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Morningstar | Novartis Posts Strong 2Q, Boosted by Sales Gains From High-Margin Drugs and Recent Launches

Novartis reported strong second-quarter results, exceeding both our and consensus expectations, and we plan to increase our fair value estimate based on the outperformance. Margin expansion was particularly pronounced, which we partly attribute to the increasing mix shift toward specialty products and continuing leverage from the growth of cardiovascular drug Entresto, trends that should continue over the next several years. Novartis' recent launches of specialty drugs continues at a relatively strong rate, which should help drive growth and bolster the company's wide moat, as these drugs tend to have pricing power.

In the quarter, total sales increased operationally by 8%, buoyed by continued gains from immunology drug Cosentyx, Entresto, and several midsize oncology drugs as well as relatively light generic pressure. Additionally, recent launches of migraine drug Aimovig and oncology drugs Kisqali and Kymriah are also boosting overall gains. We expect continued strength of new drug launches with the recent approvals of gene therapy Zolgensma, multiple sclerosis drug Mayzent, and cancer drug Piqray. Further, ophthalmology drug Beovu (RTH258), multiple sclerosis drug ofatumumab, sickle cell drug SEG101, and asthma drug fevipiprant could all gain approval by the end of 2020. While the number of drug launches is impressive, the firm is also likely facing increasing generic pressure, with several older drugs losing patent protection over the next three years, including older multiple sclerosis drug Gilenya in early 2020 depending on legal decisions.

On the bottom line, core operating income increased 20% operationally, well ahead of sales. We expect a continuing trend toward margin expansion of close to 300 basis points over the next three years, given the high margins of the new and recently launched drugs. However, patent losses will likely limit some of the margin lift potential.

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."