complete review of Novartis' pipeline and currently marketed portfolio, please see our Healthcare Observer, "Annual Drug Pipeline Report: Moats Remain Secure as Innovation Counters Pricing and Generic Headwinds, but M&A Accelerating."