For the Challenge, a panel of 27 judges consisting of peers and institutional investors evaluated ideas from over 150 fund managers worldwide. Dan H. Chen’s investment thesis on Novo Nordisk was voted by consensus as one of the top ideas.
Read the full investment thesis by clicking here: PDF Link To Dan's Novo Nordisk Investment Thesis.
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Dan H. Chen
Talguard Investments LLC
Text Version Of Dan's Novo Nordisk Investment Thesis:
Thesis Executive Summary:
The Market is oversold on concerns on Novo Nordisk’s stock while it undervalues 12 catalysts that I highlight in regards to this cash flow king. Novo Nordisk (“Novo” or the “Company”) is currently undervalued by more than 35%. This thesis is for Novo’s U.S. ADRs Class B common shares. Novo has all the qualities I like for a long term investment and it provides good value based on current prices. The Company has decades of steadily growing cash flow even through the last two recessions. Novo has tremendous new growth opportunities that the Market fails to realize as it is focused on the Company’s risks. The Company has a long track record of consistent share repurchases over the past 20 years. Management has stepped up repurchases amidst the current downturn in prices. This is exactly the right time to strike.
Novo Nordisk is a dividend blue chip as it has increased dividends every year for nearly two decades regardless of industry or economic downturns. Revenues are expected to grow 5% instead of 15% but there is real upside. The key is that revenues and EPS will continue to grow. At the same time, the Market values the Company as if it is losing both revenues and profitability. Novo’s businesses have consistent and growing demand through recessions. Novo generates over 40% operating margins even after factoring intensified competition and 20% net income margins. Currency fluctuations have negatively affected operating income by 8%. This situation will pass as time goes on. Primary and Secondary Research shows that Novo has a sterling reputation for its branded products and delivery systems.
Why Does This Situation Exist?
Novo Nordisk’s stock has dropped significantly in the past six months due to several specific reasons that I will address:
- Public concern and benefit management pushback over drug prices as a whole
- Increased competitive pressure from biosimilar branded and generic drugs
- Currency fluctuations
- Company’s announcement of a slow down in growth
Despite the current pressure, the Company is still set to grow revenues and profit by mid-single digits. Read my catalysts below for a clearer picture of the Company’s promise based on current valuations. The Company will have a good shot at beating its 5% revenue target. It has a high chance to beat a 5% net income growth target with its current share repurchase program that the Company is aggressively utilizing at this time. There has been no decline or complete reversal into negative income territory.
I Identified 12 Catalysts The Valuation Will Turnaround Summarized Here:
- Tresiba – Longest duration insulin in the market at 40 hours, 67% longer than Sanofi’s Toujeo. It has a huge U.S. market opportunity and early results are encouraging. It is much better than Sanofi’s next gen Toujeo which is a new name for its old drug Lantus with no improvement. After a delay by the FDA, Tresiba will gain steadily gain significant market share in the U.S. much as it did in Japan.
- Xultophy Combo Play – This combination of Tresiba and Victoza has tested extraordinarily well. In fact it has the best test results ever for a combo insulin package. Expect Xultophy revenue to grow to the same size as Tresiba.
- Company Is Positioned Well For Worldwide Diabetes Growth – Most growth will come from non-western nations. Novo positioned itself as the leader in China and it looks to do the same in other regions.
- Unmatched Scale and Barriers to Entry: Scale matters in testing, manufacturing, and marketing insulin drugs.
- All Star Pipeline - Novo’s product pipeline is the best in the insulin industry.
- Huge Share Repurchase Will Be Accretive: This is exactly what I want from Companies when their stock is cheap. This will boost EPS. Company’s board recently authorized a huge difference.
- Dividend Royalty Rewards You:Company has rewarded shareholders with a dividend that grew from $0.03 in 2001 to $1.41 in 2016 inclusive of a bonus dividend. Novo will continue to grow this dividend going forward.
- Wide Economic Moat: Primary and secondary research shows that the Company’s products are trusted by the medical community. Novo has highly regarded, branded products that are sticky with customers and with the medical professionals. Novo operates in an industry that requires scale not just on manufacturing, but also marketing, shipping, handling, and storage.
- Highly Innovative Company: Company’s products are high quality and have experienced less problems than competitors.
- Proactive Approach By Management:The Company was the first in the insulin industry to take the lead and cap future price increases.
- Buyout Potential: I never invest hoping for a buyout. However, Novo has zero long term leverage and a great balance sheet and one of the few pure plays in pharmaceuticals. It also has an industry leading position. These characteristics make Novo an attractive target for a large buyout or merger.
- Danish Government Support: Denmark is one of the most hospitable places for a life science company. The Danish Government recently formed committee to address industry concerns. Novo is the crown jewel in this industry.
The Following Are The 12 Catalysts Explained In Detail:
1. Tresiba Growth Opportunity In The U.S.:
Tresiba is crushing it in other regions and it will gain a lot of market share in the United States as it steps up to capture enormous market share. Tresiba is the longest acting insulin available with a 40 hour duration. This has a major advantage because it gives consumers a lot more convenience. Americans love convenience. Tresiba has shown to be effective and safe for long term use in adults and children who have Type 1 diabetes. (Source: NewsMax.com, Sep 2014). It has shown to improve blood sugar control with increasing hypoglycemia risk in children aged one to 18. Tresiba has been approved in Europe in 2013 and has had a good track record for the past three years. Tresiba has crushed it Japan as it has grown market share to 40% in three years.
Tresiba is taken by injection with Novo’s FlexTouch delivery system. Tresiba has a molecular structure that connect like a string of pearls. Once in the body, the end pearls release and then the next set releases over time giving the patient over 24 hours of blood sugar control.
Tresiba was delayed by the U.S. FDA until the first quarter of 2016. It captured an immediate 2% market share in the first month of release and it has grown to 12% of the U.S. Market by September 2016 (Source: IMS Weekly Data, October 2016). That is just 8 months. Novo’s Levemir has maintained a healthy 19% market share. Combined, Novo now has 31% of the long duration market. Tresiba’s market share is expected to grow in the U.S. Tresiba has shown a powerful long term penetration in other large developed markets. For example, in Japan, Tresiba steadily grew market share since its launch in March 2013 to capture 40% of that market. This was against the backdrop a biosimilar product that was launched. (Source: Novo Nordisk Presentation). Tresiba has a lower bar to cross versus Novo’s previous generation, Levemir, which has a 25% U.S. market share. Novo has a potential 15% upside in the U.S. if Tresiba mimics its market share elsewhere.
Much has been said about the increased competition against Novo. Tresiba is a major answer that have competitors worried. Tresiba will take a lot of market share from competitors in the U.S. market. This equates to a $2.5 billion opportunity. Levemir will not be cannibalized completely. Tresiba represents a 60% potential increase in revenues versus Levemir in the long run for the U.S. segment. Novo’s sales force has gotten Tresiba a wide 75% formulary access through a combination of commercial channels and Medicare Part D.
2. Xultophy Combo Play:
Xultophy is a combination of Tresiba and Novo’s GLP-1 drug Victoza. Results for the combo drug Xultophy are very promising as they have shown some of the strongest late-stage data that Novo has ever seen. Xultophy revenues can be as high as Tresiba. This is an upside of another $2.5 billion in the long run. According to primary and secondary research, Novo has a very experienced and professional sales force. Novo in fact has one of the best sales force in the business and that will benefit both Tresiba and the Xultophy combination.
3. Company Is Positioned Well For Worldwide Diabetes Growth:
Diabetes is on the rise worldwide and Novo is positioning itself to have a leading position to serve patients in the areas with expected large growth. It is not just a developed world health issue. According to the International Diabetes Foundation (“IBD”), there are currently 415 million people with diabetes in the world. That number is projected to grow 55% to 642 million by 2040 (Source: International Diabetes Foundation, IBD World Atlas 7th Edition, 2015). Insulin demand worldwide should increase with a CAGR of over 6% in the next five years and that is on the conservative side. Branded insulin is approximately $45 billion and set for continued growth. Novo has a worldwide market share of 28% of this segment. Novo has a market share of approximately 30% of the $30 billion of the insulin therapy market portion.
Non-western countries will have the most growth in diabetes. India has approximately 78 million diabetics and Eastern Asia including Oceania has 153 million. That is projected to grow to 140 million and 215 million by 2040, respectively. In the Middle East and North Africa, diabetes is projected to more than double from 35 million in 2015 to 72 million in 2040. In Sub-Saharan Africa, diabetes is projected to grow from 14 million to 34 million (Source: IBD, 2015). Novo has made in-roads with its older analogs and modern insulin products and delivery systems in these areas.
In China, the Company was the first to lay major groundwork in 2004. Novo now has the largest sales force and a leading market position. The Company was the first to recognize the Chinese market potential and actually take action. It was the first to build a partnership and sales force in China in 2004 and that will be pay big dividends going forward. It is now to looking to do the same in other high growth regions. This has translated to revenue growth of 12% for the First Nine Months of 2016 in China.
4. Unmatched Scale and Barriers To Entry:
Novo accounts for approximately 28% of the global market for insulin. Together with its support accessories such as its insulin delivery systems, Novo Nordisk is the clear #1 producer of diabetes treatment and care products in the world. Novo has the most extensive expertise in insulin, much more so than any of its competitors. Insulin is just a portion of revenues for its main competitors. For Novo, diabetes care is what the Company was founded on and remains its core mission. Novo is the largest company in Denmark. Denmark is a small country and it values its competitive industries. This gives Novo strong influence to ensure it has favorable treatment in its home base. The worldwide market for total health expenditure for diabetes care is approximately $81 billion. That is a staggering 12% of the $673 billion spent on global health expenditure in 2015 (IBD 7th Edition 2015).
Approximately 24 million consumers worldwide use a Novo Product now. That is projected to grow to 40 million in 2020. Novo’s sales force is a seasoned machine and highly successful at drug placement once approved.
5. “All Star” Pipeline:
If this is baseball, then Novo has one of the best “farm systems” of next generation insulin drugs in the league with a slew of “top rated prospects” in the GLP-1 segment. This positions Novo well for high margin products and to expand into new markets. The Company has filed fast acting insulin aspart and Semaglutide. It has also filed another Hemophilia compound N9-GP. Tresiba and the Xultophy Combo Play will be large drivers ahead.
For GLP-1, Novo’s Semaglutide has had fantastic trials and has proven to reduce non-fatal heart risk by 26% during a 104 week clinical trial versus a placebo with 254 events. There is a reduction of 39% for non-fatal stroke versus the placebo in the same trial. (Source: FiercePharma, September 2016).
6. Huge Shareholder Repurchase Will Boost EPS:
The Company is an outstanding steward of capital and treats shareholders very well over the long run. Novo repurchases shares on a consistent basis and grows its dividends non stop. In the midst of this downturn, the Company has stepped up share repurchases. On October 28, 2016, the Company announced a share repurchase program of approximately $2.1B (based on a 7.00 Danish Krone (“DKK”) to U.S. Dollar conversion as of December 13, 2016). The Company has thus far spent $277 million to repurchase 8.37 million shares. Since November 28, 2016, the Company has repurchased 1.57 million shares. The Company has repurchased shares for 15 straight years and has reduced shares by approximately 28%.
7. Dividend Blue Chip:
The Company is a dividend king. It has grown dividends for 15 straight years with a CAGR of 29%. The dividend enjoys a large cushion to EPS. This is all while continuing to make product investment decisions that have grown cash flow significantly. The Company has grown dividends from $0.03 per ADR in 2001 to $1.41 in 2016 inclusive of a special dividend. Back out the special dividend and the CAGR is still an impressive 26%. The Company will continue to reward shareholders.
8. Strong Economic Moat:
The Company has continued to dominate the diabetes industry. The Company has a leading position in branded insulin. Entering the insulin market requires a very significant start cost. Insulin is considered a big molecule therapy and it requires very high clinical trials costs and manufacturing costs. Big molecule therapy has more trials and machinery needed to not only manufacture but also for delivery versus small molecule therapy products.
Biosimilar products for insulin has been available for years. Yet Novo has continued to innovate and market its products effectively. As mentioned in global growth potential, the Company was the first to establish a large scale marketing and distribution system in China. It is planning to do so in other high growth regions. Because of this, Novo has an established lead in China. Why did other companies not do the same earlier? It is because Novo’s management thinks long term and plans ahead.
Insulin has to be stored in liquid form and it has a very short shelf life of less than 12 to 26 weeks. Insulin has a high shipping and handling cost because it needs to held in heavy glass containers. Novo Nordisk also has the added advantage of a diverse array of well developed delivery systems. Novo has a long history of quality products sold by a seasoned, highly trained sales force. Primary and secondary research has shown there is a high degree of trust with Novo products. Novo products are often categorized as Group 2 products which means they are the “Preferred” and more “effective” branded product in formularies. Group 1 are generics and Group 3 are less preferred branded products. These factors combine to give Novo a strong economic moat.
9. Highly Innovative Company:
Since its founding over 80 years ago, the Company became a leader in innovation and it continues to be with its impressive pipeline. This commitment to innovation has reduced the demand for older, human insulin therapies. The Company now has more than 80% of its revenues derived from modern insulin analogs. The Company has products ready to go to replace some of their current lineup of NovoLog, Levemir, and NovoMix.
10. Proactive Approach By Management:
Novo’s management team has a history of proactive thinking. The foresight to plant seeds and grow its China sales force is a championship move. In September 2016, the Company announced it would reduce its workforce by 1,000 from its current 42,600 staff. Novo has continued to innovate with its large pipeline. Novo’s management has certainly been direct in acknowledging challenges such as Roche ACE910. The same is true about insulin competition and benefit manager pushback. Novo has proactively announced it will cap price increases at 10% for any given year. This gives the Company a good response if challenged by lawmakers over drug prices. Lars Fruergaard Jorgensen, 50, will take over as CEO on January 1, 2017 following the retirement of Lars Rebien Sorensen. Mr. Sorensen is retiring after 16 years at the helm of Novo Nordisk who guided the Company to a global company. Incoming CEO Mr. Jorgensen is a seasoned veteran of the Company with 25 years of experience, currently serving as Executive VP of Corporate Development.
11. Buyout Potential:
I never invest in a company with the hopes that it will be bought out. However, Novo has attractive qualities as a target. The Company is a very large size for sure. The recent drop in stock price has made an acquisition or merger more manageable. The Company has zero long term leverage. It has a fair amount of cash on hand. Novo has an attractive current valuation. It is a focused company as the #1 company by market share for the insulin industry. It has a highly profitable secondary and tertiary businesses. It is based in Denmark which offers the opportunity for a reverse merger not just for U.S. Companies but other international companies. Denmark has a relatively low corporate tax rate, lower than most of the countries in the developed world. These factors make it attractive for an international conglomerate.
12. Danish Government Support:
Novo Nordisk’s home, Denmark, is the ideal place for a life science company. It has the most trials per capita in the world. The Danish government has set up a single point of entry for identification and contact for its vast array of sophisticated clinical trial facilities in their hospital system. The Danish system registers the entire populations from “cradle to grave” so there are more than 500 bio banks that produce extensive medical records. Denmark is one of the fastest countries to approve clinical trials which has been an advantage for Novo to test and retest early stage drugs.
In June 2016, the Danish Government set up a special committee called the Life Science Growth Team to help support the country’s life science industry. The committee has one objective and that is to put forward suggestions to boost the Life Science Industry. The Danish Government is highly supportive of this industry and has every reason to see that this industry continues to thrive. Novo Nordisk is the crown jewel of this industry.
Industry and Competition:
Novo Company Description:
Novo develops insulin, hemophilia, and obesity treatments. Novo also produces a wide variety of delivery systems to store and administer these treatments. The Company has a global supply chain to manufacture and transport the products. Novo has a seasoned sales force to get the products on to formularies around the world.
Novo Nordisk is the combination of two prominent Danish companies. Nordisk was founded in 1923 and Novo was founded in 1925. I enjoy reading about the history of leading companies and this one is no different. This Company’s longevity is an attribute I seek in investments. Novo Nordisk is the #1 global leader in insulin products. Novo’s revenues are derived from 80% in insulin and 20% from hemophilia.
Many argue that insulin is a commodity. While the manufacture of basic insulin is cheap there is so much more to this industry than meets the eye. You have to consider duration, time to act, dosage, and delivery systems. Novo is the clear leader in innovating quality products, with great delivery systems, and a strong marketing/sales force that the other companies cannot match.
Insulin Industry:
According to the International Diabetes Foundation (“IDF”), approximately 415 million people in the world have diabetes as of 2015 (Source: IDF Diabetes Atlas 7th Edition 2015). That is 1 in 11 adults. Approximately 90% have Type 2 diabetes and approximately 10% have the Type 1 variety (Source: World Health Organization, December 2014). Diabetes has grown from 108 million in 1980 to over 422 million at the start of 2015.
Novo faces competition from branded products and from generic manufacturers. There are three large branded competitors. They are Sanofi, Eli Lilly, and Merck. MannKind has a single product in Afreeza purchased from Sanofi. There is a private company called Adocia that has three products in development. Boehringer Ingelheim, Novartis, and AstraZeneca have joint venture collaborations. Johnson & Johnson produces insulin patches and pumps. Takeda produces several modern insulins.
For all the talk of increased competition, two major competitors have been nearly eliminated with Novo capturing a lot of their market share. Novo did exceptionally well in Japan over the past 10 years. Takeda global insulin market share has dropped from 19% as #2 behind Novo in 2005 down to less than 3% in 2015. GSK has dropped from number #3 at approximately 15% global insulin market share down to near zero.
Novo has by far the widest array of insulin products in every category and delivery devices. Novo’s Victoza far outperformed Sanofi’s Lyxumia. Victoza cut blood sugar levels significantly more with a 1.83% reduction in HbA1c versus a 1.21% reduction for Lyxumia, a 51% stronger reduction. Victoza helped 74.2% of trial patients reduce HbA1c targets to less than 7%, versus a 45.5% rate for Lyxumia (Source: FiercePharma.com, September 2015). Eli Lilly’s Trulicity is a direct competitor to Novo’s Victoza. Trulicity has a dosing advantage of once a week administration versus Victoza’s daily administration. Novo’s answer is to launch a once-weekly version of Victoza next year. Teva is coming to market with a generic TLP-1 biosimilar for a projected 2017 launch. I am not as concerned by this. Primary research has shown that biosimilar analogs have come to market for years but the demand for branded products continues to grow from the medical community.
Novo’s Victoza continues to experience strong growth despite exclusion from the Express Scripts formulary since 2014. There have been other GLP-1 analogs that have grown to challenge Victoza. Sanofi has a GLP-1/insulin dual product that should reach the market at approximately the same time as Novo’s Xultophy.
Tresiba experienced delays to come to market in the U.S. but it has now been approved and marketed on television since 1Q16. Novo has an excellent track record for rolling out new drugs. Tresiba is no different. Since it launched in Japan in 2013, Tresiba has grown every year and has now captured a 40% market share. Japan’s pharmaceutical market has many similarities to the United States. For example, the average price per unit is similar to the United States.
Sanofi’s next generation Toujeo product came to market first in the U.S. but this is a sub-par product. It is basically a new name for an old drug in Lantus because of patent expiration. Toujeo has no improvements. Both Lantus and Toujeo are 24 hour durations. In fact, Toujeo has a longer 6 hour onset of action versus Lantus’ 3-4 hours. Tresiba will crush this drug with its much longer duration of 40 hours. Eli Lilly is planning to launch a product similar to Sanofi’s Lantus in the coming months. This is an inferior product as compared with Tresiba.
Boehringer Ingelheim produces ProZinc as a branded product insulin. It has collaborations with Eli Lilly for Basaglar. Boehringer also produces generic drugs. AztraZeneca produces Byetta and Byuderon. It has also formed collaborations in the past such as the one that ended with Brystol-Myers Squibb to treat Type-2 diabetes. Johnson & Johnson (“J&J) produces insulin pumps and insulin patches. In October 2016, J&J announced that its insulin pump was susceptible to hacking. However, J&J will continue to be a major manufacturer of patches and pumps for the industry.
In April 2016, MannKind gained full control and marketing for Afreeza which is a human insulin. This is not a major competitor to Novo Nordisk. First of all, Afreeza is not a substitute for long form insulin and must be used in conjunction with a long form insulin for consumers with Type 1 diabetes. In other words, consumers may be using a Novo Nordisk product in order to maintain their blood sugar even when they use Afreeza. Afreeza is listed as a tier 3 medication which means it is a branded product that is not the best choice for most patients. Furthermore, the use of human insulin is on the decline. Synthetic insulin and next generation insulin control more than 80% of the market and it is projected to keep growing. MannKind is a penny stock that might go bankrupt.
Adocia has three products in development. Its Lispro product is an accelerated version of Humalog in conjunction with Eli Lilly. Its BioChaperone Combo is a mixed basal/bolus product that is combination of Lantus and Humalog. This is in conjunction with Sanofi (Lantus) and Eli Lilly (Humalog). Adocia is also developing a lower priced rapid insulin and a more concentrated version called Hinsbet. All of these are still in Phase 1 clinical trials. These are still way off in the future and the Company will find it difficult to match the marketing dollars of Novo Nordisk.
Hemophilia Industry:
Hemophilia is an illness that prevents blood clotting. Some of the most famous cases afflicted the Russian Czar families. In the U.S. only 20,000 people have this illness but it requires treatments that are very high dollar amounts. Novo has a $1.5 billion drug in NovoSeven and will have NovoEight in the future. Several other companies have treatments in this segment. Roche is coming out with a much-hyped hemophilia treatment called ACE910. It will certainly take market share but Roche’s product does have its share of problems and it may not come to market in the time frame that many observers think. The FDA is notorious for delaying new drugs at the first sign of trouble in clinical trials and ACE910 certainly has an issue that we know of so far. Read it in greater detail in the Risks and Rebuttal section below.
Obesity Industry:
Obesity is on the rise worldwide in conjunction with diabetes. Obesity is not treated as a chronic disease but the condition has been given a lot more attention by the medical community worldwide. Novo has a tremendous growth opportunity with obesity. The Company’s Saxenda revenue grew by 331% to $142 million for the first nine months of 2016. This represents approximately 1.2% of Novo sales so it is a small segment at this time. However, it is a highly profitable and growing segment. Other weight loss medicines include Xenical, Alli, Belviq, Over-The-Counter Medicines and Vitamins. Sexanda has now become the third largest player in the market with a market share of volume of 10.6% (IMS NPA, TRx, Weekly Data, 2015). Looking forward, Novo has 4 obesity drugs in the pipeline.
Growth Hormone Industry:
Novo’s Norditropin is the only market prefilled pen-based liquid growth hormone product that remains stable at room temperature (Source: Technavio.com). This gives it a strong advantage. Novo currently holds a 32% market share in volume accounting for $1.1 billion in sales for 2015. That is on pace to grow approximately 5% to $1.2 billion in 2016. This is a highly fragmented market but Novo has done well to not just maintain market share but to grow it as well. Norditropin has grown from 28% market share in 2013 to 32% in 2015 (Sources: Technavio.com, Market Realist).
Risks & Rebuttal To Shorts:
Competition:
The Insulin, Hemophilia, and Obesity markets are highly competitive. As discussed in the Industry and Competition section, the Company faces several large conglomerates such as Sanofi and Eli Lilly. Novo also faces challenges from generic drug manufacturers. The Company has been highly successful with over 80 years at innovating next generation products. Novo also has more scale than any competitor for insulin production and delivery systems. This has kept it in front and helped it maintain margins over the long run.
Roche has a new hemophilia treatment, ACE910, that will capture market share when it is released but there is now uncertainty on when that will be. It is a potential game changer and Novo management has recognized it as such. However, I do not agree with some who claim this product will take over the industry. Far from it. Bloomberg estimates $681 million in sales by 2021. This will represent approximately 5.2% of the industry based on an estimated industry size of $13 billion in 2021. ACE910 has problems. In November 2016, four patients in a clinical trial suffered “serious adverse events” due to Roche ACE910. More importantly, they were for two separate problems. There were two thromboembolic events (blood vessel clots) and two cases of thrombotic microangiopathy (capillary and arteriole blood clots). This suggests patients still experience breakthrough bleeds despite receiving ACE910. Plus this product’s potential impact on Novo has already been factored into the current valuation of Novo.
Generic Biosimilars:
Much has been made about generic biosimilars and the threat they pose to Novo and branded drugs. Novo drugs will continue to sell well because they have competitive advantages. This will be the case long after Teva launches their generic of an old insulin drug. The Company continues to innovate to keep that advantage. For example, Tresiba is the longest acting insulin in the market with duration of 40 hours. No one else has this and no one else is close. Novo used to dominate Human Insulin and then the patents expired. Guess what? Novo moved on to synthetic insulin and now is the leader in that field. Plus Novo was still able to retain market share in the declining human insulin segment.
Novo’s drugs are considered top quality and marketing counts. There are many drugs that are generic but that does not stop branded versions from dominating. If you set aside for a moment the controversy with Mylan, you will see that the drug for EpiPen has been a generic for years. Even with Sanofi having a recall and several generic brands available for decades, EpiPen has continued to dominate that world. In other words, Novo has a good reputation in the medical community and it has a solid sales force. Plus its marketing has been effective and driving trust.
Teva is launching a generic based on a dying product. It is based on AstraZeneca’s Byetta which saw sales plunge by 31% in 1Q16. Byetta is a short term insulin and its generic will have low margins. Furthermore, Teva has been making generic biosimilars for many industries but yet branded products continue to not only survive but thrive. If generics are going to dominate, why did Teva’s revenues decrease for several years in a row? Generic products have almost no economic moat. Customers do not care what the brand is, and over the long run branded products will have a much more loyal following which makes their products more sticky.
Cure For Diabetes:
Universities, research institutions, and private companies are working daily to find cures to many major diseases and illness. A cure can cause major disruption to the diabetes industry, especially Novo. For example, Johnson & Johnson announced it was collaborating with private companies to find a cure to Type 1 diabetes and that some results were promising. Primary research and other channel checks show that a cure is far off at this time. Novo is also not sitting still. The Company has devoted resources to potential cures and also to delaying the onset of diabetes. The Company’s obesity drug is doing well.
Pricing Pressure:
The Company faces pricing pressure from three angles. Benefit manager pushback, public outrage over drug prices in general and competition has reduced Novo’s share price by over 40% in recent months. Novo still projects growth of 5% on top line and bottom line. The step up in share repurchase will bump EPS growth higher than 5%. Novo has taken a proactive approach in announcing it will not increase prices by more than 10% in any given year. I support this type of logic. It is proactive and it shows the Company is getting ahead with managing expectations to both regulators and the public. This will likely result in a better climate for the Company in the long run.
Regulation:
The Company’s products and services are highly regulated. Negative public sentiment on pricing has led to hearings for a variety of drug companies. President-elect Donald Trump has called out the pharmaceutical industry that drug prices are too high. There is specific concern over the price of insulin. This can have an adverse reaction to pricing. As mentioned above, the Company has taken a proactive approach to address pricing that provides a ceiling and greater transparency over drug prices. Many investors have punished pharmaceutical stocks because of these concerns. I would not be overly negative on this industry. Many concerns have been priced in to Novo Nordisk’s stock price.
Litigation:
The Company is subject to litigation risk at any time given the nature of its products. This has been the case with the entire drug industry since inception. Novo Nordisk has operated successfully in this environment for over 80 years and there is no reason to speculate this will change at this time. Novo’s products have shown better results than many of its competitors. Most litigation cases have been for non-product related issues. Novo has been the gold standard for product reliability.
Side Effects:
Side effects can occur from insulin therapy, with hypoglycemia the most common. Novo’s products have an excellent track record. For example, Tresiba has a much lower hypoglycemia risk than competitor products.
Anti-Globalization Movement:
The elections across a number of countries have resulted in votes against globalization. From Brexit in the UK to the election platform of Donald Trump in the United States, there is a movement against globalization. This can have negative effects on a global company like Novo Nordisk.
Voting Shares:
The Class B Shares available to the public have less voting power. Class B Shares have 72.5% of the capital and 24.7% of votes. Class A shares are not listed and owned by Novo A/S. Novo A/S is an LLC in Denmark wholly owned by the Novo Nordisk Foundation. This is mitigated by the fact that the Company has return billions of capital to shareholders over decades.
Currency exchange hurts revenues:
The Company has a significant portion of its revenues outside the United States but it reports its financial results in U.S. dollars. This subjects the Company’s results to foreign currency fluctuations which can hurt results. This risk has been with the Company since its inception and it can also help the Company at times.
Financial Metrics and Valuation:
Many of the concerns are reflected in the current valuation. Revenues and net income are estimated to grow 5% which would equate to approximately $17.4B and $5.7 billion, respectively, for fiscal 2017. This accounts for $1.4B for Hemophilia revenues in 2017. SG&A expense is projected to decrease approximately 300 basis points from reduction in staff and other savings. Based on recent share prices, the repurchase program can reduce shares outstanding to approximately 2.3B shares. This generates an EPS of $2.45. Valuation based on EPS and historical P/E reflects 38% upside. 10 Year ROIC has been an impressive 28.9%. Dividend yield of over 3%. Valuation based on current EBITDA less capex has 43% upside. This does not include the 4.1% growing dividend on top of the upside valuation catalysts.
The Company grew its business from inception to 2016. It has zero long term leverage now which is a huge plus. Current ROI and EPS Growth is 24.6%. ROE is over 50%. Company has an attractive EV/EBIT of approximately 8.7x. Current and Forward P/E at 16.4x and 15.5x, respectively. Forward P/E margin of safety at 20% relative to 10 Year P/E average.
Core segments grew in 9M16. Victoza revenues increased 12% for 9M16. New generation insulin revenues grew 182% for 9M16. Saxenda sales jumped 331% for 9M16 to $142 million. New generation drugs including Tresiba, Xultophy, and Ryzodeg sales increased 185% to $400 million.
Company has an outstanding net profit margin of 32.6%. Even with compression based on current market concerns, the Company will still have net profit margins at over 25%. That is far better than most companies on Earth.
Dividends have grown every year and it is a dividend with a margin of safety. Share repurchases have occurred every year and it has been stepped up during this downturn. The Company has returned billions to shareholders over the decades through consistent share repurchases and growing dividends. These are on top of strong cash flow.
Conclusion:
Novo Nordisk offers you the opportunity to invest in a quality company with a proven track record of innovation, solid products, and creating great returns for shareholders. Some concerns are overblown. The legitimate concerns have been priced in to the stock while the catalysts have not been fully appreciated. The upsides of Tresiba, Xultophy, China, India, and worldwide diabetes trends are being undervalued. Its foresight investing in the China market is a championship move that will pay off in the coming years. More importantly, the Company can replicate this move in other target markets such as India, Africa, and the Middle East. Novo Nordisk is a cash cow king that grew cash flow and EPS through the last two recessions and it will continue to reward shareholders will repurchases and increasing dividend payouts in the coming years.
Disclaimer Statement:
This document and information herein represents the views of Talguard Investments LLC and is not to be considered investment advice. The information herein should not be considered a recommendation to purchase or sell any particular security or financial instrument. There can be no assurance that any securities discussed herein will remain in the Talguard Value Fund LP.
This document does not constitute an offer to sell or a solicitation to buy membership interests in the Talguard Value Fund LP. Past performance is not necessarily indicative of future results. All information provided herein is for informational purposes only.
Investment in the Fund will involve significant risks due to, among other things, the nature of the Fund’s Investments (as defined herein). Investment in the Fund is suitable only for sophisticated investors and requires the financial ability and willingness to accept the high risks in an investment in the Fund. No assurance can be given that the Fund’s investment objectives will be achieved or that investors will receive a return of their capital.
In making an investment decision, prospective investors must rely on their own examination of the Fund and the terms of this offering, including the merits and risks involved. Prospective investors should not construe the contents of this letter as legal, tax, investment or accounting advice. Prospective investors are urged to consult with their own advisors with respect to legal, tax, regulatory, financial and accounting consequences of their investment in the Fund.
Talguard Investments LLC
Chief Investment Officer: Dan H. Chen, B.S., M.B.A.
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©2017 Talguard Investments LLC, all rights reserved.
©2017 Talguard Investments LLC, all rights reserved.