By Richard Robinson
During the time of the Pharaohs, Egypt possessed an advanced understanding of medicine. The Greek historian Herodotus described the Egyptians as "the healthiest of all men, next to the Libyans."
This wasn't an accident.
In his history, The Persian Wars, Herodotus wrote,
"The practice of medicine is so specialized among them that each physician is a healer of one disease and no more. All the country is full of physicians, some of the eye, some of the teeth, some of what pertains to the belly, and some of the hidden diseases."
It was a hidden disease that troubled Egyptian doctors the most. An Egyptian manuscript dated to 1500 B.C. described a condition as "too great emptying of the urine."
This puzzled doctors.
About this same time, doctors in India were confronted with a similar condition they called madhumeha, or "honey urine." They called it honey urine because some people's urine attracted ants.
Fast forward 3,500 years and the existence of diabetes mellitus is still with us.
Only now, it's much worse...
That's because diabetes afflicts more than 430 million people worldwide. That's a 300% increase from 1980 levels. And that number is expected to grow to 645 million by 2040.
This means the insulin market is booming, which makes for a great investment opportunity...
Novo Nordisk (NVO) is a Danish company with a market cap of $90 billion. It has manufactured insulin since 1923. The company controls 50% of the global market for insulin and 25% of the diabetes industry.
The company generates revenues of $16 billion annually. A little more than half of that comes from its North American operations. That's not surprising given the prevalence of obesity in the United States and Canada.
Insulin sales and obesity care generate nearly about 79% of the company's revenues. The remaining 21% comes from the company's biopharma sales for human growth hormone products and hemophilia treatments.
Big Pharma lives and dies on its pipeline. NVO is no exception. The company spent more than $2 billion last year on its research and development (R&D).
Today, the company has 17 new types of insulins and drugs in its pipeline. This includes a diabetes treatment in tablet form. If this treatment is approved, diabetics will be unchained from painful injections.
Another diabetes drug already approved (Tresiba) is a long-lasting insulin that lasts in the bloodstream for up to 40 hours. It earned more than $200 million in sales during the first half of 2016. The company expects that this drug will generate up to $5 billion annually by 2022.
NVO Is Well Run And Undervalued
Novo Nordisk has grown its revenues at compound annual growth rate (CAGR) of 12.9% since 2012. That trend has continued this year, with revenues in the first half of 2016 growing by 5%.
But at the end of the day, we're looking for companies that can generate lots of free cash flow (FCF). FCF is what is left after capital expenditures are deducted from operating cash flow. And it's one of the best indicators of the health of a company.
And Novo Nordisk is a cash machine...
NVO has seen its free cash flow grow from $2.6 billion to $4.7 billion since 2012. That's a CAGR of 15.3%. But this isn't an isolated event.
Since 2005, NVO has generated $116 billion in revenues and $31 billion in free cash flow. Let me put this another way: Every dollar in sales the company makes results in $0.27 in free cash flow.
That's cash the company can use to grow or return to shareholders with dividends and stock buybacks. And speaking of dividends, NVO currently yields 4.2% with a 39% payout ratio. And since the company has no long-term debt, NVO has plenty of room for future dividend increases like the 28% increase in 2015.
Of course, no matter how great the business is, we never want to overpay for a stock...
As you can see from the chart below, NVO is trading at prices not seen since 2013.
But, don't let the 45% YTD decline in the stock price scare you off.
Investors severely punished the company after lowering its guidance for growth estimates in 2016 from a range of 5% to 9% to a range of 5% to 7%. But I believe the punishment has gone too far.
NVO hasn't been this cheap in years. The company's ratio of enterprise value (EV) to earnings before interest, taxes, depreciation, and amortization (EBITDA) now sits at 10.8. That's 32.5% below its 10-year average.
More importantly, Novo Nordisk benefits from the mega-trend in global obesity. EPS should exceed analyst estimates of 8.8%. Staying conservative and using the company's current price/earnings (P/E) ratio of 15.6, this stock goes to $50 by 2020.
Risks To Consider: NVO could continue to face U.S. price pressures on its line of insulin drugs - and a lack of product diversification could affect the stock price further.
Action To Take: Allocate no more than 2% of your portfolio to shares of NVO. I suggest a stop-loss no lower than $25.50.
This article was originally posted on StreetAuthority.com.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.