We recently compiled a list of the 10 Cheap Pharmaceutical Stocks to Buy According to Short Sellers. In this article, we are going to take a look at where Novartis AG (NYSE:NVS) stands against the other cheap pharmaceutical stocks.
The pharmaceutical industry is one of the most interesting sectors to invest in. This is because while most industries can easily be broadly categorized into either being vulnerable or resilient to economic headwinds, pharma companies have the potential to operate in both categories. Firms that develop new drugs, particularly those that operate in the biotechnology industry, don’t do well in a tough economy as they find it difficult to raise capital and keep costs under control. At the same time, large pharmaceutical companies and those that develop and sell generic drugs can survive in a tough economy due to the relatively inelastic nature of their product demand.
As is with all other industries, the pharma industry has also changed throughout the past few decades. This change has been driven by the rise of biotechnology and biopharmaceutical companies that are seeking to open new frontiers for drug development. Before we get to the data, some of the shifts that have taken place include increased spending on acquisitions as opposed to solely on research, a global industry where multinationals operate in multiple markets, and marketing campaigns that seek to extend product life cycles as opposed to maintaining competitive advantage through patents.
Talking about data, biotechnology has been catching up to the pharma sector in terms of revenue, as it accounted for 30% of total pharma sales in 2014 compared to less than 1% in 1991. At the same time, biotechnology operating margins have also been catching up. These ranged between roughly 7% to 12% between 1991 and 1993, were in the red for the next decade until 2024, and surpassed pharma margins of roughly 24% in 2014 to sit at approximately 28%. This gap widens when we remove the impact of R&D which disproportionately impacts biotechnology companies, as for the five years between 2010 and 2014, the pre R&D operating margin of pharma companies declined from 40% to ~28% while the corresponding value for biotechnology firms grew from 40% to ~56%.
During the same time period, biotech firms’ growth to R&D ratio (which measures the growth per unit of R&D per unit of sales) sat at 0.95, more than 10x of the pharma sector’s 0.08. This stellar catch up of biotechnology is also visible in pharmaceutical valuations, since in 2014 biotechnology companies accounted for roughly 40% of drug company valuations for a historic high. In terms of multiples, namely enterprise value to pre R&D operating income, the biotech sector’s premium has noticeably dropped over the pharma sector. It sat at a high of ~77x in 2000 and dropped to ~18x in 2014 for a markedly lower premium over the pharma sector’s ~11x which had sat at 20x in 2000.
Building on this, while the market level valuations of pharma companies have shifted over the years due to the growth in biotechnology companies, this does not provide us with any details about what drives firm level valuations. On this front, research that used ten year data from 101 firms demonstrates that the three key drivers of pharma valuation are R&D, advertisement, and production facilities. These three have regression derived valuation weights of 13.19, 15.85, and 19.13, respectively. This provides key insights as it suggests that R&D is far from being the key competitive edge in the industry as is commonly believed.
In fact, advertising and production are key drives for pharma valuations when we consider the biggest thorn in the industry’s side, namely patents. 2024 has seen weight loss drugs cement their place in the market, and as their patents start to expire, the industry and the government could enter more thorny fights that could impact pharma valuations. The industry’s detractors accuse pharma firms of unsavory practices such as filing ancillary patents that extend patent lifetimes by filing patents for different features of the same product, filing differently worded yet similar patents in what is called building patent thickets, and purposefully delaying upgrades to benefit from evergreening provisions.
While it might seem that this potential disruption to the pharma sector is far off in the future, the reality is different. This is because GLP-1 based weight loss drugs, liraglutide, albiglutide, and dulaglutide, were first approved by the FDA in the 2010s and firms in India and China have already started working on making cheap biosimilars that could attract a wider market. Things are moving fast even in the developed world as the Indian firm Biocon has already secured approval for a liraglutide generic in the UK while the FTC sent letters to ten companies, including some of the biggest weight loss companies, in May as part of its bid to fight bogus patents. Looking forward, you should expect the number of generics to rise and patent fights to intensify since the weight loss pie could be as big as $100 billion by 2030 according to a well known investment bank.
Our Methodology
For our list of best pharma stocks to buy according to short sellers, we ranked specialty and general drug manufacturers with a market cap greater than $300 million by the percentage of shares outstanding that were sold short and selected the stocks with the lowest percentage. Then, those stocks with a trailing P/E ratio lower than 57.63 or a current P/E ratio lower than 38.94 were chosen. These are the sector averages for the pharma industry.
For these stocks, we also mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
Dozens of pharmaceutical capsules piled on top of one another to show the scale of the company’s drug contributions to the industry.
A doctor holding a microscope in front of a laboratory sample of healthcare products.
Short Interest as % of Shares Outstanding: 0.28%
Number of Hedge Fund Investors In Q2 2024: 30
Novartis AG (NYSE:NVS) is the Swiss pharma giant headquartered in Basel. It sells prescription drugs for a variety of ailments such as those involving the liver, heart, nervous system, and kidneys. Right now, its two hottest drugs are Scemblix and Kisqali, which are used to help patients with leukemia and breast cancer and as an adjuvant, respectively. This means that Novartis AG (NYSE:NVS)’s performance is somewhat tied to these drugs, as well as other hot products such as its prostate cancer drug Pluvicto and heart disease drug Leqvio. Particularly for Pluvicto, Novartis AG (NYSE:NVS) has to fork out royalty payments which means that the firm has to carefully map out its sales estimates and marketing expenses to ensure the drug remains a money maker. The firm’s global footprint also places a wide market at its disposal, allowing it to target multiple geographies with its drugs. At the same time, Novartis AG (NYSE:NVS) has to keep focus on R&D since its status as a leader in developing branded drugs means that the firm loses revenue once patents expire – requiring it to continuously launch new products.
Novartis AG (NYSE:NVS)’s management shared key details for its pipeline during the Q2 2024 earnings call:
“Turning to our renal portfolio, as you all know, we’ve been working to build an attractive portfolio to manage IgAN, C3G and related renal diseases.
And as part of that effort, we acquired atrasentan. And in the Phase III ALIGN-IgAN study, we announced at ERA in May, a 36% proteinuria reduction relative to placebo. We’re very excited about this medicine as we think it can be a foundational medicine to provide hemodynamic and nephroprotective potential for patients and physicians. It’s a clinically meaningful proteinuria reduction. We see a very favorable safety profile. We think up to 50% of patients with persistent proteinuria progress to kidney failure. So important that these patients get better options. We’ve submitted to FDA. And of course, the study continues in a blinded fashion to 2026 when we would read out the eGFR. So looking forward to launching this medicine in 2025. Alongside that, with iptacopan, we also announced at ERA, the full result Phase III APPEAR-C3G study, which demonstrated 35% proteinuria reduction relative to placebo.
You can see the design on the left-hand side of the slide. On the right-hand side, you see that impressive minus 30% versus an increase of 7.6% in the placebo arm. We saw numerical improvements in eGFR, favorable safety profile overall. This would be the first treatment — potential treatment targeting the complement pathway in C3G. And again, in these patients, 50% of patients develop kidney failure requiring dialysis. Now importantly, today, we’re also announcing that we have end of study results for this medicine at the 12-month time point that data is consistent with the 6-month data, which now allows us to move forward with the filing in the second half of 2024, with an expected launch next year. We’ll present that end-of-study data at an upcoming medical meeting.”
Overall NVS ranks 4th on our list of the cheap pharmaceutical stocks to buy according to short sellers. While we acknowledge the potential of NVS as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than NVS but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
READ NEXT: $30 Trillion Opportunity: 15 Best Humanoid Robot Stocks to Buy According to Morgan Stanley and Jim Cramer Says NVIDIA ‘Has Become A Wasteland’.
Disclosure: None. This article is originally published at Insider Monkey.
