Streetwise for Sunday May 17, 2009

Streetwise

Lauren Rudd

Sunday, May 17, 2009

Foreign Investing Can Complicate Life

Readers continually write in asking why I give short shrift to investing in the shares of foreign companies. The primary reason is that the analysis of a foreign company complicates an already potentially difficult undertaking.

Suddenly your research is impacted by foreign accounting standards, a different judicial system, exchange rates, foreign tax policy and an unfamiliar political landscape.

Furthermore, most major international blue chip companies receive a significant share of their revenues and profits from their foreign subsidiaries. For the average investor that should be sufficient foreign exposure.

However, if you are intent on investing in foreign companies then one of the easiest, safest and most efficient ways of doing so is through the purchase of American Depositary Shares (ADSs) issued by depository banks in the U.S. under agreement with the issuing foreign company.

By definition, certificates representing a certain number of a foreign company’s shares are called American Depositary Receipts (ADRs) 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.

Depending on the level of compliance desired, a foreign company may either list its depository shares on the over-the-counter market with low reporting requirements, or on a major exchange like the NYSE with considerably stricter requirements.

While many of the foreign investing pitfalls just mentioned still hold, foreign companies listed on a major exchange (and the only ones I would recommend) are required to provide financial statements that meet Generally Accepted Accounting Principles or GAAP.

One company issuing ADSs that I last discussed two years ago, and one you might want to delve into, is Novartis (NVS). Created in 1996 through the merger of Ciba-Geigy and Sandoz, Novartis has been aggressive in attacking illnesses by means of pharmaceuticals, vaccines and diagnostics, generics, and consumer health.

Novartis’ pharmaceutical division, the largest and most profitable of its four divisions, develops and manufactures prescription drugs to treat a wide spectrum of ailments. The division recently announced FDA approval for Exforge HCT, the only single pill to combine the three most prescribed high blood pressure treatments.

The consumer health unit can claim a number of well known over the counter medications, such as Excedrin, and Theraflu, along with CIBA Vision's contact lenses and eye care products.

Looking at the company’s results for the first quarter ended March 31, net sales rose 8 percent in local currencies, but fell 2 percent in US dollars to $9.7 billion. Higher sales volume simply could not overcome the negative currency movements resulting from a stronger dollar.

Net income fell 14 percent to $2.0 billion, also hurt by the rising dollar, while earnings per share for the quarter came in at $0.87, as compared to $1.02 in 2008.

In its forward looking guidance, Novartis said that it expects to see continuing sales momentum, with overall net sales growing in 2009 at a mid-single-digit rate and sales at its pharmaceutical division growing at a mid- to high-single-digit rate. Operating and net income should see record levels in 2009.

The intrinsic value of the shares, using a discounted earnings model with an earnings growth rate of 2 percent and a discount 10 rate of percent, is $50. The more conservative free cash flow to the firm model yields an intrinsic value of $86 per share. The shares recently closed at $39.82.