Readers continually write in asking why I give short shrift to investing in the shares of foreign companies. One key reason is that your research is impacted by foreign accounting standards, a different judicial system, exchange rates, foreign tax policy and an unfamiliar political landscape.
However, if you are intent on investing in foreign companies, I suggest doing so through the purchase of American Depositary Shares issued by depository banks in the U.S. under agreement with the issuing foreign company.
Certificates representing a certain number of a foreign company's shares are called American Depositary Receipts and the individual shares represented are American Depository Shares. ADRs can represent a fraction of a share, a single share, or multiple shares of a foreign stock and are negotiable.
One company issuing ADS's, where each ADS represents one ordinary share, is Novartis (NVS). Created in 1996 through the merger of Ciba-Geigy and Sandoz, Novartis has been aggressive in attacking illnesses by means of branded drugs, as well as generics, consumer health, eye care, vaccines and diagnostics.
For example, its pharmaceutical division develops and manufactures prescription drugs to treat a wide spectrum of ailments. The consumer health unit can lay claim to a number of well-known names, such as Excedrin and Theraflu, along with CIBA Vision's eye care products. And the company is pursuing a robust pipeline of new drugs to mitigate the anticipated sales drop due to upcoming generic competition for some of its top-selling drugs.
The new drug pipeline consists of about 55 projects. By the year 2017, Novartis plans to release 14 or more new blockbuster drugs. Its advanced breast cancer drug Afinitor, also approved for kidney and lung cancer, could hit sales of $2 billion within five years. Novartis' LDK378 compound was recently designated by the FDA as a "breakthrough therapy" for the treatment of a type of nonsmall cell lung cancer.
Yet, new drugs are not the whole story. Productivity initiatives generated gross savings that contributed approximately $600 million to operating income margin, putting the company on track to achieve its productivity target of 3 to 4 percent of net sales in 2013.
However, there was a cost. Free cash flow for the quarter was $1.3 billion or $800 million lower than the same period a year ago, mainly due to higher tax payments and working capital requirements. As of March 31, net debt stood at $14.9 billion, as compared to $11.6 billion at Dec. 31.
The intrinsic value of the shares, using a discounted earnings model with an earnings growth rate of 5.47 percent and a discount rate of 12 percent is $60. The more conservative free cash flow to the firm model yields an intrinsic value of $81.55 per share. Meanwhile, the shares have increased from $52.29 to a recent close of $75.50, for a gain of 70 percent.
My earnings estimate for 2013 is $5.30 per share, $5.75 for 2014, with a projected 12-month share price of $82, for a 10 percent capital gain. There is also an indicated 1.80 percent dividend yield. Therefore, Novartis is trading at multiple of 14 times estimated 2013 earnings and about 13 times estimated 2014 earnings. Finally, with a beta of 0.55, you are taking about half the systematic risk of the overall market.
Lauren Rudd: LVERudd@aol.com.