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Novartis Answers Critics

Stocks in this article: MRK BMY PFE NVS RHHBY

NEW YORK ( TheStreet) -- With shares of Merck (MRK), Bristol-Myers Squibb (BMY) and Pfizer (PFE) all trading at or near their 52-week highs, there aren't many bargains left in pharmaceutical stocks. But Novartis (NVS), despite its 32% year-to-date gains, might be a worthwhile exception heading as we head into 2014.

While I do believe threats to the company's pipeline -- specifically from generic competition -- remain valid concerns, I believe the Street has exaggerated fears about margin pressure and the impact it would have on the company's branded drugs business. Given management's recent moves to mitigate pipeline worries, investors would do well by placing a bet here on one of the best names in Big Pharma.

Follow this sector long enough and you will come to appreciate that a company's product pipeline is its lifeblood. If the pipeline is considered weak relative to its peers, the Street will question management's commitment to long term growth, which is often punishable by a low P/E and estimate cuts. This, then, forces the company to push research and development spending higher - in a way to keep its "blood levels up."

As bad as that might appear, the biggest fear, though, is when a company approaches what is called a "patent cliff." This occurs when popular drugs lose their patents, which then opens the floodgates to generic competition, or non-branded alternatives that are often cheaper. Although Novartis has yet to feel adverse effects, the risk to drugs like Diovan, which brings in more than $4 billion in annual sales for Novartis, remains an overhang.

When this happens, and assuming that this expiring patent can't be offset by other strong-selling products within the pipeline, the Street loses faith that the company can support both its current dividend or future cash flow allocations. I don't need to tell you what can happen to a company's stock price. It's not pretty.

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