NOVO NORDISK Analyst: Recommendation: HOLD DATE: 11.11.2015 Industry: Drug manufacturers Share price 375,00 DKK Homepage www.novonordisk.com Ticker NVO Number of shares (000) 2.563.800 Target price 406,14 DKK Market Cap 961 B 52 week L/H 256 / 415 Upside potential 8,3% In mil 2014 2015 e 2016 e 2017 e Sales 88.806 96.799 104.058 111.343 Gross profit 74.244 81.654 88.157 94.487 EBIT 33.722 41.967 44.452 46.609 Net income 25.711 29.693 32.450 35.692 Gross profit margin 83,6% 84,4% 84,7% 84,9% EBIT margin 38,0% 43,4% 42,7% 41,9% EPS 10,03 11,58 12,73 14,07 ROE 61,3% 63,8% 71,1% 74,8% Price/Earnings 26,00 32,47 29,55 26,72 Price/Sales 10,85 9,96 9,26 8,66 Price/Book value 21,30 23,92 23,07 22,21 Price/Cash flow 31,20 30,42 28,97 27,59 Excluding non-reccuring items Preformance 1M 3M 6M 12M Novo Nordisk 4,54% 2,36% -2,71% 43,26% I initiated the coverage of Novo Nordisk (NOVO-B.CO) with HOLD recommendation and 12-month target price of 406,14 DKK, which at current share price offers 8,3% upside potential. Novo Nordisks long term double digit growth has come to an end, but company still offers potentially high single digit growth going into the future. Most of that growth will come from modern, and oral insulin and GLP. Company bought two small companies involved in finding other ways to fight diabetes and obesity, and is building new insulin factory in US to keep up with rising demand. Although trends in the diabetes sector, especially form Novo Nordisks biggest rivals Sanofi and Eli Lilly, aren't that encouraging, I believe that my projected sales growth at CAGR 6.16% for the projected period 2015 2024. can be achieved. Potential catalyst: roll-out of Tresiba in US and evidence of market share gains. Positive pipeline data about development of semaglutide, oral GLP-1 and oral insulin. Downside risks to my target price are: the ongoing pressures in a number of its markets after introduction of biosimilar version of Lantus, volatility in foreign currencies, downside pressure to prices from insurers, and overall market volatility. 1
About Novo Business Description Novo Nordisk is a Danish multinational pharmaceutical company engaged in discovery, development and manufacturing of pharmaceutical products. It employs more then 40.000 people and markets its products in more than 180 countries. Novo Nordisk operates in two segments; Diabetes Care and Biopharmaceuricals. The Diabetes Care segment covers insulin, GLP-1 analog, obesity, and oral antidiabetic drugs. This segment accounts for around 80% of company's revenue. The Biopharmaceuticals segment offers products in the areas of hemophilia care, growth hormone therapy, and hormone replacement therapy. Company has been a global market leader in diabetes sector for a long time, and current pipeline suggests that it will continue to do so. Novo Nordisk is the only company that offers a full portfolio of novel insulin products with a market share of around 47% worldwide. Today, Novo Nordisk's products are used by 24 million people, and they strive to increase this number to 40 million by the end of 2020. This can be easily achieved if you account that there are currently 387 million people living with diabetes. To better understand the company, and the magnitude of a problem that it its trying to solve, I will try to explain what diabetes is, and why I invested in this company several years ago. What is diabetes? Diabetes is a chronic disease that occurs either when the pancreas does not produce any insulin or when the body cannot effectively use the insulin it produces. If not treated right diabetes can cause serious complications like cardiovascular disease, stroke, kidney failure, blindness and even death. There is no cure for diabetes at this point. As of 2014, an estimated 387 million people have diabetes worldwide. This is equal to 8.3% of the adult population, with equal rates in both women and men. A further 316 million with impaired glucose tolerance are at high risk from the disease. By 2035. the number of people with diabetes is expected to rise to 592 million. The global economic cost of diabetes in 2014 was estimated to be $612 billion. This high progression rates in diabetes can be attributed to the growth in elderly population, increased life expectancy, obesity, sedentary life style, unhealthy diet and high stress levels. Further factors like smoking and physical inactivity have led to increased prevalence of both the types of diabetes. 2
There are two main type of diabetes: Type 1 - results from the body's failure to produce any insulin. Accounts for 8-10% of diagnoses. Patients diagnosed with Type 1 diabetes need to take insulin for the rest of their life. Type 2 - accounts for about 90% of diagnoses. In Type 2 the body does not use insulin properly. At first, pancreas makes extra insulin to make up for it, but over time it isn't able to keep up and can't make enough insulin to keep blood glucose at normal levels. The main reason is β-cell deterioration in pancreas. Prevention and treatment of Type 2 diabetes, at first, involves a healthy diet and physical exercise. Since Type 2 diabetes is a progressive condition, over time the patients will need to use some kind or medication, and will, eventually, end up on insulin. From OAD-s (oral anti-diabetic drug) to insulin it takes on average four years. Progression of Type 2 diabetes and treatment intensification is shown in the next two pictures: Source:NovoNordisk What is a basal-bolus insulin regimen? The role of basal insulin, also known as background insulin, is to keep blood glucose levels at consistent levels during periods of fasting. Basal insulin need to act over a relatively long period of time and therefore basal insulin will either be long acting insulin (duration of action of 24 hours) or intermediate insulin (duration of action of 12 hours). Bolus insulin is often taken just before meals to keep blood glucose levels under control following a meal. Bolus insulin needs to act quickly and so short acting insulin or rapid acting insulin will be used. With time, as the illness progresses, patients will need more and more injections during the day to keep glucose level under control. 3
Competitive Positioning In global diabetes market, insulin accounts for around 52%, oral diabetes products for 40%, and GLP-1 products for 8%. Novo Nordisk's market share in insulin and GLP-1 market is 47% and 71%, respectively. In its all-important insulin market, Novo Nordisk s main competitors are the same all over the world: Eli Lilly and Sanofi. In the biopharmaceuticals business, Novo Nordisk faces competition from a broader group of pharmaceutical companies. The insulin market is characterized by 3 segments: long-acting, medium-acting and fastacting. Since recently there were only two long-acting insulin on the market, Sanofi s best selling Lantus (glargine) and Novo Nordisks Levemir (detemir). In 2014. Lantus and Levemir had sales of 6,3B and 2,5B, respectively. Since Lantus lost patent protection this year, Eli Lilly made a biosimilar version of it, and intends to sell it with 15% discount. This can be the biggest threat to sales for Novo Nordisks Tresiba. Tresiba is a new-generation basal insulin with an ultra-long duration of action of more than 42 hours. It is approved in more then 30 countries and since recently in US. Analysts expect Tresiba to achieve sales of $2.2B by 2020. I expect sales to be much higher. My projections come from many forums that I visited, where I talked with patients who speak highly of Tresiba as compared to other basal insulin. Also, the growth in market share, where Tresiba is reimbursed as other insulin (e.g. Switzerland), is quite impressive: Xultoph is a combination of Tresiba and Victoza, since recently approved in EU. Novo Nordisk filed NDA to FDA for Xultoph several months ago. 4
Growth of Tresiba is even more impressive in Japan, where Lantus had most of the market share (drop from 70 to 56%). Sanofi launched U300 this year, a successor of Lantus, that shows little improvement to Lantus, and I believe it wont do nearly as good as predecessor. In medium-acting and fast-acting segment Novo Nordisk holds leading position with best selling drugs in this class. The GLP-1 portfolio includes Victoza, a best selling GLP-1 in its class. Novo Nordisk has recently received approval from US and Europe drug regulators for the launch of Saxenda, which is meant for obesity treatment. Saxenda is based on liraglutide which is already used in Victoza. Market share of Victoza has been dropping lately to Eli Lilly's Trulicity, a once weekly GLP-1, as opposed of once daily Victoza. Novo Nordisk's semaglutide, a once weekly GLP is currently in phase 3, and is expected to reach the market in 2017. It showed much better results than those of competitors. Novo Nordisk's pipeline: Little is known that Novo Nordisk makes all of its diabetic products from just three yeast strains, which after fermentation, purification and formulation become fast, medium or longacting insulin. This strains are the same today, as they were in the past, with the only difference in purification and formulation. Because of that, economies of scale, as seen in higher gross profit margins, are created. Greater knowladge, and experience in this field is what makes Novo Nordisk better than its competitors. Costs of developing all high volume diabetes products have been reduced up to 70% in the past ten years. 5
Historical overview Sales by segment Sales by country 10Y Revenue (mil ) Gross profit and net income Gross and net profit margin Operating Cash Flow and CAPEX Source: morningstar.com Source: morningstar.com 6
STRENGHT WEAKNESS Best products and high market share in both Diabetes and Biopharmaceuticals segment Strong pipeline of products across all phases Approval of Tresiba in US Possibility of liraglutide (Victoza) for treatment of NASH, with estimated market of $35B and no treatment available yet Oral GLP-1 in phase 3, and oral insulin being developed Expansion into obesity sector High growth in US and International markets NDA for one weekly semaglutide expected late 2016 Victoza, fastest growing GLP-1 analog, losing market share to Trulicity Growth in China losing momentum Foreign currency fluctuations Very low diversification of products as oppose to competitors Introduction of biosimilar version of Lantus Because of new, better OAD's longer time needed for patients to switch to GLP and insulin OPPORTUNITY Notable unmet need for new and better treatments Number of people with diabetes and obesity increasing at high pace Less than half of people are diagnosed Entry barriers are high High volume production with significant capital investment required Market leader in highly concentrated market Eli Lilly's long-acting insulin delayed, possibly dead Strengthening of the American dollar THREAT Companies developing new ways of treating diabetes Price pressure is expected to increase including considerable rebating The launch of new products by established competitors Increased competition from producers of biosimilar medicines in key markets. Large number of prescribers and complex distribution channels Frequent new product introductions (mostly in OAD-s) Possibility of product delay Developing a new pharmaceutical product is cost expensive 7
FORCESTS AND VALUATIONS Risk Factors The possibility of discontinuation of some products in the pipeline, primarily concerning oral GLP and insulin, can be seen as highest risk to this valuation. Since Novo Nordisk has very predictable sales and cash flow growth, I used ten year time horizon based on companies and my own projections. The company doesn't have any debt so I find FCFE model to be most adequate to the capital structure of Novo Nordisk. For 2016. I used sales growth of 7,5% based on my believe that sale of Tresiba, Levemir and Victoza will continue to expend in US and other markets. Cannibalization of Levemir from Tresiba was also accounted for, even though company believes that most of new patients will come from Lantus, as in Japan. One thing that is very important here is that doctors rarely prescribe other medicine if the therapy is working for a patient. That makes Tresibas growth in some markets even more impressive. As always, I used more conservative approach in some calculations so that valuation wont be based on my biased believes. Assumptions for Model Development ten year forecast period estimation of future cash flow is based on my projections company has no debt Cost of capital of 7,2 was calculated using risk free rate of 2,3% (yield of the USD-denominated 10 year bond adjusted for inflation of 1,9%) and beta of 1,01 (two year weekly change to index). Equity risk premium is based on historical average of Danish stock market and its AAA credit rating Terminal growth rate is projected to be 2,1% (growth of world economy adjusted for inflation) Revenue/Earnings Forecast Company's outlook for next year is revenue and earnings growth in a range of 7-9%, so I will start my model there and later expect CAGR 6,16% for the projected period (2015-2024). Expected CAGR for period 2014-2020 for diabetes sector is 7%, and most of that growth is predicted to come from US, region China and International Operations. In 2014. in US, the total estimated cost for diabetes was 6% of overall healthcare costs. That number is expected to increase to 11% by 2019. Almost 50% of companies sales comes from US. Novo's insulin market share in US is 37%, and I expect that number to increase, especially with Tresiba, Xultoph, and later introduction of oral GLP and insulin. Possibly the strongest growth in upcoming years will come from region China and International Operations, especially after counties in those regions raise healthcare standards. Non-reccuring items like spin off of NNIT are not included in the valuation. 8
Projection of sales Projection of Gross profit, EBIT and EBIT margin Source: my estimates Source: my estimates R&D projections Net profit, ROIC and WACC Source: my estimates Source: my estimates My projections see revenue at around DKK 166B in 2024. with gross profit of 142B and gross profit margin of 85%. Earnings will slightly decrease over projected period as the company becomes larger. High gross and operating margins will continue to increase during projected period before settling at Management's long term goal of around 85% and 40%, respectively. R&D costs will increase by 1,5 percentage points, as apposed to 10 year average, as more and more data needs to be collected for drugs to be evaluated. R&D costs haven't been capitalized. Sales, general, and administrative expense will remain the same as 10 year average. Most of my projections are based on ten or five year average, or are based on investment cycle, whatever makes the model more realistic. Cost of capital of around 7,2 is much lower then ROIC for projected period. High returns are expected to rise the future because or the companies policy to return all of its profit to shareholders, either by repurchase of shares or dividend. 9
Cost of capital Year 2015 e 2016 e 2017 e 2018 e 2019 e 2020 e 2021 e 2022 e 2023 e 2024 e TV Risk free rate (real) 0,40% 0,40% 0,40% 0,40% 0,40% 0,40% 0,40% 0,40% 0,40% 0,40% 0,40% Equity risk premium 6,73% 6,73% 6,73% 6,73% 6,73% 6,73% 6,73% 6,73% 6,73% 6,73% 6,73% Beta 1,01 1,01 1,01 1,01 1,01 1,01 1,01 1,01 1,01 1,01 0,85 Cost of equity 7,20% 7,20% 7,20% 7,20% 7,20% 7,20% 7,20% 7,20% 7,20% 7,20% 6,12% SALES 96.799 104.058 111.343 119.136 127.476 136.399 144.583 151.813 159.403 165.779 NET INCOME 28.686 32.091 35.248 38.610 41.521 44.649 47.643 50.187 52.865 54.974 56.074 EPS 11,19 12,58 13,90 15,27 16,50 17,74 18,93 19,94 21,00 21,84 - Δ (CAPEX-depreciation) 590 536 538 575 615 659 604 534 560 471 - Δ WCinv 1.039 944 947 1.013 1.084 1.160 1.064 940 987 829 + NET DEBT 0 0 0 0 0 0 0 0 0 0 FCFE 27.057 30.611 33.764 37.021 39.822 42.830 45.975 48.714 51.318 53.675 Terminal value growth 2,00% Terminal value 1.360.853 Discounted cash flow 25.240 26.639 27.409 28.036 28.132 28.226 28.264 27.937 27.454 26.788 751309 EV 1.025.434 Cash and cash equivalents 15.905 Number of shares 2.564 Price 406,14 Current price 375 Up/down 8,3% Terminal growth rate 1,00% 1,50% 2,00% 2,50% 3,00% 6,20% 354,64 380,15 411,86 452,33 505,76 6,70% 351,71 377,23 408,94 449,41 502,84 7,20% 348,90 374,41 406,14 446,59 500,03 7,70% 346,19 371,70 403,41 443,88 497,31 8,20% 343,57 369,09 400,80 441,26 494,70 Conclusion Projected earnings are in line with those of the industries, but could further increase if oral GLP and insulin reach the market. Obecity and NASH just add value to the company. As always, Novo Nordisk times introduction of new drugs just as old one lose patent protection. Levemir will lose protection next year but much better Tresiba will try to take its place. Victoza, a main driver of Novo's growth in past years is starting to lose its market share to once weekly GLP, but Novo Nordisk's semaglutide is expected to reach the market very soon. First results from phase 3 for oral GLP will be released in 2018 so there is a high possibility that it can reach the market by 2020. It is also worth knowing that no other large making company is developing oral GLP or insulin at this moment. If oral GLP and insulin prove to be functional this could be a huge catalyst for Novo's earnings because most of people prefer oral medicine over injections. Also, patients treated for diabetes tend to gain weight when prescribed Sanofi's or Eli Lilly's products. That is not the case for Novo Nordisk's products where patients even lose weight, and see it as a benefit to other products. Many new products like semiglutide and oral GLP shown high weight reduction in patients treated with them. Although I have a hold recomendation I believe that Novo Nordisk's current and prospective pipeline ensures that the company will continue to grow. 10