DBRS Ratings Limited (DBRS Morningstar) assigned Issuer Ratings of AA (low) with Stable trends to Novartis AG and Novartis Finance S.A. (NFSA).
Incorporated in Switzerland, Novartis AG is the parent company of the Novartis Group (Novartis or the Company), an international researcher, developer, manufacturer, and marketer of prescription drug treatments for diseases and medical conditions. NFSA is a wholly owned subsidiary of Novartis AG incorporated in Luxembourg and the Euro long-term note issuer for Novartis.
KEY CREDIT RATING CONSIDERATIONS
The credit ratings reflect Novartis' scale as one of the world's largest innovative pharmaceutical companies, as well as its geographically diverse operations and solid pipeline of new products and indication extensions. The credit ratings also consider the Company's focus on essential medicines in areas of unmet medical need, which has resulted in stable financial performance and strong credit metrics, including adjusted cash flow-to-debt of 60% and adjusted debt-to-EBITDA of about 1.6 times (x) as of 30 September 2023 (Q3 2023).
The credit ratings also reflect the impact of the October 2023 spin-off of Novartis' generic medicines division, Sandoz, which previously accounted for approximately 16% of the Company's consolidated revenues and provided a degree of product diversification to Novartis' research and development (R&D) intensive innovative medicines division. The Company's pure-play innovative focus will result in higher profitability margins although it will place more pressure on Novartis' R&D activities and pipeline development at the same time that Novartis will be facing multiple patent lapses in the period to 2026 (including the 2025 U.S. patent expiry of Entresto, the Company's top selling product). Notwithstanding, DBRS Morningstar has assessed the upcoming patent expiry risk as being reasonably mitigated by several late stage pipeline developments that should offset the decrease in revenue and stabilise earnings. This assessment, in conjunction with the Company's demonstrated discipline in maintaining relatively low leverage, supports the Stable trends.
CREDIT RATING DRIVERS
The Company's credit metrics are expected to support the credit ratings in the DBRS Morningstar forecast period, resulting in Stable trends. While unlikely, DBRS Morningstar may consider a positive rating action if, all else being equal, there were to be material and sustainable improvement in the Company's business risk profile, which is already very strong. Conversely, DBRS Morningstar may consider a negative rating action if, all else being equal, Novartis' financial profile deteriorates outside of expectations on a sustained basis, such as adjusted cash flow-to-debt below 50% and/or adjusted debt-to-EBITDA greater than 2x.
CREDIT RATING RATIONALE
Following a series of divestments in recent years including the October 2023 spin-off of its generic medicines division, Sandoz, Novartis is now a focused innovative medicines company. Novartis is centred on four core therapeutic areas: (1) cardiovascular, renal and metabolic; (2) immunology; (3) neuroscience; and (4) oncology. The Company operates globally with about 40% of its sales in the U.S. and about 32% in Europe, and is currently focussing its growth in its priority geographies of the U.S., China, Germany, and Japan. DBRS Morningstar notes that while Novartis is a large and globally diversified company, its brand recognition is relatively lower than some of its more consumer-oriented peers.
Novartis has a solid pipeline of 113 projects as of December 2023, including four projects in registration phase and more than one-third in late-stage (Phase 3) development, that is supported by the Company's consistent R&D expenditure of around $8 billion to $9 billion annually. Novartis management expects several of its new products and indication expansions to result in peak annual brand sales in excess of $2 billion and some well in excess of $3 billion. The Company's continued focus on pipeline progression will assist in stabilising earnings as multiple patents are due to expire in the period to 2026 and as some key patents are facing legal challenges from generics.
Looking ahead to 2025, DBRS Morningstar has assessed Novartis' financial profile as a pure-play innovative medicines company, net of the Sandoz spin-off. DBRS Morningstar expects that the Company's standalone 2023 revenues will continue to grow in line with its Q3 2023 performance, resulting in mid-to-high single-digit percentage annual sales growth. For 2024 and 2025, DBRS Morningstar expects Novartis to achieve average annual revenue growth in the low-single-digits with consideration of the timing and mix of new product launches and indication expansions against the revenue roll-off of lapsing patents. Notwithstanding, while revenue growth may be partially constrained by patent expiries and pricing pressures from the U.S. Inflation Reduction Act, adjusted EBITDA margins are expected to increase to approximately 35% to 37% (from about 30% in 2022) because of Novartis' focus on higher-margin innovative medicines as well as its structural cost savings programmes, resulting in annual mid-single-digit percentage growth in adjusted EBITDA.
DBRS Morningstar expects the Company to continue to generate healthy cash flow from operations (CFO) with EBITDA-to-CFO conversion of around 0.9x, which is forecast to be sufficient to fund ongoing capital expenditures, investments in intangible assets, and dividends broadly commensurate with historical annual averages. Continued positive free cash flow generation, along with available cash and marketable securities of $12.7 billion as at Q3 2023, is anticipated to provide sufficient headroom for the recently announced $15 billion share buy-back programme to be completed by year-end 2025 (with $1.1 billion having been paid out to date to Q3 2023), while maintaining adequate liquidity for modest debt repayments as well as potential bolt-on acquisition opportunities. Under these assumptions, in the period to 2025, DBRS Morningstar expects that the Company's financial profile will be maintained at, or will modestly improve from, its current position including adjusted cash flow-to-debt in the high 50% to low 60% range, adjusted debt-to-EBITDA in the range of 1.4x to 1.6x, and adjusted EBITDA-to-interest in the range of 19x to 20x.
Novartis AG provides a parent guarantee in support of NFSA's most senior class of debt (Senior Unsecured Notes) accompanied by conditions outlining that the obligations of both Novartis AG and NFSA will rank pari passu with all unsubordinated and unsecured obligations of each respective party. Therefore, DBRS Morningstar has assessed NFSA's most senior class of debt as ranking pari passu with the consolidated Company's current and future senior unsecured financial indebtedness, resulting in the aligned Issuer Ratings of AA (low) with Stable trends being assigned to both NFSA and Novartis AG under a consolidated credit approach based on the consolidated financial statement of Novartis AG and its subsidiaries.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental, Social or Governance factors that had a significant or relevant effect on the credit analysis.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (04 July 2023) https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings.
Notes:
All figures are in U.S. dollars unless otherwise noted.
DBRS Morningstar applied the following principal methodology:
Global Methodology for Rating Companies in the Pharmaceutical Industry (04 August 2023)
https://www.dbrsmorningstar.com/research/418844/global-methodology-for-rating-companies-in-the-pharmaceutical-industry
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
A description of how DBRS Morningstar analyses corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.
The primary sources of information used for these credit ratings include publicly available information from Novartis' website, including audited financial statements, interim financial reports, investor presentations, and bond prospectuses. DBRS Morningstar considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.
With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.
With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO
DBRS Morningstar does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar trends and credit ratings are under regular surveillance.
For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.
The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/425166/.
These credit ratings are endorsed by DBRS Ratings GmbH for use in the European Union.
Lead Analyst: Chloe Blais, Assistant Vice President, Credit Ratings
Rating Committee Chair: Timothy O'Brien, Managing Director, Credit Ratings
Initial Rating Date: 12 December 2023
Last Rating Date: Not applicable as there is no last rating date.
Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.
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NOVARTIS AG 
