Novo Nordisk

Novo Nordisk continues to gain market share around the world under a relatively new management. The company is incredibly strong in research and development, costs have been cut, market share in the United States continues to strengthen, and several pockets of growth are looking quite attractive – both in terms of geography and products. Novo Nordisk is a winner, who is most definitely not stalling. Quite the contrary.

Historically, Novo Nordisk has been associated with insulin. This goes all the way back to Nordisk Insulinlaboratorium (the Danish word for “insulin lab”), which was founded in 1923 and then subsequently merged with Novo Industry A/S in 1989 – and this merged business then became what is now the most valuable company in the Nordic region: Novo Nordisk.

In 2018, insulin still represented more than half of Novo Nordisk’s revenue, but it is expected that Novo Nordisk’s pre-insulin in the GLP-1 class will be the primary source of growth. However, the focus remains on diabetes, and, increasingly, obesity.

Novo Nordisk is a global market leader, and in 2018 it managed to strengthen its market-leading position. Novo Nordisk eases the symptoms of illnesses and improves the everyday lives of diabetics around the world. Diabetes and obesity are practically epidemics, and there will be a growing demand for more effective and safe products.

Up until around 2016, Novo Nordisk benefitted from high single-digit annual price increases on insulin on the important North American market. This is no longer the case, and insulin prices have faced downwards pressure – with prices declining by 20 percent per year. This is faster than both we and the management at Novo Nordisk had expected. Novo Nordisk remains a growth company, and in 2018 the revenue from diabetes and obesity care grew by six percent in local currencies.

By being half of the Group’s revenue, the North American market is, as mentioned, important to Novo Nordisk. In addition to the growing numbers of diabetics and increasing obesity rates, the market is also attractive due to other market mechanisms such as the access to medicine and the absence of public price regulation. This importance is further highlighted by the fact that Novo Nordisk divides the world into North America and International Operations in its financial statements.

Began his career as an office assistant

The growth in revenue, however, was higher in International Operations in 2018. This grew by seven percent in local currencies, compared to three percent growth in North America. International Operations is skilfully managed by Mike Doustdar, who took this position in 2016 after more than 20 years of experience in Novo Nordisk – he started his career with the company as an office assistant in Austria.

Novo Nordisk’s global market share is more than 46 percent for both insulin and the pre-insulin GLP-1, and it has a 28 percent market share in the broader market for diabetes. These are structurally growing markets, due to the disease becoming more prevalent and a higher proportion of people being treated. It is thus expected that there will be around half a billion people with diabetes in 2030, compared to 400 million today. This growth will not be isolated to Western countries – increasingly, it is a problem for developing countries as well. Generally, diabetes patients will need life-long treatment, and this indicates that there is significant long-term potential here.

In December 2017, Novo Nordisk got its improved pre-insulin product, Ozempic (a so-called GLP-1 medication), approved by the authorities in the United States. GLP-1 is typically used in an earlier stage of the treatment for diabetes than insulin, hence the name, pre-insulin. The approval was expected, but it is an important factor in the growth opportunities of the coming years.

By the end of 2018, GLP-1 was around 25 percent of revenue at Novo Nordisk, but practically all of the growth in revenues for 2018. It is expected that GLP-1 will drive the majority of the growth in revenue and earnings going forward.

The volume growth has been more than 20 percent annually on the market
for GLP-1 in the United States, but it is still only used by 7 percent of diabetes patients, and the price for treatment is more than double the costs of an insulin treatment. The GLP-1 market represents 17 percent of the value of the entire market for diabetes products, and it is shared equally in a duopoly between Novo Nordisk and the U.S.-based company, Eli Lilly.

Attractive weight loss profile

On this attractive market, Novo Nordisk currently has two products, Victoza and Ozempic, and the latter was launched on the American market in February 2018 and managed to generate revenue of almost 2 billion Danish kroner during the year. The pre-insulin product, Victoza, was for many years in a market-leading position in the United States – at one point, its market share reached a peak of around 70 percent. In 2014, the American competitor, Eli Lilly, launched a competing product, Trulicity, which has approximately the same clinical profile as Victoza, but is more convenient to use as it only requires a weekly injection instead of a daily one, as with Victoza.

Novo Nordisk’s newly launched GLP-1, Ozempic, can match Eli Lilly’s Trulicity when it comes to convenience, as it also only requires one injection per week, but on top of this, it has demonstrated significantly stronger clinical results. Ozempic has a strong blood glucose control. Therefore, there is a lower risk of suffering from hypoglycaemia. Yet, it also has a very attractive weight loss aspect to it. People can lose around 14 percent of their body weight over the course of the first year of treatment. This is approximately double of what other products for obesity currently deliver. As a result, Ozempic is not just a great product for the diabetes treatment market, it can also be used to gain market share and expand the market for obesity treatments.

The patent for the first generation pre-insulin, Victoza, expires in 2023, and the management’s strategy (and our expectation as well) is that before the patent expires, patients will be moved from Victoza to Ozempic so that Novo Nordisk can retain its market share after the Victoza patent expires. With the launch of the improved Ozempic product, Novo Nordisk has stabilised its market share on the American market for GLP-1 products.

The attractiveness of GLP-1 is not isolated on the attractive volume growth rates of more than 20 percent – the profitability is attractive as well. It is estimated that the production costs for these medicines are as low as around 1 to 2 Danish kroner per 100 kroner in sales. It should thus have a positive impact on Novo Nordisk’s opportunities to maintain high operating margins of around 45 percent despite the continued pressure on insulin prices in the United States.

Novo Nordisk is very much involved in expanding the market for obesity treatments in the United States. Victoza, which was Novo Nordisk’s first generation of pre-insulin GLP-1, is marketed as Saxenda on the market for obesity treatments, and today it represents between three to four percent of the revenue in Novo Nordisk. In 2018, Saxenda sales grew by 60 percent and amounted to almost a third of the total revenue growth in the group despite its currently limited size.

Changes in the management team

The prospect of retaining patients being treated for obesity is a major growth opportunity for Novo Nordisk. Today, patients generally drop out of the treatment after four or five months when the weight loss stagnates, but with documented evidence for the continuation of weight loss over longer periods of time, it is expected that patients will also remain on the treatment for longer.

Ozempic has a weight loss profile that, based on published studies, continues for the first year – as mentioned, weight loss here could be around 14 percent after a year of treatment, but it might continue for a longer period. There are thus great opportunities on the market in ensuring longer treatment periods and a better compliance with the treatment process. One of the steps in this direction could be to have obesity recognised as an illness, and Novo Nordisk is also fighting to achieve this via ongoing studies.

Not only insulin prices have changed since 2016, the top management team at Novo Nordisk has changed as well. After having successfully run Novo Nordisk as CEO for 16 years, Lars Rebien Sørensen stepped down and made way for Lars Fruergaard Jørgensen, who assumed the role of CEO at the end of 2016. Lars Fruergaard Jørgensen has been focusing on a controlled strategic renewal process while retaining the winning culture and the long-term focus on value creation.

His promotion was the crowning achievement of a 25-year career in the company. In early 2018, Karsten Munk Knudsen also joined the executive board, taking over the role of CFO from Jesper Brandgaard. Karsten Munk Knudsen brings to the table his strong financial and strategic understanding, which includes operational experience from the North American market. Since 2018, the chairman of the board has been the Norwegian, Helge Lund, and with his broad, successful, and international experience, we find that he is a dynamic addition to the board of directors.

A perpetually enthusiastic magician

Due to the changed pricing dynamics on insulin and projections for lower growth rates, Novo Nordisk has trimmed its organisation a few times and increased its focus within R&D. R&D remains a key focus area for the company, and as a reflection of this, they invest almost 15 billion kroner per year, which is the equivalent of 13 percent of revenue. We expect that Novo Nordisk will continue to invest such a proportion of revenue in R&D. Since 2000, this division has been driven forward by the perpetually enthused and high-spirited magician, Mads Krogsgaard Thomsen. The share of revenue invested in R&D is lower than what is typically seen among the largest global pharmaceutical companies, but Novo Nordisk has nonetheless had an impressive track record of growth and success. An obvious advantage for Novo Nordisk is its highly focused business focusing only on diabetes and closely related illnesses.

One of the success stories from R&D is the development of an oral tablet with the pharmaceutical ingredients from the GLP-1 product, Ozempic, called Semaglutide. While the competitors gave up attempting to develop similar products years ago, Novo Nordisk has now succeeded in creating a pill where the strong molecule can be ingested orally rather than what is for many people an unpleasant injection. If all goes according to plan, the application for approval on the American market will be filed during the first quarter of 2019. In 2018, Novo Nordisk purchased a so-called priority voucher that can accelerate the approval process, and therefore we expect that the tablet can be approved by the end of 2019. The tablet is not only capable of strengthening the product range on the interesting and rapidly growing GLP-1 market – it will also allow Novo Nordisk to better fight for market share on the markets for oral diabetes treatments where Novo Nordisk is currently not competing.

The new management has not only made the company more focused on costs, it has also introduced some other strategic adjustment. These include greater delegation of responsibilities to the individual markets and regions, a so-called “market-fit” approach. There are thus better opportunities for the individual market units to adapt their approaches to their specific opportunities. This applies to both individual countries in Europe and Asia and to individual states and markets in the United States. Novo Nordisk’s data-driven and analytical Vice President of Commercial Strategy, Camilla Sylvest, is assessed as having played a key role in the adjustment of this strategy since her promotion in 2017 from previously heading the Chinese market.

Market shares are increasing substantially

The sales in the United States are made via purchasing organisations that control the opportunities for selling to privately insured patients. These organisations have been going through a consolidation phase in the last few years, and this has resulted in an increased focus on rebates on life-important medicines. The combination of fewer purchasing organisations and an expiring patent for the market-leading long-acting insulin product, Lantus, has resulted in the purchasing organisations being keener on pressuring the pharmaceutical companies to grant them higher rebates. It is the size of these rebates that have resulted in negative pressure on the realized prices.

In 2018, the total rebates in the United States were 68 percent, compared to 64 percent the prior year, and this is assessed as having been a result of the developments concerning basal insulin.

Novo Nordisk’s American division is headed by Doug Langa, who has many years of experience working with other pharmaceutical giants such as Johnson & Johnson and GlaxoSmithKline. The launch of Ozempic on the American market has been a success, and Novo Nordisk has access to 80 percent of the market through powerful purchasing organisations. Novo Nordisk won significant market shares in 2018 in the market for long-acting insulin with its Tresiba product that was launched in 2017. In 2018, Tresiba managed to repeat its success by gaining an additional 5 percent market share compared to the year before, and Novo Nordisk now has around 41 percent of the American market for basal insulin, compared to less than 30 percent in 2015.

Besides strong commercial execution, Tresiba has clinically documented advantages – not just in terms of controlling blood sugar, but also due to fewer side effects on the cardiovascular system. Another advantage is the FDA approval Novo Nordisk received for its extended label for the pre-insulin product, Victoza, in 2018. Cardiovascular diseases have previously been an often-overlooked related illness for diabetes patients, and Novo Nordisk is now using the fact that there are few side effects as a selling point in the marketing of the products.

A market share of almost 90 percent in China

It is worth noting that there are only around 11 million people being treated for diabetes in the United States compared to almost 30 million in Europe, yet despite this, Novo Nordisk’s revenue in the United States amount to 55 billion kroner compared to 22 billion kroner in Europe. A difference which is also experienced in other therapeutic areas. The pricing structure in the United States thus creates significantly more value for Novo Nordisk per diabetic compared to, for example, one in Europe, where the sales and pricing is through public tenders.

With its large population and growing proportion of urban residents, China will be a source of significant future value creation for Novo Nordisk. With sales in China amounting to more than 11 billion Danish kroner in 2018, the country represented almost 10 percent of the group’s total sales, and the sales grew by 8 percent in local currencies. Novo Nordisk has more than half of the market for insulin in China, and it is also the market leader in other developing countries such as Russia and Brazil. The pre-insulin Victoza is the only GLP-1 product that is on the national reimbursements list in China. This results in Novo Nordisk’s market share being almost 90 percent for GLP-1 in China, even if it is a massively underpenetrated market that represents just 1 percent of the total market for diabetes treatments.

Last year, China represented around a quarter of Novo Nordisk’s growth outside of North America. Besides the expectation of a growing number of Chinese diabetics being treated, China also holds good opportunities for upgrading the treatments to more modern, and thus, more expensive, insulin products. Humane insulin thus continues to represent more than 60 percent of insulin sales in China, compared to 10 percent in North America and below 20 percent in Europe. A shift towards more expensive products would have a positive impact on the sales and earnings of Novo Nordisk, and at the same time, it would provide the patients with better treatments.

Novo Nordisk’s focus is on insulin, diabetes, and obesity, but around 16 percent of the revenue comes from the company’s Biopharma division, which sells growth hormones and blood clotting medicine to haemophiliacs. Due to the launch of a new and clinically superior haemophilia product by Roche, a Swiss company, there are no expectations for growth here. Novo Nordisk’s management has stated that they are looking for acquisitions in order to strengthen this division, but they have been disciplined with the capital by not making unnecessary and value-destroying acquisitions.

Novo Nordisk aims to grow the operating income by five percent per year in the years 2016-2020. We see great opportunities for Novo Nordisk to not just meet these targets, but even exceed them.

Showing restraint in terms of acquisitions for Biopharma is not the only area where both the new and prior management team demonstrated a strong discipline in capital allocation. Novo Nordisk distributes the free cash flows to shareholders each year as well. In 2018, the company thus repurchased 16 billion Danish kroner worth of its own shares, the equivalent of 2 percent of the market value entering the year. In addition to this, the dividends increased to more than eight Danish kroner per share through bi-annual distributions, and combined with the share repurchases, this amounted to five percent of the market value at the start of the year. The dividends per share have increased by almost 13 percent annually over the last 5 years and have grown for each of the last 22 years as well.

In 2019, the free cash flows are expected to amount to 32 billion Danish kroner, equivalent to almost 5 percent of the company’s market value. Novo Nordisk’s cash conversion is around 85 percent, which is in line with management’s target.

Being disciplined with capital is not just about distributing cash flows to the shareholders, it is also about making the right investments in the company in order to create the best opportunities for long-term value creation.

Since 2016, Novo Nordisk has increased its capital expenditure by investing in a production facility in Clayton, North Carolina, where the focus in particular will be on the active pharmaceutical ingredient used in the company’s GLP-1, semaglutide. This has increased the level of investments from around five billion Danish kroner to more than nine billion currently, equivalent to slightly more than eight percent of revenue. We expect that the level of investment will be lower from 2020 onwards.

Novo Nordisk is a high-quality company, which can be measured by a return on invested capital of more than 100 percent. The management aims to have returns on invested capital of more than 80 percent – though this is not an indication of qualities diminishing, as this difference is a result of new accounting rules. We regard the qualities that Novo Nordisk possesses to endure, and the shares can be bought for around 18 times current year’s expected earnings.

There is a bright future in providing the right treatment for a chronic illness that, unfortunately, is becoming more and more widespread. By all accounts, Novo Nordisk will be a large part of providing these treatments. Novo Nordisk is facing an interesting and value-creating future – and we are fortunate to be along for the ride.