Morgan Stanley downgrades Novartis amid limited innovation by Investing.com

Investing.com — Analysts at Morgan Stanley in a note dated Thursday revised their rating on Novartis (NYSE:) AG (SIX:) to “neutral” from “buy,” indicating a change in the investment outlook for the Swiss pharmaceutical company.

This comes after a period of strong share price performance, closely aligned consensus market estimates and limited near-term innovation catalysts that, according to Morgan Stanley analysts, suggest little room for further stock appreciation.

The main factor driving this rating change is the 11% rise in Novartis’ share price in recent months, outperforming the broader market.

Analysts attribute the company’s performance to a number of factors, including positive earnings momentum following an upgrade to its FY24 guidance in both the first and second quarters of 2024.

In addition, Novartis expanded its share repurchase program, doubling the number of shares repurchased from approximately 200,000 to 400,000 from mid-June 2024.

While these developments have supported the stock, Morgan Stanley suggests that these factors are now fully reflected in the share price, indicating limited potential for further gains.

Another reason for the downgrade is the alignment of the market consensus with Morgan Stanley’s forecasts for Novartis through 2028. For FY24-28, Morgan Stanley’s estimates are only slightly above consensus – by about 1% for net sales, core operating income and core EPS.

This close alignment indicates little potential for positive earnings surprises, which typically drive share prices higher.

Analysts predict limited potential for a near-term re-rating of Novartis shares, with market expectations largely reflecting the company’s current performance trajectory.

In addition to this earnings consensus, the downgrade also reflects a lack of compelling innovation catalysts in the near term.

Novartis has already hit a major milestone with its Phase 3 read-through for Scemblix in first-line chronic myeloid leukemia, “The timing of innovation remains quiet until mid-2025,” analysts said.

While Novartis has a number of promising products such as Cosentyx, pelacarsen, ianalumab and Pluvicto, key data releases and potential approvals for these drugs are not expected to materialize until the second half of 2025.

This creates what Morgan Stanley calls a “news flow vacuum,” limiting the potential for share price growth driven by new product developments in the near term.

Valuation concerns also played a role in Morgan Stanley’s decision to downgrade the stock. Novartis currently trades at about 14.2 times projected 2025 earnings per share, representing an 8% premium to the European Biopharma sector, excluding Novo Nordisk (NYSE: ). That premium is slightly above the historical average of about 7% and higher than the 5% premium seen when Morgan Stanley originally rated the stock a “buy.”

Given this valuation, and given the expected pause in innovation-driven catalysts, analysts believe the stock is unlikely to generate substantial gains over the next 12 months.

Despite the downgrade, Morgan Stanley remains bullish on Novartis’ continued earnings momentum. The company has upgraded its FY24 guidance twice this year, a testament to its strong financial performance.

While this earnings momentum will continue to support the stock, Morgan Stanley says that without the right catalysts for innovation, it is unlikely to generate earnings that would justify a “buy” rating.

Looking ahead, Morgan Stanley predicts a resurgence of Novartis innovations in the second half of 2025. Key data from pivotal studies for products such as pelacarsen (aimed at preventing cardiovascular events), Cosentyx (for various inflammatory conditions) and Pluvicto (for prostate cancer ) are expected during this period.

Positive results from these trials could reduce the risk of more potential blockbuster drugs, providing a solid foundation for renewed growth. However, with these developments still some way off, the bank’s analysts remain cautious about the stock’s near-term outlook.

Potential risks to this outlook include weaker-than-expected commercial execution for key products such as Kisqali and Pluvicto or earlier-than-anticipated generic competition for Entresto, one of Novartis’ best-selling drugs.

On the other hand, business development activities such as new acquisitions or partnerships could provide a boost to the stock, especially if Novartis accelerates its buyback program or identifies attractive opportunities in areas such as cardiovascular or oncology.

In terms of valuation, Morgan Stanley revised its 12-month target price for Novartis to CHF 103 ($121 per ADR), reflecting only a 2% upside from current levels.