Novo Nordisk

Novo Nordisk remains a powerhouse with an impressive ability to innovate, a focus on the long term, market leadership and strategic position on key markets which is envied by almost everyone in the pharmaceutical industry. In the years ahead, we have a favourable view on Novo Nordisk’s product portfolio, and there is a small and somewhat overlooked product group that is growing in size and strategic importance.

Novo Nordisk is a global market leader that eases illnesses and improves the daily life of people around the world. After a weak stock exchange performance in 2016, the share price improved throughout 2017. We still see Novo Nordisk as a company with potential for long-term growth rates in the market for diabetes and obesity, where the number of patients has reached almost epidemic proportions.

We regard 2016 as a good example of a situation that we have described several times – high quality companies find themselves in times of temporary challenges. The year brought changes to Novo Nordisk’s core American market. Several years of continual price increases turned into price reductions, and from a previous long-term target of growth in operating earnings of 15 percent per year, this was reduced to the current target of a five percent annual growth in earnings. The target of a five percent annual growth seems realistic to us, and we even think there are good chances that Novo Nordisk will grow even faster.

Novo Nordisk’s business is still growing, and in 2017, the diabetes business grew organic revenue by seven percent. The price development on long-acting basal insulin on the American market is initially assessed as having recovered from the worst declines, and we thus expect the development from here on to be relatively stable. The American market is critical for Novo Nordisk with 50 percent of revenues, and a higher share of earnings. In the long term, the American market remains interesting due to other market mechanisms related to the access to medicine and the absence of price regulation.

Novo Nordisk is a global market leader with a market share of 47 percent on insulin and 27 percent on the treatment of diabetes, which includes more than insulin. It is a structural growth market due to the increasing prevalence of disease and a rising proportion of patients being treated. The number of diabetics is growing at almost epidemic rates, and generally the treatment process is a life-long one. Diabetes does not just affect people in Western countries; it is also increasingly becoming a problem for developing nations, where rising levels of prosperity and lifestyle changes are unlikely to change this development around.

A series of sensible changes to the management

In the fall of 2016, Lars Fruergaard Jørgensen stepped in as CEO following Lars Rebien Sørensen’s long and successful leadership where Novo Nordisk became the most valuable company in the Nordics. Lars Fruergaard Jørgensen’s assumption of the role has added an element of strategic rejuvenation, but it also ensured the continuation of Novo Nordisk’s strong culture, values and long-term focus on value creation due to Lars Fruergaard Jørgensen’s long previous career at Novo Nordisk. From February 2018, he will be joined by Karsten Knudsen, who has been appointed as the new CFO following Jesper Brandgaard, who had been in this role since 2000. We believe that Karsten Knudsen will contribute with an extensive financial understanding, but also with a broad operational experience with more than 15 years in Novo Nordisk, including a number of years in its American division. The commercial strategy on the American market is adjusted with a new American executive management team led by Doug Langa.

We see the choice of Norwegian Helge Lund as the new chairman of the board as a positive development. He has previously been successful as CEO of BG Group and Statoil and has also previously worked in the pharmaceutical industry at Hafslund Nycomed.

The long-acting insulin, Tresiba, which was FDA approved in the United States in December 2016, has had a successful market launch. In 2017, the product managed to increase the market share by approximately five percent of the market in the United States for long-acting insulin, and this was also the stated ambition of senior management for the year. These market shares have primarily been won at the expense of the French company, Sanofi. Novo Nordisk is thus holding on to approximately 35 percent of the market share for long-acting insulin in the United States.

With Tresiba, Novo Nordisk has been able to clinically document a superior product quality, why there are good opportunities to gain further market shares in North America. Tresiba has a documented positive effect on weight loss, and it has been documented that it has fewer side-effects on the cardiovascular system. Cardiovascular diseases are an often-overlooked consequence of having diabetes, and the positive impacts on this are thus increasingly being used by Novo Nordisk to market its products.

A potentially highly profitable product was approved in December

While insulin has long been the cash cow of Novo Nordisk’s value creation, the so-called pre-insulin is assuming a growing role with an underlying market growth of more than 20 percent. The GLP-1 product, Victoza, which was launched in 2010, was for many years the leading product on the American market, and it won a dominant market share approaching 70 percent. After 2014, the American competitor, Eli Lilly’s, launched the long-active pre-insulin Trulicity. The clinical profile of Trulicity is, at best, comparable to Novo Nordisk’s Victoza, but it has the advantage of only requiring a weekly injection whereas Victoza requires daily ones. Based on this, the growth of the sales of Victoza has been reduced to 18 percent in the last year since Eli Lilly has gained significant market shares, in a market with over 20 percent volume growth.

Victoza is marketed as a treatment against obesity as Saxenda. This is a highly growing market, and the sales of Saxenda amounted to 2.6 billion Danish kroner – corresponding to two percent of the company’s total revenue in 2017. This was 60 percent higher than in 2016, and it amounted to 40 percent of Novo Nordisk’s growth that year. Collectively, Victoza and Saxenda represents 23 percent of the revenue.

In December, Novo Nordisk was awarded the long-anticipated approval for their long-acting pre-insulin product, Semaglutide, which has been given the product name Ozempic for the treatment of type 2 diabetes in the United States. Ozempic is as convenient to use as Eli Lilly’s Trulicity, only requiring a weekly injection, but Ozempic has a much stronger clinical profile. Besides being better at controlling blood sugar, Ozempic has a significantly better weight-reduction effect compared to other GLP-1 products. Ozempic is thus not only viewed as a potential goldmine in the treatment of diabetes, but also very much in the treatment of obesity.

The approval of Ozempic is critical for Novo Nordisk’s growth in the years ahead, even if the approval was expected. The market-leading position on the strongly growing pre-insulin market would, most likely, have been lost over the next few years if this had not happened, and it would have reduced our expectations for the long-term growth potential of the company. The patent for the daily pre-insulin Victoza expires in 2023, and it is expected that a majority of these patients will be transferred to Ozempic before this.

Today, only six percent of diabetes patients are treated with pre-insulin in the United States, why the opportunities to continue to increase this share of patients are significant. The daily sales value of a GLP-1 treatment on the American market amounts to almost a doubling of the daily sales value of a patient on basal insulin treatment.

The profitability on the American market clearly surpasses that of the European business activities

In addition to an attractive growth profile on the GLP-1 market, the profit margins are high, as the production costs are limited to a few percentage points of net revenue. Higher growth rates in GLP-1 will thus have a positive product-mix effect on margins. The market for pre-insulin is practically a duopoly and the American competitor, Eli Lilly, is seen as a rational and strategic competitor.

The sales in the United States go through purchasing organisations that control the distribution to privately insured patients. These organisations have consolidated in the last few years, and this has resulted in an increased focus on discounts on the prices of life-saving medication. The combination of fewer purchasing organisations, in addition to the patent expiration on the market-leading long-acting insulin, Lantus, has encouraged the purchasing organisations to pressure the pharmaceutical companies to increase discounts. It is the size of these discounts that have put downwards pressure on the realised sales prices. It is worth noting that there are only around 11 million diabetics in treatment in the United States, compared to almost 30 million in Europe, and despite this, Novo Nordisk’s sales in the United States amount to 58 billion Danish kroner versus 21 billion kroner in Europe. This is also seen on other therapy areas. The pricing in the United States thus provides a significantly higher value for Novo Nordisk per American diabetic when compared to a European one, because in Europe, sales and pricing are often carried out through public (and more regulated) authorities.

With its large population and growing share of urban residents, China is a source of a significant future value creation for Novo Nordisk. With sales in China amounting to 11 billion Danish kroner in 2017, China represented almost ten percent of total sales and it grew by six percent in local currency terms. Novo Nordisk has a market share of almost 60 percent in China, and it is also the market leader in other developing countries such as Russia and Brazil. Today, a third of the growth in Novo Nordisk outside of North America comes from China. Besides an expected increase in the number of diabetics receiving treatment in China, China also provides strong opportunities to upgrades of treatments. Human insulin still amounts to more than 60 percent of the insulin sales in the country, compared to 10 and 19 percent in North America and Europe, respectively. A shift in this would be positive for both the sales and margins at Novo Nordisk – while also increasing the quality of treatment for the patients.

The Biopharma division grows stronger with an important leader stepping in

While the focus on Novo Nordisk often revolves around insulin, diabetes and obesity, the so-called Biopharm division represents around 17 percent of the turnover but an even higher share of the earnings due to the attractive profit margins. More than half of this revenue has historically come from the company’s products for the treatment of haemophilia. The Swiss company, Roche, however, has developed a new innovative leading product which may have a significant impact on Novo Nordisk.

The Biopharm division has been allocated important managerial resources, with the former CFO, Jesper Brandgaard stepping in, and there is increasingly a strategic focus on taking advantage of all potential possibilities, including acquisitions. We strongly believe that Novo Nordisk will remain disciplined in its search for acquisitions – and it was also quite satisfactory to see the company avoiding getting into a bidding war when, at the start of 2018, they submitted a bid on an Belgium developer of haemophilia medication.

Novo Nordisk maintains a disciplined grip on its capital. Over the last three years, its cash conversion has exceeded the target of 90 percent of earnings. This target is expected to face some challenges in the coming years due to increased investment, including investments in a production facility in Clayton, North Carolina, which will be the second site to produce the pharmaceutical component of insulin. So far, this has only been produced in Kalundborg, Denmark.

At the same time, the invested capital must provide returns of more than 125 percent, and this highlights the value-creating business model – over the last few years, these returns have been at almost 150 percent. It is our assessment that CFO Jesper Brandgaard, throughout the last 16 years in the role, has made a significant positive contribution to this focus on creating value – a focus that Karsten Knudsen is expected to maintain. This does not mean, however, that investments are not being made in research and development, even if the lowered growth forecasts in 2016 led to a focus on research projects that had the greatest potential for commercial success. Mads Krogsgaard Thomsen has been the head of R&D at Novo Nordisk since the year 2000, and he has been with the company since 1991. Today, spending on research amounts to approximately 13 percent of the turnover, and we expect this level to be maintained. 2018 will have interesting news on the possibilities of developing an oral form of Ozempic, where the development of a pill with both a positive impact on blood sugar and weight loss is assessed as providing the company with a great opportunity to enter the market for oral treatment of diabetes, a market where Novo Nordisk has not previously had a presence.

Attractive share price

In 2017, the company made share buybacks of almost 17 billion Danish kroner, amounting to almost three percent of the market value at the beginning of the year, and on top of that, there was distributed more than three percent in dividends. In 2018, the free cash flows are expected to amount to approximately 30 billion Danish kroner, or more than four percent of the market value. It is the stated policy of Novo Nordisk that the free cash flows are to be apportioned to shareholders through dividends and share buybacks if there are no other opportunities to use these funds to expand the business – such as, for example, an acquisition for the Biopharma division. The financing of the company remains conservative with approximately 17 billion Danish kroner in the bank and no debt.

Despite a strong share price appreciation of 35 percent in 2017, the share price has fallen by 13 percent in local currencies over the last two years. Since the underlying business has seen good development, this equates to a significant de-rating of the company, which today is valued with free cash flows amounting to almost 4.5 percent of the market value and where the price per share is less than 20 times the expected earnings in 2018.

We still see significant potential in the delivery of life-improving medication to a rapidly growing number of patients. Novo Nordisk has a leading clinical product portfolio, and with it, the company is facing interesting times ahead.