Boasting revenues of over $48 billion in 2019, Novartis (NVS) is one of the largest biopharma companies in the world. Also, at more than 36%, the R&D share of total expenses is among the highest, thus benefiting the company’s Innovative Medicines segment, which is set to expand considerably.
Its share price is on the low side compared to its competitors after failing to properly bounce back from the COVID-19 sell-off. Consequently, there should be some warming up as we progress through the clinical trials and the company’s strong pipeline generates sales.
In this connection, the fact that Novartis was among the first ones to have prioritized the use of digital technologies in R&D, manufacturing and sales is a strong positive in delivering despite social distancing measures.
Diving into research, clinical trials represent one key aspect of the Swiss giant’s competitive edge.
The drug discovery process
The process of discovering a new drug is tedious, time-consuming and costly.
About 10-15 years are normally needed to develop a new treatment from the discovery of the molecule until its marketing. The problem is that currently, given the human sufferings from COVID-19 and the fact that there are economic downturns impacting economies around the world, we simply cannot wait for years.
To this effect, Novartis is, in my opinion, among the best positioned biopharmas due to the number of clinical trials the company currently has undertaken, as well as its use of digital technologies including AI since 2018 in research.
Figure 2: Number of clinical trials as phase 2 and 3 with the ones involving Hydroxychloroquine in red.
First, as for Hydroxychloroquine, the Swiss company’s medical teams are evaluating the findings reported in the publication following the WHO’s guidance to observe a temporary pause.
Second, the company is involved in seven trials making use of several drugs in collaboration with universities, hospitals and non-profit organizations. Its two main drug candidates are Canakinumab and Ruxolitinib. In addition, it has supported research proposals from Indian Institute of Technology students for other drugs.
Figure 3: COVID-19 related clinical trials for phase 2 and phase 3.
The length of study for phase 3 clinical trials is usually 1 to 4 years. To this end, artificial intelligence can speed up the development of new treatments and therefore reduce the time to market.
Exploring this further, AI can be applied to all of the phases of clinical trials right from the cohort composition and patient recruitment through to patient monitoring.
Figure 4: Use of AI in clinical trial design
Now, one area which is suffering from significant difficulties due to COVID confinement measures is monitoring of patients involved in the trials, which has become a challenge for many companies.
However, in the case of Novartis, the company has an AI system called the SENSE tower using which clinicians analyse where there are issues in clinical trials and intervene accordingly. Moreover, researchers are able to gain real-time and predictive information on clinical studies.
Figure 5: Novartis’ new nerve centre, the SENSE tower
In addition, through deployment of digital technologies, the company has been able to monitor trial sites throughout the world.
Going deeper, Novartis is using AI in clinical trials whereby researchers can make use of much more data than before. Also, by joining hands with Massachusetts Institute of Technology and the likes of QuantumBlack, the company has significantly strengthened capacity from 2018.
Figure 6: Application of AI in medical research
Source : Keylogin Analytics
In the past, Novartis has also collaborated with Roche Holding (OTCQX:RHHBY) to develop the blockbuster drug Xolair, which treats allergic asthma and chronic hives. Interestingly, Novartis is Roche’s largest shareholder and holds 6.3% of the shares.
Furthermore, Novartis has other drugs too which are already past phase 4, that is the commercial phase from which it derives significant revenues.
There was a 14% progression in Q1 2020 revenues in comparison with the last quarter year and the company benefited from COVID in terms of forward purchasing and stocking by some customers.
Figure 7: Net sales, Net sales from 20 top medicines and revenues from innovative medicines.
The company has some blockbuster drugs in the form of Cosentyx (used in dermatology) and Entrestro. More importantly with regards to Q2 2020 revenues, it has received approval to launch five treatment options in Japan, including Tabrecta, Entresto, Mayzent, Enerzair and Atectura. Out of these Entresto has significant sales opportunity due to the fact it can be administered to patients at home and hence can help to save lives by keeping patients away from hospitals.
On the other hand, Beovu, which is a treatment for improving vision and reducing retinal fluid in wet AMD patients, has suffered because of safety concerns. On further investigation, I found that the company has been working with retina experts to perform a root cause analysis with the aim to mitigate the safety concerns. This has now been done as shown by the FDA approval after Novartis updated the label to include additional safety information.
However, ophthalmology has been impacted adversely by COVID. Like other medical diagnostic and devices companies operating in the non-life saving sector like dentistry, the ophthalmology franchise has seen a drop in clinic visits, resulting in a fall in the number of prescriptions. There was some optimism voiced out by executives during the first-quarter earnings call, which I find to be realistic as people need eye care. Also, there is the need of the health care community not to defer care for patients.
The executives have also made clear their intentions to actively monitor whether health care systems return to normal prescription and consumption dynamics during the second quarter and across all markets.
For my part, I monitor the company for additional risks in this turbulent period.
Risks and mitigation
First, concerning clinical trials, more than one-third of all phase 3 compounds fail to advance to approval in normal circumstances. Also, with the costs per failed trial being in the range of $0.8–1.4 billion, it is important for the sponsor to have solid legs in order to support these in case a longer time period is needed.
Figure 8: Novartis R&D expenses plus operating margins
Source: Table built by adding individual company’s income statement figures obtained from Seeking Alpha
Here, one matter of critical importance is that despite spending higher (in relative terms) than peers on research, Novartis is still managing to extract a 23% operating margin. This means that it has a higher financial capability to maintain research.
Secondly, there are risks of another company developing a vaccine before Novartis and the investment the company has made in clinical trials is wasted. Gilead (NASDAQ:GILD) is already marketing the antiviral remdesivir, which is currently the only drug approved by the FDA for emergency use in COVID-19.
However, it must be mentioned that this drug only improves the conditions of patients suffering from COVID-induced pneumonia to some extent (65% more likely to experience clinical improvement at day 11) compared to cases where usual drugs are used. Moreover, these results are as per the clinical trial done in June after a prior trial in April.
Therefore, given the fact that no COVID vaccine has been developed together with the significant market which has been created as a result of the light-speed infection rate of the coronavirus, big pharmas should be able to more than recoup investments.
Of predominant importance in this case, two days back the FDA instructed companies to clearly mention on their websites that currently there are no drugs approved to prevent or cure COVID-19 in people.
Finally, COVID-19 has not impacted Novartis’ clinical trials. The fact that the company leverages digital tools has limited the disruption caused by the pandemic. Some slowdowns have been witnessed in new enrollments in ongoing clinical studies, but the SENSE system has been successfully used to track clinical trials (500+) in more than 70 countries.
Valuations and Takeaway
First, Novartis’ share price has not recovered following end of March lows (figure 1), a period which also witnessed significant downsides in other big pharma stock prices.
According to me, the main reason for not being able to recover was safety concerns for the Beovu drug. However, the market seems not to have priced in the fact that the company has already addressed the issue through a work-around as evidenced by the FDA travel approval.
Hence, taking into consideration a 10-13% upside, I obtain a target stock price of $97 to 100. This is below yahoo finance’s stock price of $104.
To support my bullish instance, I strongly believe that despite facing some headwinds in existing treatments like ophthalmology as well as competition from other drug companies, Novartis is still seeing strong sales for its products as it is being able to leverage on digital technologies for patient interaction and delivery.
As a matter of fact, the company has used social media to reach 900,000 health care providers in China, and in the US, it has seen a 1,500% increase in the use of telemedicine. Also, the company has been quick to capitalize on home delivery, in the case of its Xolair drug, thereby reducing the need for people to visit drugstores and thereby helping in saving lives.
Therefore, Novartis is facing some COVID-19 pressure, but it is on track to use technology to transform these challenges into opportunities.
Finally, as for the COVID-19 vaccine, things appear to be getting simpler for biopharmas like Novartis as the FDA has just released guidelines with seem to lower the bar compared to other infectious diseases.
The company has a debt to equity ratio of 0.72 with debt well covered by operating cash flow (58%). At the current price of $87 and dividend yield of 3%, Novartis is a strong buy.
Disclosure: I am/we are long NVS, SNY, GSK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.