What Does Novartis' Earnings Release Really Mean for the Company?
Earlier this morning, Novartis (NYSE: NVS) reported poor earnings for their third quarter. The company matched analysts' EPS estimates of $1.45, but missed revenue estimates by reporting $14.8 billion instead of $15.1 billion. The firm also reported that it will be cutting 2,000 world-wide. Overall, Novartis is a global health care company that delves into the pharmaceutical space along with consumer health products. While it is apparent that the company did not perform as well as expected in the third quarter, can it improve its performance going into the fourth quarter?
The biggest question that an investor needs to answer when trying to figure out Novartis' future performance is if its earnings are dependent on macroeconomic trends. While Novartis is more shielded than companies in the financial services industry, it is definitely impacted by economic uncertainty. Novartis is also doubly impacted by the fact that it is based in Switzerland. The preeminent news regarding the economic climate is European based, and Novartis may face higher risks than its American counterparts.
The first hit that the company took occurred in September 2011, when the Swiss National Bank decided to lower the the Swiss Franc's peg to the Euro. This immediately devalued the currency against the Euro and the US Dollar. While this would have made exports from Switzerland very attractive to foreign buyers, other international operations may not have been affected positively. The primary reason for this notion is that foreign operations still gain the same amount of revenues, but when they're converted back to Swiss Francs in the headquarters, the Francs are worth less than before. However, without knowing exact metrics like where the bulk of research and development occurs, it is impossible to truly know the effect of the Swiss Franc's peg. Regardless, it is extremely likely there was some effect on Novartis' business, for better or for worse. In a move which may be tied to the currency peg, Novartis announced that it will move some of its research operations from Switzerland to the US.
Novartis also operates multiple locations in Europe, with two locations in England and Italy each, and three locations in Switzerland. These individual locations, as well as the company in general, probably have higher than average exposure to European debt problems. Apart from the actual finances, the fact that these European pipelines are primarily catered to European customers may have directly resulted in lower revenues in the third quarter, as the world became more nervous about Europe's situation.
From a purely financial perspective, it seems likely that Novartis would have involved itself in the European capital markets over the course of its existence. Whether or not Novartis opened credit facilities in the European region or if it invested in various debt instruments, Novartis may have a higher exposure to the inherent European instability. In the short to medium-term, this may hinder Novartis' balance sheet. Its direct competitors like Pfizer (NYSE: PFE) and Merck (NYSE: MRK), however, do not have these problems, at least to the extent that Novartis has.
Investors also need to consider Novartis' positive aspects. While Novartis missed revenue estimate, it managed to beat net income estimates. In fact, analysts thought net income would be $2.32 billion, but Novartis managed to pull in $2.48 billion. This means that revenues may not have been as high as expected, but costs were trimmed accordingly to preserve the bottom line. Moreover, Novartis still posted revenues of about $14.8 billion. This is higher than revenues earned in the last five quarters, which still signifies growth.
Novartis's balance sheet is a bit more complicated, as it shows dwindling cash reserves along with inflated short-term and long-term debt levels. This is probably not a good thing for the company, Working capital items have also been increasing, which is not necessarily positive for the company either. A lot of the company's resources appear to have been tied to a series of acquisitions taking place in the last four to five years. While strategic acquisitions are important to boost shareholders' value, they may not be worth it when cash on hand is becoming scarce and debt loads are become larger and more complex.
Novartis boasts an impressive product line along with a state-of-the-art patent portfolio. However, with recent macroeconomic developments along with cost-cutting plans by the company, future earnings growth becomes increasingly uncertain. The pharmaceutical will have to identify ways to diversify its businesses in order to maintain robust growth to appease Wall Street. Otherwise, its stock may continue to go downhill.
Novartis is currently trading at about $56.50, down about 4.2% for the year.
Traders who believe that Novartis is an appropriate long investment might want to consider the following trades:
- It still maintains positive revenue, net income, and EPS growth.
- It maintains an impressive patent portfolio that is unrivaled by many of its competitors.
- It is a globalized pharmaceutical that also produces consumer care products and operates distribution and marketing channels across the world.
Traders who believe that Novartis is more suited for a short play may consider an alternate position:
- Novartis' balance sheet shows that it is bleeding cash and is dangerously running low, which may impede operational growth.
- Its balance sheet also shows an increasingly complex debt load, which is not being paid off timely.
- Novartis is based in Switzerland, and may face higher exposure to the European debt crisis than its competitors.
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