Streetwise
Lauren Rudd
Sunday, May 16,
2010
Why I Give Short Shrift to International Investing
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.
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 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. Of particular note is that the major exchanges require
financial statements that adhere to Generally Accepted Accounting Principles or
GAAP.
One company issuing ADSs 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 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.
When I last wrote about the company a year ago, my earnings
forecast was for $3.64 per share for 2009 and $4.09 per share for 2010, with a
12-month target price on the shares of $45, yielding a potential gain of 13
percent. There was also a dividend at the time of 4.5 percent.
Looking at the company’s 2009 performance, earnings came in
at $3.69 per share and the shares recently closed at $48.74, exceeding my
expectations. However, that is old news. What is important is the company’s
potential for 2010. The results for the first quarter ended March 31, are a good
indicator. Net sales increased 25 percent to $12.1 billion, the result of
improvements across the board in all businesses. Sales of H1N1 pandemic flu
vaccines and the rapid growth of a series of recently launched products are of
particular note.
At the same time the three of the consumer health divisions:
the over-the-counter division, the animal health division and CIBA Vision, all
grew ahead of their respective markets. Excedrin was a key contributor, while a
weak "Cough & Cold" season slightly offset that performance.
Operating income for the quarter rose 50 percent to $3.5
billion, while the company’s operating margin improved to 28.9 percent of net
sales, as compared to 24.2 percent a year ago. Net income was up 49 percent at
$2.9 billion. Earnings per share rose in line with net income to $1.29 per share
from $0.87 in the 2009 period.
The intrinsic value of the shares, using a discounted
earnings model with an earnings growth rate of 9 percent and a discount rate of
15 percent, is $60. The more conservative free cash flow to the firm model
yields an intrinsic value of $93 per share.
I am raising my earnings forecast to $4.80 per share for 2010 with a projection
of $5.00 per share for 2011 and a 12-month target price on the shares of $55,
for a capital gain of 14.6 percent. There is also an indicated dividend yield of
3.4 percent. Finally, with a beta of 0.53, you are taking about half the risk of
the overall market.
