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.