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Novo Nordisk: Back To Business As Usual

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About: Novo Nordisk A/S (NVO)
by: Daniel Schönberger
Daniel Schönberger
Value, long-term horizon, dividend investing, long only
Summary

Although earnings per share grew only 2%, Novo Nordisk reported solid results with 9% revenue growth and 11% operating income growth.

Saxenda, Ozempic and Rybelsus will contribute to revenue growth in the years to come.

Novo Nordisk has a wide economic moat based on the different patents and also high barriers to entry combined with a market-leading position.

When using moderate and realistic growth rates, Novo Nordisk seems to be fairly valued right now and should yield at least about 10% going forward.

Last week, Novo Nordisk (NVO) reported third-quarter results and despite still existing challenges, it seems the company is back on track and the steady performer again it was for several years. In the following article, we will review the third-quarter results, look at the company’s pipeline and identify those products that will lead to growth in the years to come. We will end by describing Novo Nordisk’s wide moat (once again) and provide an updated intrinsic value calculation.

(Source: Pixabay)

Solid results

Last Friday, before the European markets opened, Novo Nordisk reported results for the first nine months of 2019 and the company is presenting itself in good shape once again. While at constant-exchange rates net sales as well as operating profit could grow 5%, reported net sales increased 9% and reported operating profit increased even 11%. However, net profit stagnated compared to the first nine months of 2018. Earnings per share could increase 2% due to the share buyback program of Novo Nordisk. The reason for the stagnant profit were foreign exchange forward contracts to hedge the most significant exchange risks – as it always has been Novo Nordisk’s treasury policy. As this resulted in a loss in the first nine months, net profit could not increase. The operating margin also declined a little bit in the third quarter – it was 83.2% compared to 84.1% in the same quarter last year. The decline of 90bps reflects a negative impact from lower realized prices in the United States.

(Source: Novo Nordisk Investor Presentation)

Sales growth was also driven by all therapy areas as well as by all regions (even the United States), which is a good sign and shows that Novo Nordisk is still a solid and consistently growing business (despite its focus on only a few therapeutic areas).

Growth was especially strong in the AAMEO region with 16% growth at constant exchange rates and in Latin America, where revenue could grow 26% at constant exchange rates. In North America reported sales could also grow 6%, but this was mostly due to currency fluctuations – at constant exchange rates, revenue decreased 1% and showing still existing difficulties to grow net sales in North America.

For the first nine months, all business segments contributed to growth with “Diabetes and Obesity” growing 9% and “Biopharmaceuticals” growing 8%. Going a little deeper, we see that growth especially stemmed from GLP-1 products as well as obesity products. But growth disorder products (+7%) and haemophilia products (+9%) could also both increase in revenue. When looking at long-acting insulin, premix insulin as well as fast-acting insulin, newer products could often gain market shares while older products declined in revenue, but overall, these product categories were more or less stable in sales.

When looking at the three products that contributed the most to overall revenue growth, it is Tresiba growing at 19% (reported numbers) and now generating sales of almost DKK 7.0 billion, Saxenda growing 56% to DKK 4.1 billion (reported numbers) and Ozempic increasing from DKK 804 million in the first nine months of 2018 to DKK 6.9 billion right now. Ozempic was launched in the United States in February 2018 and therefore it doesn’t make much sense to compare the numbers YoY, but the growth is impressive and it took Ozempic only 19 months to reach blockbuster status. Aside from these three, Fiasp is another product worth mentioning. Although it contributed only 9% to the total revenue growth in the first nine months, the sales for Fiasp increased 109% compared to the first nine months of 2018.

Finally, Novo Nordisk updated its guidance. Sales growth at constant exchange rates is now expected to be between 5% and 6% (instead of 4-6% before) and free cash flow is now expected to be between DKK 31 billion and DKK 35 billion (instead of DKK 30-34 billion before). Reflected in the guidance is also the intensifying competition within the diabetes and biopharmaceutical business and also the continued pricing pressure within the diabetes segment (especially in the United States). Guidance also includes the funding of the Medicare Part D coverage gap with an expected negative impact of approximately DKK 2 billion.

(Source: Novo Nordisk Investor Presentation)

Pipeline and Growth Potential

When looking at the current pipeline of Novo Nordisk, the column “Phase III” and “Submitted” are rather empty, meaning that for the next few years, Novo Nordisk will have to rely on already approved products for revenue growth.

(Source: Novo Nordisk Investor Presentation)

But it shouldn’t be a problem if Novo Nordisk won’t get any major drugs approved within the next few years as there are several promising drugs with the ability to deliver high growth rates in the years to come. When looking at the long-lasting insulins, Xultophy and especially Tresiba can still grow in sales. Tresiba could grow at 19% for the first nine months and in August it was added to the National Reimbursement Drug List in China effective from January 2020, which should have a positive effect on sales growth. In total, Tresiba has been launched in 85 countries. A problem could be Levemir as the patent recently expired and for the first nine months, sales already decreased 18% compared to the same time last year (sales especially declined in the United States – 30% decrease in sales at constant exchange rates in the third quarter). It could very well be the case, that growth of Tresiba and Xultophy will be offset by the decline of Levemir.

Still very promising is Saxenda, which could reach peak sales between DKK 7 billion and DKK 10 billion according to analysts’ expectations. In my opinion, peak sales could even be higher as annual sales are already around DKK 6 billion and generated revenue is still growing at 42% in the third quarter.

And finally, growth expectations are relying especially on Ozempic and Rybelsus. So far Ozempic (Semaglutide as weekly injection) has been launched in 24 countries and is off to a solid start with strong uptake in launch markets. A second promising drug is Rybelsus (formerly known as Oral Semaglutide), which has been approved on September 20, 2019, by the U.S. FDA and is the world’s first GLP-1 in a tablet as an adjunct to diet and exercise to improve glycemic control in adults with type 2 diabetes. Rybelsus showed an up to 4.4 kilogram reduction in body weight and also demonstrated clinically meaningful and statistically significant reduction in HbA1c compared to other leading oral antidiabetic agents (like sitagliptin and empagliflozin). Early launch to specialists in the United States and full launch to primary care physicians will start in 2020 and for the first half of 2020, regulatory decision from the EU CHMP and for the second half of 2020, regulatory decision from the Japanese PDMA is expected.

Peak sales for both products based on Semaglutide are expected to be between $3.5 billion and $4.0 billion, which would be around DKK 25 billion (depending on the exchange rate). And the impressive launch of Ozempic with DKK 3.1 billion in quarterly sales (Q3/19) should make us very optimistic. But despite all the justified optimism, we should consider that sales of Ozempic (and later Rybelsus) might cannibalize sales of Victoza to some degree. So far, Victoza declined a little in sales, but the growing Ozempic sales did not “steal” huge market shares. However, in the third quarter, sales for Victoza declined 15% overall (steeper declines in the United States with 24% revenue decrease). In the company announcement, management states especially for North America:

The declining Victoza sales reflect a negative impact from changes in the channel and payer mix and the changes in the coverage gap legislation, impacting average realized prices negatively. Furthermore, sales of Victoza were negatively impacted by the launch of Ozempic and a competing once-weekly product.

New products cannibalizing the sales of existing products is a problem and especially sales of Levemir might decline due to increasing sales for Tresiba und Xultophy (and the patent loss) as well as sales of NovoRapid might decline due to increasing sales for Fiasp (side note: Patents for NovoRapid expired several years ago and sales are still strong). However, Saxenda won’t cannibalize any sales at all and is patent protected until 2023 and especially Ozempic and Rybelsus will grow at such high rates (for Rybelsus it is just an assumption, for Ozempic we have strong numbers indicating such growth) it is really neglectable if sales of Victoza are cannibalized in some way and Ozempic and Rybelsus are patent-protected until 2031. Overall, I would assume that Novo Nordisk can add between DKK 15 billion and DKK 20 billion in sales in the next few years – mostly driven by sales from Saxenda, Ozempic and Rybelsus.

Wide Moat

When thinking about products like Ozempic, Rybelsus or Fiasp, the patent protection is an important aspect – as already mentioned above. Patents are not necessarily the best source for a wide economic moat, but in the case of Novo Nordisk the patents create a very strong moat as it is not only based on one single patent, but on several, long-lasting patents. Additionally, Novo Nordisk has proven again and again that the company is able to develop new medications and constantly improve its portfolio by replacing existing drugs with better ones and generate patent-protected revenue again and again. We also have to acknowledge the superiority of many products that makes it difficult to replace the medications even after patents expired. I already mentioned NovoRapid above: the patent in the United States expired in 2014 and in the European Union it already expired in 2011 and generated revenue is still pretty stable.

(Source: Novo Nordisk Investor Presentation)

Novo Nordisk is also market leader in almost all segments it operates in. It is only second in the Haemophilia market, but has leading positions in the diabetes as well as the obesity market, which were growing in the double-digits over the last few years.

(Source: Novo Nordisk Investor Presentation)

And Novo Nordisk is not only market leader, but could also grow its market share. In the obesity market, the Danish company could increase its global market share to 54%. Additionally, Novo Nordisk could expand its global market leadership in the diabetes market from a market share of 27.6% one year ago to a market share of 28.4% right now. The company also has a market share of 46.5% in the global insulin market and a global market share of 47% in the GLP-1 market.

Novo Nordisk could especially increase its market share in the insulin market in Latin America from 44.5% a year ago to 51.0% and it still has a high market share in the insulin market in China (50.2%). As these two regions could be two potential regions for high growth in the future, a high market share for Novo Nordisk is positive. Novo Nordisk has also an extremely high GLP-1 market share in Latin America (68.3%) and in China the company is dominating the market almost entirely with a market share of 92.4%.

Aside from being market leader within the diabetes and insulin market, there are also high barriers to enter the segment which is dominated by a few major players – aside from Novo Nordisk, the two competitors Sanofi (SNY) and Eli Lilly (LLY) have the highest market shares. As for the entire biotechnology and pharmaceutical market, it usually takes about 10 years (or in some cases even longer) between the first research and the final submission and approval. This is not only a very long time frame for a new competitor, it is also extremely expensive and companies have to spend huge amounts on research and development (research and production facilities, scientists, know-how). Insulin is also a rather low value product (compared to many other patent-protected pharmaceuticals), which makes high sales volumes necessary. The incentives for new companies to enter the insulin market compared to some other diseases are rather low.

Overall Growing Market

Aside from the wide moat around the business, that is protecting Novo Nordisk from new entrants stealing market shares, the overall market is also expected to grow in the years to come. According to the IDF Diabetes Atlas, the global number of diabetics (type 1 as well as type 2) was around 425 million in 2017 and is expected to grow to about 630 million in 2045.

(Source: IDF Diabetes Atlas)

And although this reflects only 1.4% annual growth (which is bad enough as we are talking about people with a chronic disease), it will support revenue growth for Novo Nordisk.

Intrinsic Value Calculation

When assuming that Novo Nordisk’s free cash flow will stagnate in 2019 and 2020 (for example, due to a potential recession) and start growing again in 2021 to about DKK 35 billion and DKK 40 billion in 2022 and then continue to grow about 6% annually until perpetuity, we get an intrinsic value of DKK 350 (using a 10% discount rate). In my opinion, 6% growth is a moderate and very realistic growth rate for Novo Nordisk – especially considering that Novo Nordisk was able to grow in the double-digits for many years or even decades and had a long-term growth target of 10% or more a few years ago. Although the long-term growth target was abandoned due to the difficulties to grow in the recent past, I still don’t consider it to be unrealistic as a long-term goal and, in that case, Novo Nordisk would be severely undervalued.

Conclusion

The conclusion for my articles about Novo Nordisk was often a very similar one. I praised the company as one of the greatest out there, as it combines stable, above-average growth rates and very high, stable margins with above average RoIC and it will also profit from increasing demand in future decades. And all those in doubt if Novo Nordisk could grow again or if the growth story is finally over should have realized by now, that we only saw a small bump in the road and the company almost returned to business as usual.

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.