Background - Digging in on out-of-favor secular growth stocks
In the immortal words of the TV sitcom character Rob Petrie:
A man's gotta do what a man's gotta do. And so do I.
And so does yours truly, in this case sitting tight on shares of a strong company that I believe is doing the right things in the attractive market of "diabesity" (see below for details).
Even though the stock is going nowhere fast.
The venerable Novo Nordisk (NVO) just rolls along, experiencing an operational slowdown that is milder than the stock price volatility the past two years. As an example, going back 5, 3 and 1 years, these were the sales and diluted EPS (in Danish kroner = DKK):
- 2013: 83.6 B; 9.39
- 2015: 107.9 B; 12.75
- 2017: 111.7; 15.49.
There has been a slowdown. This can happen to any company for a while.
Note, the Danish kroner is pegged to the euro, so the changes in the USD/DKK pair are essentially equal to the much better-known USD/EUR pair.
Basically, growth slowed to a crawl or to zero the last 1-2 years, due mostly to insulin pricing pressures in the US following years of rapid price increases. NVO stock has tracked sales more than EPS (semi-log scale):
The 5-year trend is up, which may be a good sign.
Over the past 10 years, the trend is up strongly:
NVO has beaten a proxy for "tech" (QQQ) over this time by a tiny amount on price, while yielding more than QQQ. This fact makes me believe that NVO remains in a structural bull market and has time to show it is rejoining that impressive major trend.
So I feel what I "gotta do" is see if the basic story at NVO is staying the same (which would be good enough), worsening or even getting better. Mostly I think it's stable to improving, and that a renewed R&D focus on diabesity may pay big, enduring and possibly accelerating dividends over the next 10-20 years.
This article provides an update on what I see as most important at NVO, with some brief comments on the Q1 results. First up, I like the big picture at NVO.
Structural reasons to like NVO
This company thinks long term. The shares that outsiders own, which in any case are shrinking due to buybacks, collectively do not control the fate of the company, which is controlled by a foundation which is forbidden in its charter from selling the company. The foundation's interests thus are as long term as can be. NVO carries no long-term debt. It also goes further than "best practices" US-style, which prescribe that the CEO not also be chairman. At NVO, the CEO is not even a board member. The board is possibly the most independent board of any major public company that trades on a US exchange.
Why should NVO think long term?
First, because it is the global leader in drugs for diabetes, an "epidemic" of large, growing and global proportions. NVO propounds the idea that only about 6% of people with diabetes are treated properly, and only 12% are under treatment at all; the rest either are not diagnosed (1/2 the total) or if they are diagnosed, only 1/4 of them are treated at all (getting to 12%). See Slide 37 of latest presentation for the relevant chart. Given the enlarging market, there are almost infinite growth possibilities in most of the world.
Second, NVO is gaining share of dollar in obesity treatment. Its current entry is a high dose of its diabetes treatment Victoza (branded as Saxenda); it has several pipeline efforts underway to seize a clear lead in this "epidemic." With obesity a major risk factor for development of Type 2 (maturity onset) diabetes, the combination of increasing rates of both conditions has been called diabesity. NVO is positioning itself to grow endlessly as the leading pharma company treating diabesity. See p. 76 of the presentation and subsequent pages for its take on obesity with special attention to 82-3.
Third, I assume that NVO developed a biotech division as an outgrowth of its work in human insulin, which was an early biotech product. It is a global leader in biotech products for hemophilia and growth hormone deficiency. Because of its global scope, its loss of market share has been mitigated by its presence in many markets outside of the US. The company makes its case for long-term renewed success beginning on Slide 85, and I think it's a credible program.
Fourth, the company fully expects that the 50% (or so) of revenues it gets from the US is going to shrink in relative importance. It is seeing growth in Greater China and other developing areas, and expects that to continue as a mega-trend for many years to come. The US and Western Europe are deep into spending on healthcare, but that is not so yet in most of the world. This projected growth will take time and requires the sort of commitment that a company that thinks strategically can give to the effort.
Competitive strengths, Part 1: Marketed products
My view is simple: that NVO is a clear #1 in quality of diabetes and weight loss drugs. There are three aspects to this thinking. The first part is the most complicated, but it's only one of three market segments. It's difficult to make this simple, but here goes with point 1:
Diabetes/weight loss with GLP-1 agonists
The results of Lilly's (LLY) REWIND study (cardiovascular outcomes trial, or CVOT) for Trulicity, the major competitor for Victoza and Ozempic in the fast-growing GLP-1 agonist space, are pending, perhaps in Q3. For now, and I think permanently, the Victoza/Ozempic pair comprises the pacesetter in this space of injectible drugs. Victoza has a CV indication, and Ozempic showed statistically positive CV results in its Phase 2 (preliminary) CVOT. It is good news that this under-powered but still statistically positive study is described in the prescribing information. A large, potentially ground-breaking CVOT for Ozempic is underway.
Because the drug in Ozempic, semaglutide, is almost identical to the drug in Victoza (liraglutide) except for an add-on to the molecule to give it a much longer life in the body allowing once-weekly dosing (same as Trulicity), I have a high degree of confidence (but something much less than certainty) that the large-scale CVOT on Ozempic will succeed.
Ozempic is known to lower body weight while lowering blood sugar.
Meanwhile, Saxenda - which is just very high dose Victoza - has the formal indication for weight loss that neither Victoza nor Ozempic has. But Ozempic works fine, too. In contrast, Trulicity appears quite unlikely, based on what I know, to ever get a weight loss indication.
So NVO looks to me like the clear leader over LLY in this important drug class, and I think that if Trulicity has a good, positive CVOT, the two companies will have a duopoly in injectible GLP-1 agonists.
Moving on to the well-known and highly competitive insulins:
Tresiba - best in class basal (long-acting) insulin
In making its case to analysts at Goldman Sachs (GS) in London after releasing its Q1 numbers, the NVO team was ecstatic over this from the Tresiba label (see p. 9 and Table 16 of the P.I., and Slide 12), showing a key superiority of Tresiba over Lantus and its biosimilars:
The pre-specified secondary endpoints of event and incidence rates of severe hypoglycemia were sequentially tested...
The incidence of severe hypoglycemia was lower in the TRESIBA® group as compared to the insulin glargine U-100 [Lantus] group. Glycemic control between the two groups was similar at baseline and throughout the trial.
Tresiba was already best in class amongst long-acting insulins, a class which NVO believes has been under-used due in part to hypoglycemia concerns. It may now grow more rapidly according to NVO.
Blood sugar goes up during and after eating, and NVO believes that its latest very short-acting insulin, Fiasp, mimics the insulin curve of non-diabetics when injected at mealtime. I believe that it is also best in class. Exactly how commercially important this particular drug is as a stand-alone agent is to be determined, as its global roll-out continues.
Sales are beginning to ramp for two combinations that I believe are first/best in class. One is the novel concept of Xultophy; this combines Victoza and Tresiba. The other is Ryzodeg, which contains Tresiba and Fiasp, thus it is an optimized traditional combination of short- and long-acting insulin. NVO is bullish on both these combination products.
With no guarantees, I think that these young, superior products are likely to allow NVO to return to solid sales and earnings growth, with EPS being enhanced by buybacks and significant share count reduction year after year.
Next, the pipeline.
Major pipeline products
A quick summary look at the pipeline is on NVO's web site, which shows clearly by color-coded indication what's hoped to be coming. The 4 key products and indications in diabesity I'm focusing are:
1. Oral semaglutide, hoped to be approved by the FDA in early 2020. This had successful Phase 2 trials and one successful Phase 3 trial. NVO believes that the program has now been de-risked, with the rest of the Phase 3 program due to be completed this year. This would be a breakthrough product involving significant technical competence that could be years ahead of the competition. The underlying technology was licensed from Emisphere (OTCPK:EMIS).
I'm optimistic that oral semaglutide will go all the way to approval and becoming a commercially important product for NVO and an important part of its set of solutions for diabesity.
2. Semaglutide for weight loss, namely the injectible form of Ozempic (Though oral semaglutide likely deserves the same indication in my opinion). A once-weekly injection of Ozempic for weight reduction would take Saxenda, given daily, almost completely out of the picture. I expect this approval and think it should be commercially important.
3. Semaglutide for NASH, in Phase 2 based on one study in the UK. This is for Stage 2-3 NASH (moderate-severe) and just might succeed well enough to justify a Phase 3 program. This is more of a "sleeper" possibility than anything else, but it's worth keeping an eye on.
4. Ultra-long-acting insulin, which has completed Phase 1 and is going to enter Phase 2. This was the comment from NVO during the prepared remarks:
LAI287 is a long-acting analog of human insulin that has just completed successfully multiple dosing in Type 2 diabetes up against Tresiba with I would say equipoise both on efficacy and safety, which bodes well for this once-weekly insulin.
It's still early days, but I'm optimistic on this one.
If NVO can bring this through to approval in several years, and assuming it is first in class, I would have to say "wow." A once-weekly basal insulin would change the game big-time in my humble opinion.
Moving on, just a quick mention that NVO plans to return to higher market share in growth hormone deficiency and in hemophilia, and would like to make bolt-on acquisitions in biotech (It just did a deal for sickle cell anemia).
All the above looks not only attractive for the stock but also as good as it gets for any drug company I know. The patent positions are reviewed on Slide 33, and look attractive as well.
I am giving these last because there were few surprises, and they were a little confusing. From the prepared remarks:
In terms of our operating profit, then the 5% sales growth turned into 6% operating profit growth, also measured in local currencies... However, given the development on the U.S. dollar compared to the Danish krone, then in reported terms unfortunately it looks significantly less nice. So, our sales growth in reported terms was down 5% and our operating profit was down 8%. So a 10 and a 14 percentage point negative impact from currencies in the first quarter.
But then there were currency hedging gains, a one-time tender offer in Brazil that helped sales, and so on. Thus I don't know how to comment on the quarter. ETrade is showing consensus EPS for 2018 of $2.56 on $17.8 B revenues. With all the currency cross-currents, I'd rather wait for a clearer picture to comment on current EPS.
I've been bullish (and wrong/early) on NVO's high-quality product line leading to growth for over two years, yet it has not happened. Shortly after I went long NVO in early 2016, at a P/E of 28X (higher than I was happy with), the stock plummeted on an insulin price war in the US. There is no clarity these days on pricing in the US, and there is no easy way to know how adept NVO will be in its pricing and general go-to-market strategy with its drugs over time, and region by region. With NVO ADRs around $48 as of Wednesday night, when this article is being submitted for review, then the stock is at an 18-19X P/E on projected 2018 EPS. That's not terribly cheap. After all, NVO's main long-acting insulin, Levemir, far outsells Tresiba, and it loses patent protection in the US in 2019; I do not know the biosimilar situation for this product.
So, please be careful with this stock, high-quality (and debt-free) though I believe the company is.
Concluding thoughts - NVO for the long run
The basic reasoning I like NVO as a permanent buy-and-hold, so long as it meets an appropriate percentage of its goals, is via the following reasoning:
P/Es of stocks such as NVO with few hard assets are determined by a combination of growth rates and expected persistence of that growth. In the case of NVO, its younger marketed products have long patent lives, and its market of diabesity is more or less eternal (barring some horrible global famine or the like). So while the growth rate I expect, assuming reasonable pipeline success, is perhaps in the 7-8% annual rate (maybe a bit higher), I expect that growth to be non-cyclical and sustainable for many years.
Putting it another way, many electric and gas utilities (XLU) in the US have the same forward P/Es as NVO, their expected growth rate is very low. And times are changing, in that the rise of rooftop solar, even backyard solar for rural properties, etc. are threatening to send utilities into shrinkage mode. Whereas, huge numbers of diabetics in the US alone are un-diagnosed or under-treated, and global numbers for the same are gigantic. Then there's the obesity commercial opportunity. On a relative basis, for the market and economy we have, NVO looks to me like an above-average stock going forward.
In conclusion, I continue to see NVO as a strong, well-run company with first-/best-in-class drugs focused squarely on a very attractive market niche of diabesity, with good profit growth potential in the biotech field as well. My plan is to sit tight, enjoy the 2% or so dividends, and trust that sooner rather than later the company will grow faster, providing alpha via dividend growth and a return to steady and meaningful share price appreciation. As always, there are no guarantees for the company's operational success or for how the stock will trade.
Thanks for reading and sharing any thoughts you wish to contribute.
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.