>NOVARTIS (EUROPEAN STOCK)

Upgrade to Neutral on valuation, macro & catalysts

■ Macro driven Underperform thesis diminishes
We are upgrading Novartis to Neutral from Underperform and raising our price objective to CHF50 from CHF45. In our view, our macro-driven Underperform thesis is becoming less relevant as investors have moved more Neutral-weight the pharmaceutical sector, its valuation appears undemanding, and there are some catalysts on the longer-term horizon. However, our Neutral thesis is driven by Novartis’s continued unexciting forward growth through a period of cyclical recovery and limited upside potential to our CHF50 fair value and price objective. Neutral.

■ Valuation seems undemanding but not compelling
Novartis appears appropriately valued. The stock trades within 2% of our CHF50 DCF-based price objective (up from CHF45). On a core EPS basis (which we expect the company to use as focus EPS from 2010 onwards), it trades on a 2010E PE of c9x, a c10% discount to its EU Pharma peers and c40% discount to the EU market. This appears appropriate to us given its expected lacklustre 2% 10-13E EPS CAGR, below the sector average c5%.

■ Near-term events not material. Longer-term catalysts seen
We see near-term 2009 events (Flu vaccine driven EPS upside, FTY720 (multiple sclerosis) 2-year data, oncology investor event Dec 9th, including new Phase III data for Tasigna head to head versus Gleevec in front line CML and QAB149 (LAMA, COPD) head-to-head data versus Pfizer’s Spiriva) as insufficient to materially move the shares. However into 2010, we see more material catalysts as: 1) New CFO Jon Symonds (aggressive cost cutter) takes the role in April; 2) Meningitis B vaccine phase III data expected 2H10 ($5bn sales potential or 6% EPS upside); 3) Final analysis of ASA404 in non-small cell lung cancer which, if positive, could trigger c2% EPS upside (interim analysis expected 2H09).

To see full report: NOVARTIS