Novo Nordisk--new position--working through the complexities of a miracle drug

 NOVO NORDISK

Understandable business.

NVO is an old pharma company that is one of the major producers of insulin used for diabetes. Development work by NVO, lead to the creation of a drug for weight loss as well as diabetes. That drug was semaglutide and the brand is Ozempic. Subsequently, NVO developed a form of the drug specifically for weight loss called Wegovy.

Unfortunately, diabetes is a growing disease with estimates of growth of around 3.3% cagr from 2021 to 2050 driven by obesity and aging. NVO is a leader in this field and is expected to maintain its share of the market. Insulin is quite a complex molecule and commoditization has proven difficult.

Weight loss is a separate growth avenue and a relatively new market. Some forecasters estimate that the market will be $100m rev pa by 2030. NVO is the front runner in this market and has current revenues of about US$10b comprising $8b for Wegovy and maybe $2b for Ozempic being used off-label (non-diabetes).

Due to shortages of the weight loss drug, the US has allowed compounders to use similar products until the supply and demand are more even. Assuming success in NVO and its big competitor LLY halting the imitators' products, volumes should grow strongly. LLY and NVO are expected to dominate market share and are already deploying major capital into manufacturing facilities.

Obesity, as a disease, has proven complex with individual variations common (reactions to the drugs), which means that many variations are expected and NVO and LLY have the resources to fulfil this dynamic. It should be noted that the LLY drugs are proving slightly more efficacy than NVO but the difference is not large and with the leading brand, manufacturing footprint and distribution/GTM, NVO is expected to maintain its share.

Operating History.

Given the above NVO can be considered two companies, firstly the diabetes market which is relatively stable and growing at a sound rate, and secondly the weight loss market which is expected to be high growth. That must be kept in mind when examining historic results and growth numbers.

2024 revenues are split, Diabetes 71% of which maybe 10% is off-label weight loss, Obesity 22% and rare disease (haemophilia) 7%. Over time the obesity share is expected to match or surpass diabetes.

EPS growth on a 5-year roll has been between 6% and 17-21% over the last ten years with the acceleration with obesity coming in the last few years. Likewise, revenue growth has ranged from 2-7%pa 5Y cagr but accelerated to 15-17% post obesity. TA also grew 5-10% cage on a 5Y roll and is now over 20%. That opens up reinvestment opportunities that have not been available for NVO.

GM% history is high and very stable averaging around 84% for the last 10 years. The GM is expected to hold with obesity. ROE again high and stable averaging around 73% for the last 10 years. Note the company is investing significantly in plants for expansion and also acquired Catalent for its production capability and its plants are being repurposed for NVO. That may weigh on ROE over the short term as the producing assets are fully utilised. NPM has averaged 34% with a tight band of 31.4% to 36% over the last 10 years.

FCF reconciliation is excellent and shows possible conservative accounting with 3 and 5-year cashflows being 18% and 14% above declared NPAT.

These numbers are very strong and highlight the potential huge profitability if obesity emulates diabetes in any reasonable way. The future rests with the development of the obesity market and NVO participation in it.

Management

NVO is Denmark's largest company by a significant margin and also one of Europe's largest companies. It is controlled by a benevolent trust that exercises control and is tasked with a mandate of providing a stable basis for the commercial and research activities of the firm. That has set a conservative and research culture that exists to this day. Management appears very conservative and takes their brief seriously, patients first. Management turnover is low and has been promoted from within.

Balance Sheet

As could be expected the balance sheet is conservative. The recent large acquisition of Catelent brings debt to 0.5X EBITDA and NVO can be expected to reduce this quite quickly. The cash flows are strong and research and SG&A expenditures are well covered.

Other

SBC is low in keeping with the European heritage 2%, and amortisation is low around 2% reflecting the emphasis on organic growth.

The 5 year PE range of NVO has been 17X to 35X with an average of 24X

The market is very concerned about the results from each trial, measuring the efficacy of NVO versus the competitors and how the obesity market fragments over time. Regulation remains an ongoing issue and increased competition is expected but as discussed NVO remains an active leader.

CONCLUSION - VALUATION

The base case for NVO at $79 is that earnings will grow at 15% cagr for the next 5 years driven by both obesity and secondly diabetes. An exit PE of 24X is assumed which is the mid-range over the last 5 years, but could be considered conservative given the growing diversity of earnings and tailwinds. A return of 14% is generated with these assumptions and the stock appears attractive at these levels.

Risks are the obesity market disappoints and/or NVO fails to execute in GTM, manufacturing or expanding its competitive portfolio of drugs. All variables will have to be watched.

 

 

 

 

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