Morningstar DBRS Confirms Issuer Ratings of AA (low) With Stable Trends on Novartis AG and Novartis Finance S.A.

DBRS Ratings Limited (Morningstar DBRS) confirmed its AA (low) Issuer Ratings on Novartis AG and Novartis Finance S.A. (NFSA). The trends on both credit ratings are Stable.

Incorporated in Switzerland, Novartis AG is the parent company of the Novartis Group (Novartis or the Company). NFSA is a wholly owned subsidiary of Novartis AG incorporated in Luxembourg and is the euro long-term note issuer for Novartis. Novartis AG fully and unconditionally guarantees NFSA's debt.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations reflect Novartis' scale as a global innovative pharmaceutical company, as well as its geographically diverse operations, demonstrated growth of in-market brands, and solid pipeline of new products and indication extensions. The Company's focus on essential medicines in areas of unmet medical need and its commitment to balance sheet strength have consistently resulted in stable financial performance and strong credit metrics, including cash flow-to-debt of 53% and debt-to-EBITDA of about 1.8 times (x) as of 30 September 2024 (Q3 2024). The credit ratings also consider Novartis' refocused strategy as a pure-play innovative medicine company, which, while resulting in higher margins compared with its historically more diversified structure, has placed more pressure on the Company's research and development (R&D) activities and pipeline development, especially considering Novartis' upcoming material patent expirations.

CREDIT RATING DRIVERS
A positive credit rating action is unlikely in the near to medium term, as this would require material and sustainable improvement in the Company's business risk profile, such as strengthened brand recognition and expanded market share across its therapeutic areas, along with notable improvement in operating margins and key financial metrics. Morningstar DBRS may consider a negative credit rating action if, all else being equal, Novartis' financial profile deteriorates outside of expectations on a sustained basis, such as debt-to-EBITDA significantly above 2.0x and cash flow-to-debt trending negatively toward 40%.

EARNINGS OUTLOOK
Morningstar DBRS forecasts that Novartis' 2024 revenue will continue to grow in line with its Q3 2024 performance, resulting in high-single-digit percentage annual sales growth (including foreign exchange headwinds). For 2025 and 2026, Morningstar DBRS expects Novartis to achieve average annual revenue growth in the low single digits, considering the timing and mix of in-market growth and new products and indications against the revenue roll-off of lapsing patents and pricing pressures from the U.S. Inflation Reduction Act. With the Company's increasing focus on R&D, marketing of new brands, and ongoing legal matters related to generic entrants, Morningstar DBRS expects that the pace of margin progression from Novartis' cost saving programmes may be constrained and that Morningstar DBRS-adjusted EBITDA margins will be maintained in the mid-to-high 30s percentage mark during the forecast period. As such, Morningstar DBRS estimates average annual adjusted EBITDA of around USD 18 billion to USD 19 billion in the period to 2026, compared with USD 16 billion in 2023.

FINANCIAL OUTLOOK
Morningstar DBRS expects the Company to continue generating healthy cash flow from operations (CFO) with EBITDA-to-CFO conversion of around 0.9x, which should be more than sufficient to fund capital expenditures and investments in intangible assets equal to about 6% of revenue as well as ongoing progression of dividends. Novartis' capital allocation policy remains flexible and prioritises investments in organic growth and value-creating bolt-on acquisitions. The Company has historically distributed surplus cash flow via share buybacks. As of Q3 2024 there was USD 7.9 billion remaining under its USD 15 billion buyback programme expected to be completed by mid-2025. While Novartis does not have a formal leverage target, Morningstar DBRS expects the Company to maintain its current balance sheet strength and liquidity position, as this allows Novartis the capacity for opportunistic investments and to absorb legal expenses incurred in normal operations. As of Q3 2024, Novartis' liquidity reserves included USD 14 billion in cash and marketable securities and an undrawn committed credit facility of USD 6 billion. Morningstar DBRS anticipates that Novartis will manage its capital allocation activities such that key financial metrics remain relatively stable to current levels, including cash flow-to-debt above 50% and debt-to-EBITDA in the range of 1.7x to 2.0x.

CREDIT RATING RATIONALE
Novartis faces headwinds from recent losses of exclusivity on certain products and upcoming patent lapses in the period to 2027, including the 2025 U.S. patent expiry of Entresto, the Company's top selling medication. U.S. sales of Entresto account for about 8% of Novartis' total revenue. Notwithstanding, Morningstar DBRS has assessed these patent risks as being reasonably mitigated by in-market growth of other key brands, several late-stage pipeline developments, and Novartis' position in international markets that helps to stagger patent expirations away from the lucrative US market. Morningstar DBRS acknowledges a degree of uncertainty in the pace of revenue and earnings growth in the near term; however, Novartis' strong cash flow generation, flexible capital allocation policy, and liquidity reserves provide levers for the Company to maintain its gross debt-to-EBITDA at less than 2.0x, a range supportive of the credit ratings and the Stable trends.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024), https://dbrs.morningstar.com/research/437781.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of Novartis, the relative weighting of the BRA factors was approximately equal.

(B) Weighting of FRA Factors
In the analysis of Novartis, the relative weighting of the FRA factors was approximately equal.

(C) Weighting of the BRA and the FRA
In the analysis of Novartis, the BRA carries greater weight than the FRA.

Notes:
All figures are in U.S. dollars unless otherwise noted.

Morningstar DBRS applied the following principal methodology: Global Methodology for Rating Companies in the Pharmaceutical Industry (09 August 2024), https://dbrs.morningstar.com/research/437748.

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (15 April 2024; https://dbrs.morningstar.com/research/431186) which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodologies have also been applied:
-- Morningstar DBRS Global Corporate Criteria (15 April 2024), https://dbrs.morningstar.com/research/431186
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024), https://dbrs.morningstar.com/research/437781

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyses corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

The primary sources of information used for these credit ratings include publicly available information from Novartis' website, including audited financial statements, interim financial reports, and investor presentations. Morningstar DBRS 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

Morningstar DBRS 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. Morningstar DBRS trends and credit ratings are under regular surveillance.

For further information on Morningstar DBRS 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 Morningstar DBRS 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://dbrs.morningstar.com/research/444535.

These credit ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Chloe Blais, Assistant Vice President
Rating Committee Chair: Anke Rindermann, Managing Director
Initial Rating Date: 12 December 2023
Last Rating Date: 12 December 2023

Information regarding Morningstar DBRS ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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