Streetwise

Lauren Rudd

Sunday, May 19, 2013

Invest In Foreign Stocks With Care

Readers continually write in asking why I give short shrift to investing in the shares of foreign companies. One key reason is that 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 I suggest 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.

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.

One company issuing ADSs, where each ADS represents one ordinary share, is Novartis (NVS). Created in 1996 through the merger of Ciba-Geigy and Sandoz, Novartis has been aggressive in attacking illnesses by means of in branded drugs, as well as generics, consumer health, eye care, vaccines and diagnostics.

For example, its pharmaceutical division 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. And the Company is pursuing a robust pipeline of new drugs to mitigate the anticipated sales drop due to upcoming generic competition for some of its top-selling drugs.

The new drug pipeline consists of about 55 projects. By the year 2017, Novartis plans to release 14 or more new blockbuster drugs to treat cancer, heart, and respiratory diseases. Its advanced breast cancer drug Afinitor, also approved for kidney and lung cancer, could hit sales of $2 billion within five years. Novartis’ LDK378 compound was recently designated by the FDA as a “breakthrough therapy” for the treatment of a type of non-small cell lung cancer.

Yet, new drugs are not the whole story. In the areas of productivity and procurement, Novartis generated savings of approximately $250 million during the first quarter of this year. At the same time, the Company recorded exceptional charges related to production transfers, impairment charges and inventory write-offs amounting to $66 million.

Productivity initiatives generated gross savings that contributed approximately $600 million to operating income margin, putting the Company on track to achieve its productivity target of 3 to 4 percent of net sales in 2013.

However, there was a cost. Free cash flow for the quarter was $1.3 billion or $0.8 billion lower than the same period a year ago, mainly due to higher tax payments and working capital requirements. As of March 31, 2013, net debt stood at $14.9 billion, as compared to $11.6 billion at December 31, 2012.

Among the not so flattering developments are two recent civil-fraud lawsuits filed against Novartis for giving discounts and rebates to pharmacies and multimillion kickbacks to doctors. In addition, Novartis was downgraded by one notch by Moody's in February 2013. The long-term credit rating is AA.

The intrinsic value of the shares, using a discounted earnings model with an earnings growth rate of 5.47 percent and a discount rate of 12 percent is $60. The more conservative free cash flow to the firm model yields an intrinsic value of $81.55 per share. Meanwhile, the shares have increased from $52.29 to a recent close of $75.50, for a gain of 70 percent.