Novo Nordisk Is At The Vanguard Of The Weight Drug Revolution

Novo Nordisk (NVO) has been in our Green Screens for quite a while now, and I've yet to cover it. The stock has more than doubled since the current format went live in late 2022.

That ends today.

While you may not know the company, you've almost certainly heard of its products, or seen them in TV ads. The company is emerging as a leader in what may be the largest pharmaceutical category since cholesterol statin drugs went mainstream 25 years ago. Frankly, this category could even be many times larger.

The question is - is it too late? Has the market already bid the stock past a reasonable economic return - even with continued growth? Let's take a closer look at this interesting company.

A Diabetes Drug Powerhouse

About 93% of Novo Nordisk's revenues come from selling treatments for diabetes and, increasingly, obesity.

Its largest category are so called GLP-1 therapies. These drugs reduce blood sugar and stimulate the pancreas to produce more natural insulin. Novo Nordisk's main product is called semaglutide, which has proven highly effective for Type 2 diabetes management. No doubt most investors are more familiar with its brand names, Ozempic (which is injected), and Rybelsus (oral). GLP-1s for diabetes made up 53% of 2023 sales and grew 48% over 2022.

An interesting side-effect of Novo's GLP-1 drugs was that they tended to reduce appetite, leading to substantial weight loss in patients. This led to off-label prescriptions for obesity management, particularly for Ozempic, spiking demand but also leading to supply shortages for diabetes sufferers that needed it more acutely.

In response, Novo developed Wegovy and Saxenda, forms of semaglutide geared more towards the obesity management category. Demand for these has been tremendous, with revenues up 147% in 2023 and continuing supply shortages. The weight loss category was 18% of sales in 2023 (and the fastest growing).

Novo Nordisk is also one of just a handful of pharmaceuticals that dominate the global synthetic insulin market. Insulin makes up over 20% of total sales.

Finally, the company also has a comparatively small rare diseases business, focused mostly on blood-borne disease. This segment is 7% of sales and declined 16% in 2023.

Novo Nordisk is based in Denmark and sells around the world. Its largest market is the U.S., at about 50% of sales.

Revenue - Growth and Recurrence

Type 2 diabetes does not have a cure and can only be managed. Most sufferers will need to manage their blood sugar throughout their lives. Novo's treatments are regular, with Ozempic dosed weekly and Rybelsus daily. Insulin sales are a similar story. While unfortunate, this makes the bulk of Novo Nordisk's product sales open-ended and recurring for long periods of time.

Ideally, weight loss would be a shorter-term use of the GLP-1 drugs. Sadly, though, history shows that it is likely that most people who lose weight using them will gain it back (and possibly have to re-dose). This is a very high recurring revenue business.

Growth has not been a problem, either. Novo Nordisk sports a 3-year compound annual growth rate of over 22%, and analysts expect 20-25% annual growth over the next 5 years. Category growth alone is huge. The GLP-1 market was worth just under $20 billion in 2022, and is expected to grow to $100 billion or more by 2030, indicating 20%+ annual growth over the next 6 years.

And that's just in its current indications for diabetes care and obesity. Novo and others are doing studies into the drugs' efficacy in areas like treating fatty liver disease, Alzheimer's, and heart failure. Early trials have Wegovy reducing the risk of major cardiovascular events by 20%. Additional good results could vault this class of drugs into one of the most utilized in history and boost Novo's results even further.

The two things we look for from sales - growth and recurrence - are covered in spades by Novo Nordisk.

Eyeing Up The Moat

Novo Nordisk has a strong competitive position. It currently controls 54% of global GLP-1 sales, the market leader, with competitor Eli Lilly close on its heels. Ozempic is the world's best selling diabetes medicine, with a leading 57% new-to-GLP share. Novo also is the largest insulin provider worldwide, with 44% market share.

The active molecule in its diabetes and obesity drugs, semaglutide, is patent protected until 2032 in most of the world. That, of course, has not stopped generics firms from challenging it, but this is "business as usual" in branded pharmaceuticals. It is reasonable to expect Novo's patents to provide suitable protection against generic competition for the next 8 years, although it does come off patent in China in 2026.

2032 presents a patent cliff for the firm that investors need to be aware of. An example of what happens is illustrated by Victoza, one of Novo's older GLP-1 formulations. It came off patent in 2023, and sales plummeted 30%. The company will have to formulate new variations to extend its patent protections, which is a risk.

Competition is a risk, too. Eli Lilly has been quite successful catching up in this space, and its new obesity drug Mounjaro is quickly gaining share against Wegovy as a more effective alternative.

At large, though, the size of the global diabetes and obesity market, its underlying growth due to continuing health and age trends, and Novo's strong positioning within it give it a big competitive advantage over most prospective entrants. Even with strong competition from Lilly, this space is large and fast growing enough to support two big winners.

Management and Financials

This Danish firm is over 100 years old, so obviously founder management is out of the question! The CEO is Lars Fruergaard Jørgensen, who took over in 2017. He has been with Novo Nordisk since 1991 (33 years), and held numerous leadership positions within the company before being elevated to the top spot.

Under Jørgensen, Novo has been extremely successful, with the stock increasing in price 5 times over, and revenues have more than doubled. At present, the firm is in the midst of one of the best growth runs its history, a testament to his successful leadership.

Financially, the firm is quite strong. Free cash margins have averaged over 37%, near the top of the big pharma cohort. Cash ROI is also excellent, at 50%. While it has some smaller acquisitions under its belt, the firm hasn't blown up its balance sheet on them. I don't see much to complain about here.

Risks

Novo Nordisk would rate on the "high" risk scale. The singular reliance on GLP-1 drugs is the headline risk.

Like most pharmaceutical firms that rely on just a handful of drugs, patent risks are the most prevalent. The company has and will continue to have to face off in court against patent challenges from competitors and generics makers. The core compound underneath all of its diabetes and obesity sales goes off-patent in 2032, and the firm will have to come up with new formulations (or new drugs) to avoid the dreaded "patent sales cliff". Trouble showing progress here will lead to stock price declines well before that date.

Longer-term safety issues are also a risk, especially considering how high-profile Novo's drugs have become in the media. Any safety panic could lead to rapid loss of revenues.

As we talked about in the Moat section, there is also strong competition from Eli Lilly. Mounjaro could prove to be more effective than Wegovy in the weight loss category. Novo Nordisk is going to have to fight hard to keep its market share, with R&D spend, marketing spend, and possibly even price reductions.

Conclusion

I've always been hesitant to invest in the branded pharmaceutical space. While there's a lot to like - recurring revenues, tremendous and growing addressable markets, high margins and cash flows - there are a lot of risks, too. Patents expire or are challenged away, intense competition erodes profitability, gatekeepers like PBMs and insurance firms erode pricing power, and so forth. Investors have to tread carefully in the space. Once-hot pharma stocks like Pfizer and Bristol-Myers have produced little for investors in the past 25 years!

After waffling back and forth on this one, I think there are just too many potential event risks to recommend it. The safety concern really weighs on me here - headlines that one of its drugs could lead to cancer, or reduce lifespan, or whatever - could sink this stock overnight. There's no backup plan - GLP-1 drugs are the whole story here.

Weighing all the risks offset with the attractive growth and margin profile, I came up with a fair value price of about $82 for Novo Nordisk. Considering the stock trades over $130, passing on it becomes a lot easier. An interesting company for sure, but no "green dot" stock.