Every once in a while one gets a buying opportunity on a specific stock, where the news causing the drop just doesn't look as important as what's being forgotten.
In today's market, that generally means that instead of almost every good company's stock being aggressively priced, the stock retreats to what would have been a normal valuation before the era of QE made central banks sponsors of widespread financial bubbles.
That's how I look at Novo Nordisk's (NYSE:NVO) 10% decline Friday on a downbeat forecast for the rest of this year and especially next year. Actually, I think the news from the company Friday was OK if not better than that.
Here's the rationale and why I've been trading it as I have.
Novo Nordisk - background and context
Novo and Nordisk were two separate pioneers in insulin development in the 1920s. Nordisk was founded in 1923 to commercialize insulin, which was discovered in 1921. An intra-company dispute led to a key employee founding Novo in 1925. Thus the two key companies in insulin therapeutics existed near each other in Denmark; the main initial and historical, and continuing, competitor, was and is Eli Lilly (NYSE:LLY). In the 1980s, Novo developed the world's first genetically engineered human insulin, meaning that animal pancreases were no long needed. Nordisk then developed a pioneering human growth hormone. The two companies merged in 1989 to form Novo Nordisk. They spun off Novozymes A/S (OTCPK:NVZMF) in 2000.
Looking at Yahoo! Finance (NASDAQ:YHOO), the stock chart that goes back to 1982 (a question of Novo rather than Nordisk) shows that it has risen about 130X since then. Adding in dividends and the spinoff and I would guess that the CAGR is in the high teens. This puts the company in an elite category.
NVO has ridden the diabetes pandemic to a high level of success. It also maintains a growing biotech division focusing on hemophilia and growth hormone, but the revenues from this division are less than 10% of the total.
NVO has no long-term debt and by charter, cannot be acquired. Thus there is no takeover premium in its valuation, which in any case, as a mega-cap stock, would not be easy to do even for one of the pharma giants.
NVO has an active shareholder capital return program. It aims to return 90% of profits to shareholders, roughly evenly split between shrinkage of the float and dividends.
Over the past decade, it has retired about 2.7% of the shares outstanding annually. Over the last 12 months, it has retired 1.7% of shares outstanding. At a share price just under $50, the dividend yield is looking like 2%, and the TTM P/E is around 25X.
NVO derives half its revenue from the US. The rest is diversified between the EU, China, the rest of the Pacific area, etc.
Friday's news - the good and the mediocre
As a European company, NVO thinks more in half-year blocks than Americans are used to. Here's the first part of the Friday press release, to be supplemented with more granular news after that
Novo Nordisk increased adjusted operating profit by 8% in local currencies in the first six months of 2016
Sales increased by 7% in local currencies and by 5% in Danish kroner to DKK 54.7 billion.
- Sales of Victoza® increased by 14% (13% in Danish kroner).
- Sales of Tresiba® increased by 167% (161% in Danish kroner).
- Sales in the USA increased by 7% (7% in Danish kroner).
- Sales in International Operations increased by 11% (decreased 2% in Danish kroner).
- Sales in Region China increased by 10% (5% in Danish kroner).
Operating profit decreased by 3% reported in local currencies and by 6% in Danish kroner to DKK 24.8 billion. Adjusted for the non-recurring income related to the partial divestment of NNIT and the income related to out-licensing of assets for inflammatory disorders, both in 2015, operating profit in local currencies increased by 8%.
All the above looks OK to me for a high quality name. After all, US multinationals with P/Es in the 25-30X range or higher have routinely been running minimal sales and operating profit growth lately, before financial engineering maneuvers such as debt-fueled buybacks.
Here are the two main things that bothered traders. First, from the press release regarding this year:
For 2016, the range for expected sales growth has been narrowed to 5-7% and growth in adjusted operating profit is now expected to be 5-8%, both measured in local currencies.
That means that sales growth has been lowered from a mid-range projection of 7% to a mid-range projection of 6%, or maybe $16 MM dollars in revenue. It also means that operating profit growth was lowered by 1/2% at the mid-point. That's a tiny number.
If that were all, the stock shouldn't crater 10% and more intra-day. Here are the details that probably meant a lot more. First, from the press release, semi-buried at the end, was this:
In the USA, the market environment is becoming increasingly challenging and contract negotiations for 2017 have reflected an intensifying price competition. In spite of this, we see significant growth opportunities based on our strong diabetes care portfolio".
The Power Point Presentation accompanying the press release phrased it this way (slide 11 of 20):
US formulary negotiations and 2017 pricing
- Majority of formulary negotiations for 2017 completed
•Tresiba® is expected to maintain more than 70% combined access for the patients in commercial channels and Medicare part D
•Based on the outcome of the formulary negotiations to date, net prices of the portfolio as a whole are expected to be moderately lower compared with the levels in 2016
Moderately lower prices are not desirable.
I do think this is an ongoing problem for the pharma industry. It goes along with what I said after the biotechs sold off nearly a year ago after a newspaper article, politician's tweet and speech, and short seller's attack. The point I've been making is that the main threat to the industry is the same as with oil: overcapacity. Too many companies doing the same or similar things. That's what allows, or basically forces, prices to drop.
In any case, this puts 2017 EPS goals that analysts were carrying for NVO in jeopardy. We'll have to see how that trend goes in the next week or two.
So what's the offsetting good news?
This is described in NVO's half-year report (p. 15), which presents Q2 data in Appendix 1, p. 22.
The yoy comparisons are skewed by fluctuating forex losses, both hedged and unhedged; a significant gain last year due to the partial divestiture of NNIT A/S; and US Medicaid rebate income in H1 this year. Also, free cash flow this year was revised upward despite the mild downward operating guidance; this was because the company now expects tax refunds or settlements in H2 this year that are financially meaningful.
In any case, my interest in holding NVO for the very long term is more related to its unusually promising pipeline, including possible important label changes for two of its important marketing drugs, Victoza and Tresiba.
Much of the rest of the article, therefore, focuses on these opportunities, which I view as head and shoulders above those of any Big Pharma peer adjusted for market cap.
First, probably the most speculative, and extremely interesting and potentially the start of something very big. No guarantees ever, and especially with this one:
Oral insulin may become a reality
No guarantees, but first the company comment, then my thinking:
Phase 2a trial with oral insulin OI338GT1953 completed
During the first half of 2016, Novo Nordisk completed a small
8-week phase 2a trial with the once-daily oral insulin analogue OI338GT compared with subcutaneous insulin glargine U100 in 50 insulin-naïve adults with type 2 diabetes. The trial investigated the safety, tolerability as well as pharmacokinetic and pharmacodynamic profiles of OI338GT. The results were
generally encouraging with a decrease in fasting plasma glucose of approximately 2.5 mmol/L (45 mg/dl) for both treatment arms, and OI338GT generally appeared safe and well-tolerated.
Novo Nordisk is currently assessing the therapeutic use and investment needs of the oral insulin program, and an update will be provided in the second half of 2016.
This formulation was studied as described in ClinicalTrials.gov as NN1953. The study was titled:
Trial to Compare NNC0123-0000-0338 in a Tablet Formulation and Insulin Glargine in Subjects With Type 2 Diabetes Currently Treated With Oral Antidiabetic Therapy
That's formidable, but what it appears to mean is that the oral insulin was given once a day and gave fasting blood sugars comparable to that of market leader Lantus, a Sanofi (NYSE:SNY) product.
The formulation was developed by a very small Irish company, Merrion Pharmaceuticals.
The technology and the concept - why it could be the game-changer of game-changers
This could be the Big One. PMLiVE, a trade journal explains in a Feb. 2016 article:
The search for a better delivery method for peptide, protein and antibody drugs
That is particularly disappointing as biologics are also the fastest growing segment of the pharma market, tripling in value from $36bn to $163bn between 2001 and 2012, thanks to their high specificity for drug targets. Their specificity derives from their structural complexity, which is also the reason they are so challenging to formulate and deliver.
At the moment, biologics are generally delivered by intravenous or subcutaneous injection, which is effective but not desirable for patients, particularly for chronic conditions. Other routes of delivery such as transdermal, intranasal, inhalation and oral administration are under investigation, but oral delivery is generally considered the optimal route.
However, while convenient for patients, there are a host of challenges which make this route of administration challenging for large-molecule drugs. Foremost among these is enzymatic and pH-dependent degradation of drugs in the stomach and intestines, the low permeability of epithelial cells that line the gastrointestinal (GI) tract and the intrinsic instability of these compounds.
That means that proteins and peptides typically have extremely low bioavailability in the range of around 0-2% when taken by mouth. As a result, it is estimated that upwards of 100 projects focusing on oral delivery of peptides and proteins have ended in failure, despite myriad strategies aimed at increasing the bioavailability of drugs, overcoming acid and enzymatic degradation and enhancing the permeability of the gut lining.
Insulin has long been the most popular target for oral delivery as it needs to be injected every day and - even with new self-injector pens - can be burdensome for patients. The only alternative to injections of the hormone at the moment is MannKind's (NASDAQ:MNKD) inhaled insulin Afrezza - partnered with Sanofi - which has not gained much momentum yet in the marketplace with sales running at a few million dollars a quarter.
Oral insulin that could be taken alongside meals is considered to be the best option for patients, as the insulin would pass directly into the portal circulation running between the liver and the GI tract, allowing it to work more efficiently.
In fact, diabetes is thought to be the single largest area for oral delivery of biologics, with a number of groups working on oral insulin as well as analogues of glucagon - like peptide-1 (GLP-1), a hormone that works independently of insulin to stimulate glucose release.
Now, after a number of failed projects, some progress does seem to be happening. Novo Nordisk and Merrion are working on an oral formulation of insulin based on the latter's GIPET technology, an absorption enhancer designed to help large molecules cross from the GI tract into the blood, and recently entered their candidate into phase IIa trials.
GIPET uses oral formulations based on proprietary combinations of excipients which increase the permeability of the GI tract lining, boosting the bioavailability of compounds by 10 times or more. The oral insulin - called NN1953 - is currently in phase I trials [correction, has completed Phase 2a]
Don't worry if some of that is too technical. The point is that oral insulin is a target that NVO and others have been going after for years. And it's drawing near - at least, it might be.
Issues with bringing this oral insulin to market
First, this product cannot come to market soon, if ever. Patients already have a safe, time-tested set of insulin delivery devices. So there's absolutely no need from the standpoint of regulators to fast-track this to market, in contrast to a drug for a rapidly fatal disease that has no acceptable alternative.
We will have to wait for NVO to announce its plans. Typical would be a Phase 2b larger study than the 50-or-so patient Phase 2a study. A broader range of ages, ethnicities, etc. would likely be looked at. However, the commercial importance of this might be that a very large 2b study could be designed so that if the results are strong, it could count as a pivotal study. And if the results are overwhelmingly strong, well, you never know what the regulators might allow. Perhaps limited sale to patients in need of insulin who are unwilling or unable to take insulin through conventional means?
There should, in my view, though, be little of the safety concerns that Afrezza had. Probably about two years ago, I received a few private requests from readers for my opinion about the commercial potential of Afrezza. I simply said that it was a clever idea, and I had great respect and admiration for Al Mann (R.I.P.) for developing inhaled insulin - but that I would have recommended to my patients that they avoid it unless they had no choice. The unknown safety issues with inhaling a protein were just too daunting to me. Maybe in 10-20 years we'll know enough to say it's safe.
In contrast, I'm certain that all the components of the GIPET coating system are generally regarded as safe by the FDA and all major regulatory agencies. And there should be no worries about delivering a protein into the stomach and intestines. That's precisely what they like down there - it's called food. There will be tons of animal data and if necessary endoscopic data in humans to show that there are no dangerous buildups of material lining the stomach or gut. I'm sure that the cautious NVO has examined this in excruciating detail. We are, after all, dealing with a 93-year-old company operating in the same area of pharmaceuticals the entire time.
Finally, the company would need a larger group of patients to be exposed to this pill to know its tolerability.
Safety and efficacy; and manufacturing issues
There are overlapping questions here. Without getting technical, prescribers need to know whether the formulation will dump a large dose of insulin into the body, resulting in more instances of hypoglycemia. They will want to know how inter-patient and intra-patient absorption patterns are; how many doses fail to be absorbed at all; how many doses do not last 24 hours, etc. These are combined safety-efficacy questions.
NVO's statement also alluded to the importance of consistent manufacture of these products. Quality control - production of the pill within tight limits, pill after pill - is critically important. Any significant change in the formulation to aid QC issues or absorption issues may mean going nearly back to square one.
All one can say is that the general promise of oral insulins is very large.
There are two main classes of insulins. One class is the short-acting insulin. These used to be called "R" for "regular" insulin. Our bodies secrete insulin in response to stimuli, and the goal of short-acting insulin is to supplement or replace the body's inadequacy in that regard.
The other basic class is long-acting or basal insulin. These have progressed a lot to the level of very good, once-daily injections. Best-known is the SNY Lantus and its biosimilars; other insulin glargine brands are marketed. Peak Lantus sales were over $8 B.
The GIPET formulation NVO has now commented on appears to be a basal, long-acting version based on its once-daily administration in the clinical trial and comparison to insulin glargine in that trial.
So it addresses what definitely is a multi-billion market opportunity. Whether it could be a $10 B annual opportunity, possibly beyond that, remains to be seen.
Other implications of oral insulin development for NVO
Once this sort of "encouraging" Phase 2a study is in the books, reported by the world's leader in insulin therapy, then I start thinking about what future advances in oral insulins come after this initial promising formulation. Perhaps this is the start of a series of improving oral insulins.
Then, of course, the question of what other oral formulations NVO may have up its sleeve that we do not know about, with Merrion, Emisphere (OTCPK:EMIS) or some other formulation company has to be asked.
NVO is given to secrecy. It will not give anything away to its competitors just to pump the stock.
Effect of the oral insulin news on NVO's value
I think the simplest way to comment is that my estimate of the present value of NVO rose Friday rather than fell. It's really too soon to speculate on what chance this product may have of coming to market, when it might do so, and how compelling a choice it will be versus traditional injectable insulins.
If NVO is encouraged, then so am I.
There was other news from the company Friday and recently.
Update on Tresiba
This is NVO's one-upping of all insulin glargine formulations, in its view. NVO has been coming out with clinical data comparing this ultra-long-acting insulin with insulin glargine (I believe Lantus) and finding Tresiba having several relevant advantages:
- less hypoglycemia, including less at night
- less variability in blood sugar levels
- greater potency.
See Power Point presentation, slide 13 for some of the above supporting data.
I'm optimistic that Tresiba can continue to prove its superiority, get claims in the label that insulin glargine cannot get and then build to very high peak sales.
The DEVOTE cardiovascular outcomes trial with Tresiba should have results announced in 3-6 months. The FDA required an interim analysis in late 2014 in order to approve Tresiba. Apparently senior management was blinded to the results, if I understand NVO's prior communications on this correctly.
Update on IDegLira
Known as Xultophy outside of the US, the FDA wanted a name that made it clearer that this was a combination of two injectable drugs, liraglutide (Victoza) and insulin degludec. The FDA convened an advisory committee meeting, which favored approval of the injection with a 16-0 vote. The briefing book the FDA had created for the AdComm meeting had been pretty tough, so the unanimous vote was reassuring. I believe that NVO had to scramble to prove that prescribers comprehended the name and usage of this product, even though it's been on the market in the EU and elsewhere, apparently generally uneventfully. In the presentation, all NVO would say is that it expects a final FDA decision within 3 months.
This is an important secondary product. I expect the FDA to go with the global flow and approve IDegLira; but I'm not highly confident about it. I expect the decision to move the stock, more to the downside if it's not approved than to the upside if approved.
Update on Victoza
This market-leading GLP-1 receptor agonist (stimulator) for diabetes and weight loss (under the Saxenda name) had positive results in its CVOT for safety as well as for prevention of major adverse CV events, or MACE. NVO says that it will file for a label update by November in the US and EU reflecting this LEADER study. That would imply a decision by the regulators next year; one would hope in H1.
Approval for reduction in CV events is not guaranteed, but it appears clear that Victoza will be proven safe. The P value for prevention of MACE was 0.01, right at the borderline of what FDA typically will accept based on a single study.
Reduction of MACE appears not to be a class effect of GLP-1s, so the LEADER results are already a positive. FDA and EU agreement that Victoza lowers MACE safely could be a material plus for what is already NVO's most important drug.
Potentially important for NVO is the fact that the AdComm meeting for the oral diabetes drug Jardiance, from LLY, only received a 12-11 favorable vote for prevention of MACE. One of the weaknesses of the Jardiance study, EMPA-REG, was that silent MIs (heart attacks) were not part of MACE per the trial analysis. When silent MIs were added into the analysis
Semaglutide (injectable) update
This is a next-generation GLP-1-acting drug. It can be given weekly subcu, as is Victoza. US and EU submissions are now expected in 3-6 months (I would expect them before year-end).
NVO has completed a smaller CVOT on semaglutide, and not only was it safe, but a statistically significant protective effect on MACE was seen. Whether this is persuasive enough to allow the regulators to grant a MACE prevention claim is uncertain.
Semaglutide is, as NVO describes it, very close to Victoza in its chemical structure. Given the concordant Victoza and semaglutide data, I'm optimistic that semaglutide will be viewed by specialists as best in class. The major competitor to Victoza is LLY's Trulicity, a once-weekly GLP-1-acting drug. However, it looks as though CVOT is not expected to be completed until July 2018.
I, therefore, am bullish on semaglutide once-weekly.
Using Emisphere technology, this takes semaglutide to the next level. This is in an extensive series of Phase 3 trials; the PIONEER trials.
NVO did not provide a written update on this. I think that with good Phase 2 data, the odds favor this being approvable. There are more GI side effects with oral semaglutide than with injectable, so exactly how this will play if approved is just going to have to await first the extensive Phase 3 data and then real world use.
My opinion is that oral plus once-weekly injectable semaglutide is positioning NVO to leave its GLP-1 competition in the dust.
Of course, that's off in the future. I do like the set-up, though, in this space.
Risks, trading considerations and concluding thoughts
Stocks are funny things. When they drop in price on news of decelerating price realizations, but are up massively over many years, trading with no relation to tangible asset value, the first decline often marks the beginning of a period of underperformance. So who needs to be brave and open a position in such a name? This is NVO's situation today.
NVO of course has company - and market-specific risks that are significant. In general, the Big Pharma names we know today have not recovered their 1998-2000 high prices. Might NVO be about to suffer the same multi-year or multi-decade fate?
I think that the company has a strong chance of being on the cusp of a new wave of growth. The company itself has suggested this year on one of its calls that it sees itself transforming into a CV disease prevention company rather than just a company controlling blood sugar - a proxy endpoint just as cholesterol is. The liraglutide and semaglutide outcomes studies indicate it might just be the leader in this critically important therapeutic breakthrough. In addition, the DEVOTE study of Tresiba needs to be analyzed carefully.
On a trading basis, I was lucky enough to take modest profits on about 25% of my NVO stock in the $56-57 basis more on seasonal concerns, just recently. I bought some but not all of that back Friday below $50. My plan is to respect the new downtrend and downbeat guidance before scaling in more deeply.
At 25X TTM GAAP EPS, therefore, the same multiple as the S&P 500 (NYSEARCA:SPY), but with no long-term debt and the above constellation of potential blockbuster products or possibly even a mega-blockbuster or two, I like NVO a great deal. There is a diabetes boom going on, and if it can indeed show the way to improved injected and then oral medications for it, I believe that NVO can be a long-term winner for many years to come. Exactly where EPS in 2017 come out is not all that important to me, though if they really crater, that's another story.
Thanks for reading. Your comments are welcome.
Disclosure: I am/we are long NVO.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice. I am not an investment adviser.
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