Novo Nordisk (NYSE:NVO) is a company for the record books and MBA lesson plans. This Danish biopharmaceueticals company doesn't try to do very many things, but it does them very, very well. With modest near-term competitive risks and substantial potential value in the pipeline, operationally there is little to fear at Novo Nordisk. The question for investors, as is so often the case with this stock, is what is the proper price to pay for that excellence.
A Familiar Story In Q4
Novo Nordisk has a history of top-notch performance, and this quarter was no exception. Revenue rose 16% (as measured in Danish kroner), good for a small beat relative to sell-side expectations. Diabetes sales rose 18%, while biopharmaceuticals sales rose 8%.
Novo management once again paired strong sales growth with improving profitability. Gross margin improved more than two points, while operating income increased by a quarter over last year. Not only was that good for an eye-popping operating margin above 36% (better than Pfizer (NYSE:PFE), even), but that operating income number was about 8% better than the average sell-side expectation.
Continuing To Flex Its Muscle In Diabetes
If Novo Nordisk is losing momentum in the diabetes market, there's really no sign of it this quarter. Sanofi (NYSE:SNY) has yet to report, but Novo's insulin growth was well ahead of Lilly (NYSE:LLY) in both analogs (up 20% versus 7% contraction) and human insulins (up 8% versus 1% contraction), and favorable currency moves for Novo really don't change the conclusion by a meaningful amount. While Novo Nordisk management did report some slight volume share erosion in the global diabetes market from 2011, the fact remains that Novo Nordisk is still the dominant insulin player with leading share everywhere in the world (including 60% share in China).
Novo also continues to do well in the GLP-1 market. Despite the added muscle of Bristol-Myers Squibb (NYSE:BMY) and AstraZeneca (NYSE:AZN) behind Bydureon and Byetta, Novo's Victoza continues to outgrow it.
At least insofar as the short term goes, it's hard to see major changes to this strong, dominant really, market position. Lilly and Sanofi are both continuing to work on advanced analog insulins, but Novo has its Tresiba (a novel ultra-long acting insulin) on the way, with Ryzodeg (a once-daily combination of Tresiba and NovoRapid) behind that.
Better still for Novo, the list of would-be biosimilar competitors appears to be thinning. A partnership between Pfizer and Biocon fell apart last year, while Actavis (NASDAQ:ACT) recently terminated a partnership for biosimilar insulins. With Teva (NYSE:TEVA) and Novartis (NYSE:NVS) showing lukewarm interest at best in the space, it doesn't look like there's major risk to the top three insulin franchises (though Lilly is working on biosimilars, particularly a knock-off of Sanofi's Lantus).
Will A Tough Label Or Outright Rejection Set The Shares Back?
Diabetes isn't going to get cured in the next twelve months, nor is the treatment of the disease likely to change. With that, the biggest likely risk to Novo Nordisk's near-term performance comes from the FDA.
While an FDA panel voted 8-4 that Tresiba should be approved, there was a unanimous view that the cardiovascular risks of the product needed further investigation. The FDA has become significantly stricter about diabetes products in recent years, particularly with respect to CV issues, and that led to disappointments for investors in companies like Amylin (since bought by Bristol-Myers and AstraZeneca) and Bristol-Myers/AstraZeneca over their SGLT-2 drug dapagliflozin.
Novo Nordisk has generally had good success in dealing with the FDA, but there is still risk here. It's a near certainty that the FDA will demand a cardiovascular outcomes study, but the timing is the key. The best case scenario is that the FDA approves the drug on time and with no particularly serious warnings or notations in the label, and that the CV study can occur post-approval. An intermediate case would have the FDA approving the drug with a fairly strict label, one that may reduce usage and blunt the initial launch expectations. The worst case scenario would be a complete response letter (a rejection) that requires that CV outcomes study prior to approval.
A Highly Focused, High-Potential Pipeline
Novo Nordisk has a strong near-term pipeline that could substantially improve its revenue potential over the next three to five years. Even though that pipeline is heavily focused on diabetes and blood disorders, only Roche (OTCQX:RHHBY) comes close in terms of the near-term pipeline revenue contribution potential.
There are the aforementioned compounds Tresiba and Ryzodeg - both likely to get approved eventually, but with some risk to the timing on both. Novo also has a fast-acting insulin aspart moving into Phase 3 studies soon and a weekly basal insulin under development.
Novo also isn't through with the GLP-1 market. The company has developed IDegLira, an insulin/GLP-1 combo. Sanofi is working on a similar combination of Lantus and Lyxumia, and should the insulin/GLP-1 combo approach prove successful, this too is likely to be a share-driver, as Bristol-Myers and AstraZeneca lack the insulin platform to combine with Bydureon.
Novo is also moving ahead with a weekly GLP-1 drug, semaglutide. While this compound is likely to be quite late to the once-weekly GLP-1 market, early data has suggested that it may be the only long-acting GLP-1 drug to show actual superiority in efficacy to the daily versions.
Last and by no means least is the potential of Victoza to gain a label for treating obesity. Pivotal data is due in the first half of 2013, with the trials expected to show that 30-40% of patients treated with Victoza losing 10% of their body weight. At that level, Victoza would be well ahead of Arena's (NASDAQ:ARNA) Belviq (16% losing 10% of their body weight), a little ahead of Orexigen's (NASDAQ:OREX) Contrave (about 27% losing 10%+), and a bit behind Vivus's (NASDAQ:VVUS) Qsymia (more than 45% of patients losing 10% or more).
I will be very interested to see how the market plays out if the Victoza data comes in as expected. On one hand, a daily injection doesn't sound like an appealing option compared to oral medications. On the other hand, the drug is likely quite effective (compared to Belviq) and acceptably safe (compared to Qsymia). Moreover, it is already established in clinical practice and pharmacies, and the reimbursement is already in place. Still, there are tolerability issues (nausea, constipation, and diarrhea), and the drug is not cheap, though payers have shown that they're willing to pay up for a drug that produces real results.
Last and not least, Novo Nordisk has additional products in development for blood disorders including hemophilia A and B. This is getting to be a more crowded space due to the efforts of companies like Baxter (NYSE:BAX) and Biogen Idec (NASDAQ:BIIB), but it's still a worthwhile market for Novo Nordisk.
Growth Potential Continues To Look Impressive
With the incidence of diabetes on the rise around the world, Novo Nordisk is looking at many years of solid growth potential. While I think Novo Nordisk is liable to lose some GLP-1 share to new entrants from Sanofi and Lilly, the company is in a very strong overall competitive position. In comparison, I see relatively little near-term risk to its diabetes franchise - it may trade some share with Sanofi and Lilly, but I don't see a major shift on the way. Longer term, I think the company's price points could make it challenging to hold that share in emerging markets, but I see little to no threat from companies like MannKind (NASDAQ:MNKD).
Given the global growth in both Type 1 and Type 2 diabetes, I believe Novo could grow its top line by 7% to 8% over the long term, with even more upside if Victoza really takes off in obesity and/or if the company would acquire other anti-diabetes drugs (like an SGLT-2 inhibitor).
Novo Nordsk already has an operating margin in the mid-30%'s, and only a very small number of drug companies (Questcor (QCOR) and Pozen (NASDAQ:POZN) among them) do that well or better. By the same token, Novo Nordisk does trail a few well-known names like Shire (NASDAQ:SHPG) in gross margin by a few points, and very manufacturing efficiencies could be attainable. As a result, I believe that Novo can continue to leverage its very efficient operating model to produce higher free cash flows, but not dramatically higher. I'm hesitant to project significant margin expansion given how well Novo Nordisk already does, but I nevertheless believe that 10% long-term annual free cash flow growth is attainable.
The Bottom Line
The problem with Novo Nordisk is a familiar one - even double-digit free cash flow growth doesn't suggest that the shares are undervalued today. I have no doubt that Novo Nordisk bulls will point out that people have always said that Novo shares are expensive, and it hasn't kept them from making 40%, 200%, or 900% on their original investment.
Investors who choose to believe that valuation is secondary to growth may find plenty to like in these shares. For those more concerned with valuation, I'd suggest waiting to see what happens with Tresiba, as disappointment here (particularly a complete response letter and a request for a CV study prior to approval) could create a rare buying opportunity.
Disclosure: I am long OTCQX:RHHBY. 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.