Novartis Answers Critics

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.

In the case of Novartis, which I believe has (at least) five years left of strong growth before pipeline fears become truly legitimate, it's always been premature to assume that management wouldn't have made the necessary adjustments to shore up the business. And with last week's breakthrough in multiple myeloma, which strengthened the company's oncology business, management justified why it has always resisted pleas to breakup the company.

While Novartis' oncology business has not had the strong reputation of, say, Roche (RHHBY), given Novartis' recent progress with agent LBH589 (Panobinostat), which is in phase-3 studies and used to treat various forms of cancer, I believe it's only a matter of time before the company is mentioned in the same breath as both Roche and Bristol-Myers.

In the recent trial, it was discovered that combining bortezomib (a proteasome inhibitor) and dexamethasone (a steroid) with LBH589 actually outperformed conventional therapies of just dexamethasone and bortezomib when it comes to stopping cancer progression. This was the first step in what is called a primary endpoint. How the patients react to safety and responses, which are included in the overall survival study, will be revealed in the secondary endpoint.

Essentially, while well-established players like Roche, with a reputation that is well-deserved, continue to bring new oncology drugs to the market looking to increase market share, Novartis is not asleep at the wheel, either. And I believe it's a mistake to continue to discount the breakthroughs this company is making. To that end, I can't subscribe to ongoing fears about patent cliffs.

Now, I don't want to make light of what can potentially hinder the company's long-term growth. Nor am I advocating that investors should dismiss anything that can fundamentally impact the company's bottom line. At the same time, there is a risk/reward tradeoff here that needs to be considered. And relative to its peers, I believe Novartis' reward ratio sits at the top of the sector, given its recent cancer breakthrough.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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