Novo Nordisk A/S (NYSE: NVO) is a large-capitalization, global healthcare company and the world's leading provider of products for the diabetes care market. The Danish company is also the closest thing to a pure play in the diabetes therapeutic category, deriving some 78% of total sales from that arena. Its common equity, which is traded in the United States as ADRs (American Depository Receipts), has been one of the best performers over the past 15 years, generating total returns of roughly 1,100%. This extraordinary showing reflects some eye-popping numbers concerning both the company and its primary target market. With respect to the former, Novo has compounded per-share sales, earnings, and cash flow by 14.6%, 20.3%, and 18.0%, respectively, over that extended time period. The number of diabetics, meantime, is rising rapidly, with the current estimated total of 371 million projected to approximate 550 million by 2030. Significantly, too, even though Novo Nordisk is the leader in a sector that has few players (albeit expanding), it reaches only about 23 million patients, which underscores the substantial long-term growth potential still remaining.
Providing some color to the numbers outlined above, the company has grown sales through the introduction of new products, entry into new geographies, and organic growth in the overall market, consisting of both expanding numbers of diabetics and those receiving treatment. The operating margin, meantime, has widened by some 12 percentage in the past decade, reaching 37.8% in 2012, enhanced by economies of scale, efficiency gains, and an improving sales mix. Below the operating line, the bottom line has benefited significantly from a roughly 10 percentage-point reduction in the effective tax rate and a 27.8% shrinkage in the number of shares outstanding; share profits increased every year but one (in 1999) since 1997, while the number of shares outstanding fell every year but one (2001). Novo has also increased the annual dividend distribution every year since at least 1997, growing it at a compound annual rate of 28.2%; it was raised by 29% (to 18 Danish kroner) earlier this year. Importantly, even though the blue chip has returned tens of billions of dollars to stockholders in the form of dividends and share repurchases, the drug maker has rock-solid finances, with the 2012 yearend balance sheet showing shareholder equity of US$7.2 billion, zero long-term debt, and short-term debt of only US$88.3 million.
Valuations on Novo ADRs are higher than those of every stock we've recommended to date, despite setbacks to the company's most advanced new-drug prospects that hurt the equity earlier this year (discussed below). It's also important to note that the diabetes-care terrain is becoming rougher as new players enter the large market, products lose patent protection, and cash-strapped governments exert pricing pressures. That said, valuations are largely in line with where they've been for most of the past decade and the company probably has better long-term growth prospects than most of Corporate America. Indeed, valuations look quite attractive on a relative basis, considering the probability that second-quarter results, which are just starting to roll out, will show continued flattish- to- low-single-digit year-over-year earnings growth. All in all, we think these high-quality ADRs will provide double-digit percentage annual total returns over the long haul. Our three-to-five-year price targets are $240-$295, based on a profit projection of $12.80 a share.
(Note: Our financial discussion of Novo Nordisk covers both U.S. dollars and Danish kroner to take into consideration the facts that "foreign" sales are translated into kroner for the company's reporting purposes and the vast majority of trading in its shares is conducted in Denmark. There is very little institutional research coverage of this relatively unknown issue in the United States and trading volume in the ADRs is very light, averaging little more than 300,000 a day.)
Novo Nordisk A/S is a global healthcare company and the world leader in diabetes care, with a global value market share of 26%; this includes 49% of the total insulin market and 46% of the modern insulin market, as measured in volume. It has one of the broadest diabetes product portfolios in the industry, including both an advanced portfolio of modern insulins and a human once-daily GLP-1 analog. The company also has a leading position within hemophilia care, growth hormone therapy and hormone replacement therapy. Bagsvaerd, Denmark-headquartered Novo Nordisk traces its origins back to 1923 but the current version was formed in 1989 by the merger of two Danish enterprises, Nordisk Gentofte A/S and Novo Industri A/S, both of which got their start producing and selling insulin for the treatment of diabetes. The company has more than 35,000 employees in 75 countries and markets its products in 180 countries.
The large healthcare concern operates in two business segments - Diabetes care and Biopharmaceuticals. In the insulin market, the main competitors all over the world are Eli Lilly (LLY)and Sanofi (SNY). It also competes against small local companies but they don't pose much of a threat, primarily offering older-generation products. In the relatively small biopharmaceuticals business, Novo Nordisk faces competition in some markets from producers of biosimilar medicines, human growth hormones, for example, but they haven't had a huge impact yet. As of December 31, 2012, the Company marketed its products in five reported geographical regions, namely North America, Europe, Region China, Japan and Korea, and International Operations.
Diabetes Care (78% of '12 revenues; 76% in '11)
The Diabetes care business provides a wide range of products, including (durable and disposable) insulin pens and needles, such as FlexPen, NovoPen and FlexTouch, and diabetes medicine, such as insulin, GLP-1, other protein-related products (glucagon, for example), and oral anti-diabetic drugs. It's also developing a product that targets the huge obesity population. Segment sales totaled 60.9 billion kroner in 2012, up from DKK50.4 billion in 2011 and DKK45.7 billion in 2010. Modern insulins, which consist of NovoRapid/NovoLog (DKK15.7 billion), NovoMix/NovoLog Mix (DKK9.3 billion), and Levemir (DKK9.8 billion), are Novo Nordisk's largest top-line contributor, accounting for 44.6% (or DKK34.8 billion) of 2012 companywide revenues and 57.2% of total segment sales. Last year's tally represents year-to-year growth of 21.1% and 8.1% from 2011 and 2010, respectively. Human insulins are the company's second largest contributor, totaling 11.3 billion kroner in 2012, 10.8 billion in 2011, and 11.8 billion in 2010 but, as the numbers indicate, this category has stagnated, in favor of the modern analogs. Significantly, sales of Victoza, a GLP (Glucagon-like Peptide 1) that was launched in 2009, are ramping up strongly, rising from DKK 2.3 billion in 2010 to DKK6.0 billion in 2011 and DKK9.5 billion last year. Other protein-related products, meantime, added 2.5 billion kroners to 2012's top line, while oral anti-diabetic products chipped in another 2.8 billion kroner; the totals of these two product lines weren't all that different from the previous two years.
Victoza is from a new class of diabetes treatments, a human GLP-1 analog with 97% similarity to the natural gut hormone. It's administered once daily and works by stimulating the beta cells in the pancreas to release insulin only when blood sugar levels are high. It has been launched in 62 countries, the U.S. and Japan in 2010 and China in October 2011. The drug, which quickly became the leading GLP-1 treatment globally, is approved for adults with type 2 diabetes who are unable to achieve blood glucose goals with lifestyle changes and metformin, the most widely used tablet for type 2 diabetes. NovoRapid (NovoLog in the U.S.) is the world's most widely used rapid acting insulin (RAA) for use at mealtimes. It's used by people with both type 1 and type 2 diabetes. NovoMix (NovoLog Mix in the US) is a dual-release modern insulin that covers both mealtime and basal requirements. It can be used either to initiate or intensify insulin therapy and is primarily used by people with type 2 diabetes. Levemir is a soluble, long-acting modern insulin for once-daily use for people with type 1 and 2 diabetes.
Biopharmaceuticals (22%; 24%)
The biopharmaceuticals segment covers the therapeutic areas of hemophilia, growth hormone therapy, hormone replacement therapy and inflammation. Novo Nordisk entered the hemophilia market in 1996 when it introduced NovoSeven for the treatment of hemophilia patients who form antibodies against traditional treatments. Sales of NovoSeven totaled 8.9 billion kroner in 2012, up from DKK8.3 billion in 2011 and DKK8.0 billion in 2010. Management's goal is to move from this niche into the main segments of the hemophilia A & B market and achieve leadership by developing improved treatment options for all patients. In October 2012, turoctocog alfa - a recombinant factor VIII therapy - was filed for approval in Europe and the United States. Moreover, long-acting versions of recombinant factor VII and factor IX are in phase 3 development. Norditropin, a liquid growth hormone, is the second-largest top-line contributor in the biopharmaceuticals segment, with sales of DKK5.7 billion, DKK5.0 billion, and DKK4.8 billion in 2012, 2011, and 2010, respectively. Vagifem, a hormone replacement therapy for menopausal symptoms added DKK2.16 billion to last year's revenues, while other products chipped in another 345 million kroner. The company currently has no products marketed within inflammation but has a prospect for treating rheumatoid arthritis in phase 2 clinical studies.
Hemophilia is an inherited or acquired bleeding disorder that prevents blood from clotting. An estimated 400,000 people worldwide are living with severe or moderate hemophilia. The global hemophilia drug market is estimated at DKK 50 billion and has grown by around 8% annually in recent years.
A Huge and Growing Diabetes Market
According to the International Diabetes Federation, the number of people with diabetes approximates 371 million. Changes in lifestyle and consumption habits have spread the disease to all corners of the world and the total number is expected to reach 550 million by 2030. There are an estimated 26 million diabetics in the United States, 32 million in Europe, and 91 million in China. Affluent Japan and Korea also have a relatively large proportion of their populations suffering from the disease, with a combined total of 14 million people. The global market for diabetes care products is correspondingly large, aggregating approximately US$40 billion in 2012. Various insulin products account for about 49% of the total, oral diabetes products 45%, and GLP-product 6%. The market has grown at a roughly 10% rate annually in recent year and should approach $70 billion by the end of this decade.
Diabetes is a serious, lifelong condition that is associated with long-term complications such as blindness, heart disease and stroke, kidney failure, amputations, and death. It is a metabolic disorder characterized by the body's inability to properly break down the foods we eat into glucose, which is the main source of energy in our bodies. Insulin, a hormone produced by beta cells in the pancreas, normally regulates the body's glucose levels, but in people with diabetes, insufficient levels of insulin are produced (type 1), or the body fails to respond adequately to the insulin it produces (type 2). The result is an abnormally high build-up of glucose in the blood, a condition called hyperglycemia.
The primary treatment for type 1 diabetes is daily intensive insulin therapy. For type 2 diabetics (about 90% of the total), the treatment initially takes the form of lifestyle intervention (diet and exercise) and non-insulin oral medications. Eventually, however, most will require insulin therapy. The currently available insulin products have limitations, including: risk of severe hypoglycemia (excessive insulin); weight gain; inadequate post-meal glucose control; the need for complex titration of insulin doses; and the need for multiple injections daily. Because of these limitations, patient compliance with prescribed treatment regimens is low, and the disease is often undertreated. One challenge in managing diabetes with insulin is to maintain appropriate blood glucose levels, adjusting insulin dosing as necessary to balance the impact of food and exercise and to avoid low blood glucose levels (hypoglycemia), which, if untreated, can lead to seizures or unconsciousness.
Novo Nordisk is the leader in the market for diabetes products, with a global market share of 26%, in dollar value. The Danish company is also the closest thing to a pure play in the diabetes therapeutic category, deriving some 78% of total sales from diabetes care products. The other major players in the category are France-based Sanofi, which markets Lantus, the top-selling branded insulin product, with sales of US$6.5 billion in 2012 (up 19.3% on a constant currency basis), and U.S.-based giants Merck (MRK) and Eli Lilly. Oral medications Januvia and Janumet contributed US$4.1 billion and US$1.7 billion, respectively, to Merck's top line last year, while injectable insulin Humalog added US$2.4 billion to Lilly's sales, and Humulin another US$1.2 billion; Humalog lost market exclusivity earlier this year.
An Extensive Geographic Presence
Novo Nordisk's insulin and other pharmaceutical products are marketed and distributed through subsidiaries, distributors and independent agents with responsibility for specific geographical areas. The company's most important markets are North America, China, Japan and the major European countries. In addition, there is an increasing contribution to Novo Nordisk's total sales from key markets in the "International Operations" sales region, such as Algeria, Argentina, Australia, Brazil, India and Turkey, which has an estimated combined total of 197 million diabetics. In 2012, North America accounted for 43.8% (or DKK34.2 billion) of aggregate revenues. Europe was a distant second, with 25.2% (DKK19.7 billion), and International was in third place, with 14.2% (DKK11.1 billion). Bringing up the rear were Japan/Korea and Region China with 8.5% and 8.2%, respectively. The North American, International, and Chinese markets are growing at rapid rates, but contributions from the European and Japan/Korea sectors have stagnated, hurt by a combination of austerity programs, pricing pressures, and relatively mature markets. Sales in North America increased by 19.2%, 17.9%, and 22.4%, in 2012, 2011, and 2010, respectively, on a constant currency basis. The introduction of Victoza certainly helped, as did America's general willingness to pay a premium for new products. Underlying sales growth in China was almost as impressive (up 16.3%, 11.7%, and 19.9%), reflecting that nation's increasing prosperity, which is closely correlated with healthcare expenditures. International Operations also grew at double-digit rates (in constant currencies) in each of the past three years (16.2%, 17.1%, and 22.3%), supported by awareness programs, improved training, and better availability of medical products.
Novo Nordisk allocates about 14-15% of revenues to research and development activities, with a focus on therapeutic proteins within insulin, GLP-1, blood clotting factors, human growth hormone, and inflammation. This amounted to 10.9 billion kroners in 2012 and 9.6 billion in both 2011 and 2010. At the end of 2012, the company had a dozen diabetes products in either clinical studies or awaiting regulatory action. The most advanced of the 12 are Tresiba and Ryzodeg, which are already approved for marketing in the European Union, Japan, and Mexico but failed to get the U.S. Food and Drug Administration's clearance earlier this year (discussed below). Also in late-stage (phase 3) development is Liraglutide, which is being studied as a possible treatment for people with severe obesity, including those at particular risk of developing diabetes. The biopharmaceuticals R&D program also has 13 new-drug prospects in either clinical trials or awaiting regulatory action. NovoThirteen, for treating congenital FXIII deficiency, has been launched in the EU and Canada but is awaiting marketing authorization in the U.S. and several other countries. Turoctocog has also completed all studies and has been submitted for marketing authorization in all of the major markets.
The primary goal of Novo Nordisk's research in diabetes is to discover new therapies that safely and effectively lower blood glucose while reducing the risk of low blood sugar (hypoglycemia). Tresiba and Ryzodeg are the latest fruits of this effort. Tresiba is a once-daily basal insulin analog with an ultra-long duration of action and a flat and stable action profile that reduces the rate of hypoglycemia, which also makes it possible to adjust insulin dosing time when needed. Ryzodeg is a soluble insulin combination of Tresiba and NovoRapid (insulin aspart), which provides both basal and mealtime glucose control. The early sales data on Tresiba in the markets where it has been commercialized is very encouraging, but Novo received a complete response letter (CRL) from the FDA in February for both Tresiba and Ryzodeg, in which the company was told that it needs to conduct a dedicated cardiovascular outcomes trial before reviews of the drugs can be completed. As such, it's impossible to know at this juncture when, or indeed if, these long-acting insulin products will be introduced to American diabetics. The CRL triggered a sharp sell-off (14%) in the price of Novo ADRs from which they have yet to recover.
Some patents on several key Novo products have expired or will expire within the new few years. The implications of these expirations aren't that simple, though, for myriad reasons. Some products, for instance, are often protected by multiple patents. Moreover, those based on recombinant DNA technology can be either difficult to copy or be covered by process and manufacturing patents. The drug compound patent for NovoLog/NovoRapid, the company's largest-seller (DKK15.7 billion), has already expired in Japan and in Europe. As well, it's slated to expire in December 2014 in the United States. In addition to the drug compound patent, however, the company holds a formulation patent on the product that provides coverage until 2017 in all major markets. The U.S. drug compound patent on NovoLog/NovoMix, another large seller, expires in December 2014. As with NovoLog, though, a formulation patent will provide exclusivity through June 2017.
The picture isn't all that different in the biopharmaceuticals segment. The drug compound patent on NovoSeven, which generated sales of DKK 8.9 billion in 2012 and DKK 8.3 billion in 2011, has expired in all major markets. But two formulation patents on the room temperature stable preparation are expected to provide cover through 2023/2024. The complexity of the molecular structure of NovoSeven is also keeping potential competitors at bay, as is the complex regulatory pathway for "biosimilar" coagulation factors. The drug compound patent on Norditropin has also expired, but it is covered by a formulation patent that expires in 2017 in the U.S., Europe, and Japan. Moreover, the pen devices that patients use to inject the growth hormone are covered by separate patents.
A Phenomenal Track Record
Despite a challenging economic backdrop, Novo Nordisk performed admirably in 2012, posting improved results across virtually all product lines and geographic markets. Indeed, other than the small "other products" category, which saw a 27% sales decline (to DKK324 million), all products and geographic markets recorded better results. All told, revenues soared 18% (to 78.0 billion kroner) on a reported basis and 12% measured in local currencies - reflecting strong demand for some of its key products. As in 2011, the products behind most of the growth were the once-daily human GLP-1 analog Victoza and two of the modern insulins, NovoRapid/NovoLog and Levemir. The solid top-line advance supported an incremental expansion in the operating margin, which, in turn, fueled a 25% surge in total profits. Factoring in management's continued repurchase of company stock, the bottom line advanced a whopping 30%, to DKK38.85. Translated into U.S. dollars, revenues increased 19.3%, while profits rose 27.1% and share net surged 31.5%.
Incredibly, Novo's superb performance in 2012 isn't particularly out of the norm in the company's history over the past 15 years or so. Revenues, for example, have increased from US$2.5 billion in 1997 to US$13.8 billion in 2012, representing an annual compound rate over that lengthy period of 11.0%. The results are even more impressive when viewed on a per-share basis, which is relevant considering the large number of shares that Novo Nordisk has bought back over the years (207.7 million shares, or 27.8%). On a per-share basis, revenues compounded at a 14.6% rate, while earnings and cash flow compounded at 20.3% and 18.0%, respectively. In addition to buying back its common equity, the company increased the yearly dividend distribution at a rate of 28.2%. The performance was achieved through the introduction of new products in an expanding number of geographic markets, and enhanced by a rapidly growing market. It was further supported by benefits accruing from economies of scale and efficiency gains.
Off to a Strong Start in 2013
Novo Nordisk reported a 13% year-over-year increase in March-quarter revenues, 14% in local currencies. As was the case throughout 2012, the top-line advance was fueled by vigor in Victoza (up 35% in Danish kroner) and modern insulins (up 14%), particularly NovoRapid (up 14%) and Levemir (up 17%). The North American market continued to pace the gains, with an increase of 23%. The company also reported advances of 28% and 32% in net profits (to DKK6.0 billion) and earnings per share (DKK10.98), respectively. Profitability was aided by a comparatively modest increase in both R&D expenses (up only 6%) - given the timing of (and expense) certain clinical trials - and administrative costs (up 3%), which combined to add 1.8 percentage points to the operating margin. Significantly, too, the bottom line was enhanced by a net DKK535 million swing in foreign exchange hedging income. In U.S. dollars, Novo posted aggregate revenues of $3.5 billion (up 13%), net profit of $1.3 billion (up 28%), and diluted per-share profits of $1.94 (up 32%).
Looking to the balance of the year, management's guidance for 2013 revenues is growth of 9% to 11% in local currencies and about three percentage points less in Danish kroner. Interestingly, the low end of the range is 1% higher than the guidance provided at the end of January, which was before the CRL on Tresiba and Ryzodeg. Reported operating profits, meantime, are expected to be about 5% above last year's total. All in all, we think the drug maker will earn about $7.40 a share this year, factoring in the swing in hedging gains. This represents a smaller gain than investors have been accustomed to, but it is reflective of increased pricing pressures in various markets, including in the U.S., China, and various European Countries. Costs associated with the launch of Tresiba will hurt earnings, too, as will generic competition to oral anti-diabetic products and generally intensifying competition in the diabetes care arena.
The Long-Term Outlook Remains Bright
Novo Nordisk's long-term targets, which it has been able to achieve consistently over the years, include operating profit growth of 15%, on average, with an aim of boosting the operating margin to 40%; it was 37.8% in the first quarter. The margin expansion is expected to be supported by product mix improvements, productivity improvements, a modest development in administrative costs and scale benefits stemming from sales and marketing. Looking at the broader picture, secular trends that have driven Novo's performance over the past decade will likely persist well into the future. These include changes in demographics globally, namely the increasing proportion of elderly people and the growing problem of obesity, with both contributing to the significant increase in the number of people with diabetes worldwide. The ongoing transition from human insulins to premium-priced insulins and new delivery devices also augur well for the company, which has a leading share in all of its geographic markets. As such, we think share net could compound at a mid-teens annual rate over the next three to five years. Our long-term expectations assume that Tresiba and Ryzodeg receive FDA approval in the outer years of our projection horizon. They also assume that management continues its long-standing practice of regularly shrinking the diluted share base.
The unanticipated setbacks with the two key new-drug prospects in the United States underscores the risks inherent in the R&D-intensive pharmaceuticals sector, highlighted by a relatively unpredictable FDA. That's not all, problems, at least the perception of same, can even occur after a drug has been commercialized, as was amply illustrated earlier this year when U.S. regulators announced that two classes of diabetes drugs - GLP-1 mimickers, taken by almost one million Americans, and DPP-4 inhibitors (1.6 million Americans) - were under investigation over possible risks of pancreas inflammation and cellular changes in the pancreas that occur before cancer. The GLP-1 class (administered by injection) includes Novo's Victoza while the DPP-4 class (pills) includes Merck's huge-selling Januvia. Heightening competitive pressures, from the likes of Eli Lilly, Sanofi, and others, certainly can't be ignored either. Indeed, the other might include small biotech MannKind Corporation (MNKD), which is developing an inhaled insulin product that could pose a substantial threat to Novo's RAAs.
Mitigating the aforementioned concerns are the company's many strengths and the massive (and growing) target market, which is certainly big enough to lucratively support many players. Novo's broad product line is clearly a competitive advantage as its wide geographic presence. Well documented brand loyalty is another huge plus for an enterprise that has large, well-established positions in virtually all markets. The Danish drug maker's prolific cash flow and ample borrowing capacity also afford management considerable flexibility, in terms of boosting growth and earnings through both internal and extraordinary activities. (As we've noted in previous reports, Novo undoubtedly represents a potential, if not ideal, suitor or marketing partner for MannKind.) All in all, Novo Nordisk stock looks attractive for the pull to late decade, especially on a risk-adjusted basis.