Streetwise for May 8

Streetwise for Sunday, May 8, 2011

 

 

Streetwise

 

Lauren Rudd

 

Sunday, May 8, 2011

 

 

Foreign Investing Made Simple

 

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 is a more 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.

 

When I last wrote about the company a year ago, my 2010 earnings forecast was $4.80 per share and $5.00 per share for 2011. My 12-month target price on the shares was $55 for a capital gain of 14.6 percent. The indicated dividend yield was 3.4 percent.

 

So how did the company perform? Earnings for 2010 came in at $5.15 per share, well above my estimate, while the shares recently closed at $60.35, a result that was also well above my projection.

 

History if fine but it is the future that counts. The company’s 2011 first quarter ended March 31 performance is a good indicator of what lies ahead. Net sales for the quarter increased 16 percent to $14 billion when compared with the same period a year ago (14 percent in constant currencies, or cc). The use of constant currencies allows companies to show performance unaffected by currency fluctuations. Core operating income was up 4 percent (+6 percent cc) to $4.0 billion, despite the negative impact from the loss of A(H1N1) pandemic flu vaccine sales.

 

Meanwhile, the company’s core earnings decreased by 3 percent (0 percent cc) to $1.41 per share. Free cash flow was $1.6 billion. If you exclude A(H1N1) pandemic flu vaccine sales and the Alcon purchase, net sales were up 10 percent (+8 percent cc), while core operating income rose 13 percent (+16 percent cc). Note that the operating income from A(H1N1) pandemic flu vaccine sales in first quarter of 2010 was not repeated in 2011.

 

On April 8, Novartis announced that the company had completed its acquisition of Alcon. This adds a fifth growth platform as it combines the Alcon portfolio with Novartis ophthalmic medicines and the CIBA Vision contact lens business. Annual sales of the new division will likely exceed $9 billion.

 

The intrinsic value of the shares, using a discounted earnings model with an earnings growth rate of 9.56 percent and a discount rate of 15 percent, is $75. The more conservative free cash flow to the firm model yields an intrinsic value of $112 per share.

 

I am raising my estimate for 2011 to $5.40 per share with a 12-month target price on the shares of $68 for a potential capital gain of 12.5 percent. In addition, there is an indicated dividend yield of 3.40 percent. Finally, with a beta of 0.58, you are taking about half the risk of the overall market.