Novartis AG (NOVN) Earnings Call Transcript & Summary

I'm the moderator for today's Novartis Materiality Assessment 2021 kickoff webinar, and it's a pleasure to welcome you all to today's discussion. The next slide will give us the agenda for our discussion. And you can see that we'll be taking a look at why materiality assessment is important, what has Novartis achieved, where are they heading, and also there will be an opportunity, as usual, to hear from all of you with your questions and comments. The next slide is just some logistics for us. The duration of the meeting will be an hour. [Operator Instructions] Now let me turn to our speakers and introduce our panel. We have a distinguished group of speakers from Novartis. On the next slide, we'll show some photos of them. We'll be hearing first from Patrice Matchaba, who's the Head of U.S. Corporate Responsibility and President of the Novartis U.S. Foundation; Dr. Lutz Hegemann, who's the Group Head of Corporate Affairs and Global Health; Samir Shah, the Head of Investor Relations; and Carrie Scott, the Head of the ESG Management Office. So without further ado, let me turn to Patrice Matchaba to introduce our speakers and to get us going.

So thanks, Jeff, and good morning, good afternoon and good evening to all of you, and thank you so much for making the time. We do take your inputs as stakeholders and shareholders very seriously. This is the fourth materiality analysis we will discuss and show you with the team that each time you have given us input we have integrated that into our core strategy. And hopefully, we have become a better company for all our stakeholders and shareholders. Now just thinking the timing of your input could not have been more appropriate. So we're in the middle of this pandemic, 1 in a 100 years. Health care systems have been decimated. There's a recession going on and millions of people have lost their lives and infected. And how we rearrange and reorganize ourselves as a company, as Novartis and the priorities that we need to concentrate on would be critical to somehow circumvent the damage that COVID has impacted on humanity and on the economic system. So your inputs in that light would be really important. Now just as an update, in the invitation, you have seen just my picture as Global Head of Global Health and Corporate Responsibility. But as of the first of this month, there's been some changes. As of first of this month, I am now the Head of the U.S. Corporate Responsibility and the President of the U.S. Foundation with a clear view that we need to do something different in the U.S. COVID has shown us the differential impact on communities based on income and race and somehow or the other, we need to think differently as a company. Now it gives me really great pleasure to introduce someone I had known for the last 15, 16 years, a solid drug developer and outstanding public health person. We've worked together in drug development and global health for the last 15 years. Lutz takes over as the Group Head of Global Health and Corporate Affairs. He integrates the ESG office, and you'll hear from Carrie, that will also be integrated to global health and also the strategy. And the whole idea here is to make sure that whatever inputs you give us that we integrate this into our core strategy and Lutz will be reporting to Vas. So with that, I want to hand over to Lutz.

Yes. Thank you very much, Patrice, for your kind introduction and a warm welcome to everyone on the call today. It gives me great pleasure to kick off this materiality assessment. And as Patrice had mentioned, we really depend on the input that all of you so kindly give to us. And let me move to the next slide, please, which summarizes how we as Novartis currently define our purpose. And you will see a few themes that will bring you back to previous input that you have given in materiality assessments. It's very much about innovation. Obviously, that's at the center of what we do in order to address some of society's most challenging health care issues. Then also very important is this second paragraph here, which goes beyond just creating innovation, but making it accessible to as many people as possible. And the theme of access was an inspiration that came through the materiality assessments in previous rounds very loud and clear. And then last but not least, Patrice briefly mentioned it, it's the shift from shareholder primacy to stakeholder primacy, which includes essentially our partners, our suppliers and our associates. And next slide, please. Going through that in a little more detail because we have to realize that we, as a company, are embedded in a very complex health ecosystem. And that all of those groups here, all of those stakeholder groups really help us in defining who we are as a company and what should we stand for. And it would be incorrect to just single one group out here as it had been done for many, many years with the investor side, which doesn't mean that they are not critically and are essential to everything that we do. But likewise, we care about deeply about our patients, our associates and our partners, as I had mentioned earlier, and it's important that we listen to all of them in order to define the role that we play in society. The next slide, please. Now as many of you know, this is our fourth materiality assessment. And the valuable insights that you have all provided us with have informed our approaches for the last 20 years. If you go to the very left of the slide here, then many of you may recall that 20 years ago, there was almost a dichotomy between maximizing the business revenues and then doing philanthropy or some specific programs on the side. And over the last 20 years, we have made steps to further integrate all of this and to make sure that we bring ESG, environmental, societal and governance topics very closely into the corporate strategy. And as Patrice had mentioned, the recent change that we have made in how we operate as Novartis has further informed that. But it's important that you see themes that have come about in previous materiality assessments like the necessity to work more broadly in the community, which gave rise to Healthy Family programs, the access theme, which came out in the second materiality assessment, very loud and clear that give rise to our Novartis Access portfolio to local innovative brands in low and middle-income countries and culminated end of 2017 in the Novartis Access Principles, which holistically define how we ensure access to innovation. And then further beyond, just in the last 2 years, we have, as many of you know, taken a very different approach for our strategy and our approach in sub-Saharan Africa, where we prioritize patient reach over any other performance indicator or the ESG bond that was just issued a few months ago, which, again, very closely brings ESG targets to the financial performance and Samir Shah will allude on that a little further. But it's now important that we move from taking a reactive approach to health systems challenges to more proactively shaping systems and solutions. And our recent programs that we have started, for instance, in sickle cell disease exemplify that. I think it's also important to see materiality assessment as, I would say, the next level of granularity of the Sustainable Development Goals, which to us serve, of course, as a proxy for the expectations of the international community, but we need to go deeper. We need to be much more specific for us to ensure that the input becomes meaningful and that we can play the role in society that society expects from us. Next slide, please. Now here, I would like to reassure you that the output of materiality assessment or your input really informs our conduct across the value chain. And if you start with divisional and functional processes, just to give one example that the materiality assessment that we recently did in procurement, for instance, informed our third-party risk management process and has now become a standard corporate approach. Risk management certainly benefits a lot from the input that we get out of the materiality assessment all the way to annual corporate strategy. And I can assure you that the Novartis Executive Committee, but also our Board of Directors is very interested in receiving this feedback and takes full ownership as we implement it in our operations. I'll stop here with this brief introduction and now have the pleasure of handing it over to Samir Shah, our Global Head of Investor Relations. Over to you, Samir.

Thank you very much, Lutz, and good morning and good afternoon to everybody who's joining us. We really appreciate the time that you've actually taken to participate in today's webinar. If you could move to the next slide, please. Apologies, yes. So in this slide, what we've tried to do is to actually look at what determines a company's valuation. I think most of you will be familiar with the classic inputs into what actually raises the value of a particular company. Essentially, these are increasing the expected growth of the company, increasing the length of the growth period, increasing cash flow and reducing the cost of capital. So translated into a health care company, it basically means driving our launches for the top line growth, means operational excellence for the bottom line growth. And it's actually delivering on our pipeline, which actually relates to maintaining a sustained growth period. Last but not least is ES&G. And from an ES&G perspective, most people think of it in terms of reducing risk, and therefore, reducing the cost of capital. However, the ESG framework is much more encompassing than that. You can imagine it would influence the other 3 factors as well. For example, diversity itself leads to better decision making. I just want to go very briefly on to ESG with the next slide, please. And here, we've actually outlined some of the principles we have in Novartis with respect to ES&G. First and foremost, which is the subject of this webinar is materiality analysis. Everything starts with materiality analysis because that defines the most important ES&G-related factors which a company should focus on. The second principle from an ESG perspective is, it needs to be integrated into all our functions. So it should not be an afterthought or have we done this or that from an ESG perspective? It's just a part of the routine business. The final point, which I did want to point out with respect to ESG is, it's great that ESG scores have improved for Novartis. But for us, it's not our objective to get high ESG scores. We think that these will follow if we do the right thing. So as an example, we have had increasingly better scores on MSCI Sustainalytics and many other indices, including the recently announced Access to Medicine Index, where we came second amongst our peers, which is great, but that's not our direct objective. So it's all about materiality analysis. So if you go into the next slide, please. In terms of materiality analysis, this is actually a huge subject and it's fundamental to determine the relevance of the different ESG factors. As an example, and I think you all know this, there are 17 Sustainable Development Goals. And underneath these, there are 169 targets. We can't possibly focus on 169 targets, which is why we do the materiality analysis to work at which ones we should focus on for maximum impact. And that's what the materiality analysis is all about. And if we go into the next slide, we mentioned that we have done 4 analyses. The last one took place in 2017. The results from our analysis of going to internal, external stakeholders is shown on the left-hand side. And we use that as the basis to determine our ESG strategic pillars, which is shown on the right-hand side of the chart. And these are ethical standards, pricing and access, global health and corporate citizenship. Next slide, please. Now we talked about materiality and talked about materiality analysis. How the way we think of it is perhaps materiality analysis is much more the question of what is the use of the ESG data and what's the purpose of the ESG data. And that's how we think about materiality. And in this regard, there should be no surprise that materiality, therefore, depends upon the stakeholder. And from an investor relations perspective, our stakeholders are asset managers, investors, hedge funds, pension funds, but you have all the other stakeholders who are important and which were alluded to by Lutz. Because we're trying to work out what the purpose of the ESG data is, it also depends very much on the geography and obviously changes with time. So what's material today in 2021 is clearly different from what was material when we last did our materiality analysis back in 2017, pre-COVID, pre-Black Lives movement, et cetera. And this explains -- because there are so many dependencies, it explains why materiality is sometimes seen as both the most as well as least consensual term in terms of ESG investing. And here are some different quotes from our investor relations stakeholders in terms of what materiality means. And you can see, it's very, very different depending on who you actually talk to. And that's just in the investor relations world. Imagine what happens when you talk to associates, third parties, patient association groups, et cetera. Next slide, please. Because of this difference in terms of terminology and what materiality actually means, it's super important for us to have a very robust methodology. And the Novartis approach, which Carrie will talk about in a little bit more detail, takes into account the varied inputs from all the different stakeholders. It takes into account geography and it's time relevant. We begin with what's termed desk or secondary research. And with that, we have a number of medical journals, analyst reports and other research articles which we analyze. There's 180 articles which we are analyzing or have analyzed. And from that, we work at the most relevant questions to ask for the primary research. And that's why we do the quant and qualitative research with you, the stakeholders. The stakeholders are both internal and external. It's also important to note that we do the materiality analysis locally as well, and that's important from a geography perspective. The other aspect which we also take into account is, we do, do forward-looking scenario analysis to make sure that the materiality is relevant for different scenarios which may occur in the future. Next slide, please. The work of George Serafeim was also very interesting. And he published this in the Harvard Business Review, in fact, only last year during the October, November time frame. And what this shows is, if you think about a company's share price or its impact, it's maximized when you actually focus on material issues. So if you look at the chart on the right-hand side, this shows how companies who focused on either material issues or immaterial issues did in terms of either share price or impact. The first clear point is, if you focus on material issues, i.e., on the top part, you did better than if you focus on immaterial issues. What's even more surprising though is, if you focused on both material and immaterial issues, you did less well than if you solely focused on material issues from an ESG perspective. That's perhaps due to the fact that you may be diluting your efforts if you try and do 170 things as opposed to the most 8, 9 or 10 relevant ones. So that's the work from George Serafeim and again emphasizes the importance of materiality. Next slide, please. I just wanted to finish off in a way with a practical example and also refer to the works of Mariana Mazzucato. Many of you will know her. She's an Italian economist. And I'm very grateful to my son for referring me to her, her works and her talks as well as the books she's actually written. It's probably no surprise to those of you who know her, but it was a surprise for me that she actually talked about the virtues of stakeholder capitalism over a decade before the CEO Roundtable came out with their statement in 2019. Of the many meaningful suggestions she has, she had a couple of quotes, which I've just highlighted on the left-hand side of the chart. She said, everybody talks about purpose and stakeholder value. But if you really want to make purpose and stakeholder value come alive and really want to drive it and make it happen, it needs to be at the center of systems and needs to be integrated into the business. You need to have targets that are mandatory as opposed to voluntary, and they should be conditional. Mariana then goes on to say that it's important to have a symbiotic innovation ecosystem, where she was actually talking about the private and public sector, but it's equally applicable to any other 2 parties. And here, I wanted to give you the example of the Novartis' sustainability-linked bond. And we've encapsulated a lot of what she said are the basic principles, sometimes fortuitously, sometimes deliberately. And the sustainability-linked bond was issued last September. It was issued by our treasury department, which goes to the heart of what she says, which is that it has to be integrated. ESG has to be integrated within the business. In terms of the sustainability-linked bond, we had KPIs which were based on our materiality analysis, so they were linked to access to medicines and global health. The next aspect was conditional. So we had to step up if we didn't meet the targets. The third aspect is, it's mandatory. So the targets which are included in the access to medicines and the global health targets are also a part of the CEO balanced scorecard and his remuneration. And the final point, which is sometimes missed, is the symbiotic ecosystem, where bond buyers are, to a certain extent, partnering with the company to do good in terms of bringing this access to medicines. So the work of Mariana Mazzucato, if you haven't read her book, The Value of Everything or the Mission Economy, thoroughly recommend that you perhaps have a chance to look at it. In the final slide, which I'm going to show, I just wanted to say that the Novartis in Society Report was published on the 26th of January. It covers our key 4 areas from a materiality perspective and our key performance indicators by those specific ESG pillars. And with that, I'll hand the call to Carrie.

Thank you, Samir. My name is Carrie Scott, and I'm leading our newly created ESG Management Office, which was created to ensure that, number one, we are fully embedding our ESG targets, the ones that Samir was just alluding to, and our goals into our operations. And number two, to look ahead and set a 5-year strategic road map to keep our approach relevant and meaningful. We've talked a lot in this session so far today about the importance of materiality assessments in helping us understand those relevant issues along our entire value chain to help us manage better our ESG impact. Next, we want to talk about where we're heading in our 2021 materiality process. And this is an exciting moment. As we all recognize, society is tangibly transitioning from shareholder to stakeholder capitalism. Expectations are changing for Novartis, for our customers and our own associates, and we're keen to hear from and learn from you. So I'm going to start off with a very short 2.5-minute video about our process. And then when that video is over, we'll talk about the next steps that are kicking off this week. So Denise, can we show the video.

To build trust with society, we need to understand societal expectations and showcase how we live up to them. Novartis has a long history of conducting materiality assessments, fostering a systematic dialogue with our key stakeholders, such as patient representatives, customers, suppliers, investors, peers, regulators and other partners. Materiality assessments help us identify what matters most to these stakeholders and how we impact their lives and livelihoods. Understanding the relevant issues to our business along our entire value chain allows us to manage our financial, environmental and social impact. Hence, we can deliver greater benefit for all our stakeholders. Our materiality assessment follows a multi-step process that includes 3 major elements: identifying key stakeholders, collecting quantitative feedback from them and gaining qualitative insights through interviews. We first conduct a holistic stakeholder analysis, targeting internal colleagues across all divisions and functions along with external stakeholders from all relevant categories. Hereby, we make sure to include multinationals as well as smaller organizations in the nonprofit space. Next, we collect quantitative insights through an online survey. In this survey, we ask our stakeholders to rate a set of relevant issues according to the importance of each topic. In addition, they tell us how we perform in each of these issues. The results of the quantitative assessment show us the relative significance of each issue overall, but also for each stakeholder category. Then we conduct interviews and workshops with survey participants to learn why these issues are perceived as important. These qualitative insights are essential to inform our strategy and help us allocate our resources to the most important issues tailored to the context within which we operate and the assessment took place. Besides building strong relationships with our stakeholders, materiality assessments help us to identify what matters most, so that we can make better business decisions, improve our communication and strengthen trust with society.

Thank you. Great. So now we can go to the next slide. So a few words about our process overall. On the QR code here is also a link to that video, if you would like to share it or watch it again later. So now we wanted to say a few words about our process overall. We actually already kicked off at the end of 2020 with our desk and secondary research to build the study and the process to identify the stakeholders internally and externally. We aim for an inclusive sample across stakeholder groups of NGOs, of private and public organizations and of roles, customers, suppliers, regulators, patients, as a few examples. Now as of today, we're entering now Phase 3 and 4, which is the quantitative and qualitative pieces of the survey. Later on this year, in Q2 and Q3, we will have the analysis interpretation and then make the report available for our management, but also share it as in previous years with more people. On the next slide then, just to zero in on what's happening here this week in Phase 3 and in 4. Beginning this week, the survey will be available beginning today to our external stakeholder groups and will roll out throughout this week to include the internal stakeholders as well. The study will run through the end of March for the external stakeholder input, the end of March. And then in Q2, we will enter process step #4, where we will hold a number of qualitative interviews to better understand the context of some of the themes we'll pick up in the quantitative work. We thank you in advance. A big thank you from our full team for participating in the survey that's launching today and throughout this week. Your views are important to us and will help us really define that 5-year strategic road map I mentioned before. But of course, the input is only as good as the input we receive from you. So thank you very much in advance for taking the time to let us hear from you. And now with that, I'll hand it back over to Jeff for the Q&A.

Thank you, Carrie. Well, I want to thank all of our speakers for a really fascinating review of how Novartis is looking at these issues. And we have a number of questions that have come up already, and let me just start us off. The first question to go back to, right back to Patrice Matchaba. Patrice, what are some of the differences between shareholder and stakeholder capitalism? And why does Novartis believe so strongly in the latter?

Thanks, Jeff, and thanks for the person who fielded that question. Well, in our industry, if we think about it, right, so we are given a license to discover medicines. And we're the only ones who are given a license to actually experiment on human beings. That responsibility is not a pure shareholder responsibility. It's a responsibility and accountability to humans. And it's important that we consider all stakeholders. We know for a fact that it is possible to be extremely profitable, but practice child labor, slavery in different parts of the world and not even have a diverse population working for you. We know, for example, also that it's possible to be profitable in the fossil fuel industry and not take into consideration the damage to the climate. So this is important. Now for us, it's important also because it is captured, as Lutz said, in our mission, vision and purpose. There's 3 components to it. So we talk about discovering breakthrough medicines to improve and extend life. That's the first one. So that's our innovation mandate that we have to do. The second piece I want you to remember is that we go on to say, and we find ways to make our medicines available to as many people as possible. That is the access piece. We need to find models and products that can be accessible to people all over the world, low income, middle income and upper income, within a timely period. The third piece in our mission and vision, we go on to say, we will use science and technology to solve some of the world's challenging global problems. Now you know that we've defined 4 key challenging areas. You know about our work in malaria, our work in leprosy and our work in Chagas disease and then sickle cell disease. All these areas have lacked innovation power to finally eliminate them. So stakeholders are important, just like our shareholders, but in our industry, even more so, we owe this to society. Thanks, Jeff.

And thank you for that response, Patrice. A related question that's come up is whether you have begun to think about ways of shifting your approach to the U.S. market given the impact of COVID-19 over the last year. And given that you have a new area of responsibility in that area, I wondered if you might want to say a few words about that.

Thanks, Jeff. And this is now my responsibility. So what we have seen with COVID. We've seen a disproportionate impact on black, brown and native Americans and people of low income, irrespective of race. And the question we have to ask ourselves is, why is that so? And what is our role as an innovation pharmaceutical company to ensure that the next time we have a pandemic or a recession that we don't see this differential impact because it brings us all down when parts of our community are impacted. The second thing we've seen is that there isn't trust in the system or the health care system or the innovation, so the whole topic about vaccine hesitancy. And then fundamentally, again, we have to answer the question, why is that the case that certain parts of the communities in the U.S. do not trust the health care system. And we need to do a better job of looking at diversity and inclusion by looking at, does our portfolio cover diseases of high burden in these communities. Do we have the right number of investigators from these communities? Do we have all the patients we need proportional in terms of population and race in our clinical studies. Because without data, without disease burden data, we can never generate the kind of trust and the kind of products that are useful to those communities. So that is really important. Then finally, the question of human capital development. It is important that we integrate people of color into our research and development enterprise so that they can also be part of generating their own information and providing solutions and research agendas that address the topics or the diseases that are high burden treated. So at Novartis, we will do our part going forward. And I'm sure that elsewhere as an industry would do so. Just lastly, I think Larry Fink captured it quite nicely in his letter to the CEOs for last year, 2020, '21. Two issues come up, climate, climate, climate, climate. Climate is an existential threat to all of us. So we need to look at our company and see, are we doing less harm and can we be positive in terms of climate. The second piece that Larry Fink picks up on here, which is specific to the U.S., is the issue of integrating racial diversity into our ecosystem and value creation. Thanks, Jeff. Jeff, I hand over to you.

Those are both very important points, Patrice. Thanks so much. Let me turn to Lutz next. And this really expands upon what Patrice was just saying with respect to the issues in the U.S. environment and with concerns like climate. But one of the points that you made during your presentation, Lutz, was that Novartis is no longer just reacting to health care challenges, but you're trying to transform health care proactively by shaping systems and solutions. Could you give us an example or 2 of how you're doing that and how this work on materiality assessment is related to that objective?

Yes. Thanks very much for the question. I think first, it's important again to highlight that the outcome of the materiality assessment ultimately helps us to define areas where we can be of greater service to society at large, and then become a better corporate citizen because we can, of course, consider those things, and we do this on an ongoing basis ourselves. But anyone who thinks about their own approach, you may have certain blind spots. And I think this is where really the materiality assessment and the input from a diverse slate of stakeholders really helps us look at this holistically. And then we have seen that the more we innovate, the more it becomes demanding on health systems to make sure that those innovations can be used in the best interest of the communities that they serve. And what we've also seen is that even if you lower the price and you give these medicines, in some instances, even for free, it doesn't mean that they can be deployed to the benefit of patients if the health care system doesn't support this. And a recent example where we have seen this is in sickle cell disease, where we have an advanced therapy that is disease-modifying and really helps people live with this condition and potentially bridge the time until we have curative gene therapy available. But if you then consider that 80% of those patients live in sub-Saharan Africa and lack access to basic health care, that the disease is not being diagnosed through newborn screening, that fundamental approaches first-line treatments are simply lacking, then you have to go several steps back from your initial challenge to bring cutting-edge technology into these countries and work with partners to help strengthen this health system and to create an ecosystem that ultimately has the absorptive capacity for this innovation. And that's what we are increasing the focus on. I think also the COVID-19 crisis now has mainly showed how fragile health systems are, and this is no longer, as we all know and experience, limited to the so-called developing countries. And here, we have to look at those challenges and opportunities holistically, and that's where the stakeholders and their expectations really matter in order to inform us how we can do, how we can take our approaches in a more meaningful way. Hope that has answered the question. Back to you, Jeff.

Yes. No, thanks so much, Lutz, for that explanation of how you look at these issues. It was very helpful. I wanted to go back to Samir's, one of the questions that Samir raised. And this really has to do with a general question about looking at this from the point of view of investor relations. And I'll just put the question bluntly. Can you explain to us how Novartis' ESG importance is relevant to sell-side analysts and shareholders. That's often a question that comes up. And I think our listeners would be interested in your response.

Thank you very much, Jeff. I think I'd rather put it the other way around. It's very important to the shareholders themselves, which are the buy side and which are the portfolio managers because ESG is now used as a key factor in terms of the valuation of a company as well as the investment decision making. And we have lots of different research which suggest that nearly all portfolio managers have an ESG factor. The sort of methodology which they use is either ESG integration, which is the most common. The other rapidly developing area is called impact valuation, which is also incorporated into the investment decision for a particular share. And then the final example, which a lot of people used to use in the past was what's termed exclusionary or in terms of controversy. And that's how the old way of looking at ESG used to be, which is that if you've performed badly in certain parameters, then they'll give a discount to the valuation. Now that's still a part of the case, but much more they're now looking at the positive impact as well. So in simple terms, a sell-side needs to look at it because his clients, the buy side, use ESG and incorporate it into their investment decision-making in terms of trying to work out the valuation of a company.