Novartis AG: An Undervalued Healthcare Giant With Catalysts in Sight

Novartis AG (NVS) has long been a stalwart in the pharmaceutical industry, but recent financial metrics and strategic moves suggest it's undervalued despite its robust growth profile. With margin expansion hitting record levels, a drug pipeline rich in approvals and late-stage candidates, and disciplined capital allocation, Novartis presents a compelling risk-reward opportunity for investors willing to look beyond short-term valuation metrics.

Margin Expansion Fuels Profitability

Novartis' first-quarter 2025 results underscore a dramatic turnaround in profitability. Net sales rose 15% to $13.2 billion on a constant currency basis, while core operating income surged 27% to $5.58 billion. Operating margins jumped to 36.9%, a 370 basis-point improvement year-over-year (). This expansion stems from cost discipline, productivity gains, and a shift toward higher-margin therapies like oncology and specialty drugs. Kisqali (breast cancer), Kesimpta (multiple sclerosis), and Leqvio (cholesterol) are driving this momentum, with combined sales growing over 30% in Q1.

The margin story is critical because it suggests Novartis can sustain high returns even amid flat revenue growth. With a return on equity (ROE) of 32.89% and a return on invested capital (ROIC) of 16.23%, the company's capital efficiency ranks among the best in its sector. These metrics, paired with a manageable debt/equity ratio of 0.81, highlight a financially robust foundation.

A Pipeline Bursting With Growth Catalysts

Novartis' pipeline is its most underappreciated asset. The company currently has 45 new molecular entities and over 100 total programs in development, targeting areas like oncology, cardiovascular disease, and rare genetic disorders. Notably:
- Pluvicto (Lutetium Lu 177 vipivotide tetraxetan): Approved in 2023 for metastatic prostate cancer, Pluvicto could reach $1 billion in sales by 2026, according to analysts.
- Vanrafia (Atrasentan): A kidney disease drug approved in the U.S. and EU, with peak sales potential exceeding $500 million.
- Fabhalta (iptacopan): Recently granted accelerated approval in the U.S. for a rare kidney disease, with broader indications pending.

The pipeline's diversity reduces reliance on any single drug, while regulatory wins in 2024-2025—such as the CHMP's positive opinion for Kisqali in early-stage breast cancer—suggest a steady stream of revenue catalysts. Management projects that priority brands (those with sales exceeding $1 billion) will drive 80% of growth through 2030, ensuring long-term stability.

Capital Allocation: Balancing Growth and Shareholder Returns

Novartis' management has demonstrated a knack for allocating capital prudently. The $23 billion U.S. manufacturing investment—a response to trade policy risks—ensures supply chain resilience while positioning the company to capture domestic demand. Strategic acquisitions, such as the $3.1 billion buy of Anthos Therapeutics (focused on oncology and autoimmune therapies), further bolster its R&D pipeline.

Shareholders benefit from a conservative dividend policy. With a 2.3% yield and a payout ratio of just 28%, there's ample room to increase dividends or repurchase shares. In fact, buybacks have been a key driver of EPS growth, with $25.3 billion in free cash flow over the past year providing ample fuel.

Valuation: A Mispriced Opportunity?

At first glance, Novartis' valuation appears stretched: the stock trades at 14.2x forward earnings, near its five-year average. However, the EV/EBITDA ratio of 7.81 () suggests it's undervalued relative to its peers. Analysts' fair value estimates cluster between CHF 70.72 and CHF 95.95, with the current price (CHF 95.42) near the upper end of this range.

The disconnect arises because the market underestimates Novartis' ability to sustain margin gains and pipeline execution. While near-term revenue growth is modest (projected at 0.4% in 2025 due to patent cliffs), the bulk of its pipeline's value isn't yet reflected in earnings. A PEG ratio of 1.6—lower than growth peers—supports the case for revaluation as new drugs hit the market.

Risks to Consider

• Patent Expiries: Generic competition in legacy products like Exelon (for Alzheimer's) could pressure revenue.
• Regulatory Delays: Pipeline setbacks or pricing disputes in key markets like the U.S. or Europe could delay earnings contributions.
• Geopolitical Risks: The U.S. manufacturing investment underscores vulnerabilities to trade policies, though it also mitigates them.

Conclusion: A Buy for the Long Run

Novartis is undervalued in the context of its operational strength and pipeline potential. While short-term metrics like revenue growth are lackluster, margin resilience and a best-in-class drug portfolio position the company to outperform over the next five years. The dividend offers a 2.3% yield with room to grow, making it attractive for income investors.

For growth investors, the stock's current price represents a discount to its long-term potential. Analysts' average target of $112.64 implies modest upside, but catalyst-driven revaluation could push it higher. Hold for the long term, and consider accumulating on dips below CHF 90. Novartis is a rare blend of stability and innovation—a healthcare giant that deserves a place in patient portfolios.

This analysis is for informational purposes only. Always conduct your own research before making investment decisions.