Novo Nordisk (NVO)

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Solomon Select (October 2016)

Novo Nordisk (NVO)

This month we take a look at another “flavor” of repeat selections. Guest damsel Kim Butcher presented this world class leader in insulin and diabetes care during the August and September Round Table webcasts. The audience was polled and sanctioned the nomination both times.

As detailed in recent Barron’s coverage, Denmark’s Novo Nordisk (NVO), the global leader in diabetes medications, will get a new CEO in January, when company insider Lars Fruergaard Jørgensen takes the reins from his long-serving predecessor. But don’t expect the company’s strategy to change, even though increased competition and turmoil in the U.S. health-care market lately have pressured results.

NVO intends to stay the course, building on its No. 1 status in diabetes management, and expanding its drug pipeline into other lucrative areas, such as medications to fight obesity, hormone regulation and treatment of hemophilia. With a portfolio of new and more efficacious diabetes drugs, and other promising treatments in the wings, the company is likely to win back investors.

Novo Nordisk (NVO): Business Model Analysis. 9-10% top line growth has been the trend for NVO in the face of economic pressures in Europe and the long term market drivers (demographics and obesity macro trends) suggest continuing growth. Profitability has been steadily improving but will likely plateau under competitive pressures and P/E ratios in the realm of 20x seem reasonable going forward.

Growth, Profitability, Valuation

The Manifest Investing sales growth forecast for NVO is 9.2%. Value Line has a 3-5 year sales growth forecast of 10% and Morningstar “dissents” a little with 5% revenue growth expectation through 2020. The company has scaled back top line growth projections for 2016 to 5-7% and the analyst consensus expects a continuation in 2017. Novo Nordisk “should return to double-digit growth when new products reach critical mass,” says ABG Sundal Collier analyst Andrew Carlsen. But that might not happen before the end of 2018. By then, sales of new products could offset the effects of U.S. pricing pressure.

We’re using 31.0% for the projected net margin. The average net margin has been 28.2% for the period 2010-2015. Value Line has a 3-5 year projected net margin of 34.0%. The trend as shown in the accompanying profitability graphic is strong and in the right direction. Morningstar acknowledges pressures on margins but stipulates that manufacturing efficiencies and product mix will alleviate some of this.

The median P/E for the period 2008-2015 is 20.3×. We’re using 21x for the projected average P/E.

At the time of selection (10/4/2016), the stock price is $40.63, the projected annual return is 15-16%. The quality RANKING is 99 (Excellent, Top Shelf) and the financial strength rating is 94 (A+).

Points of View

The Value Line low total return forecast for NVO is approximately 12%. Morningstar has NVO with a fair value of $51 for a price-to-fair value ratio of 82%.

Last week, the company announced it would cut about 1,000 jobs from its 42,300-strong workforce to reduce costs. The move underscores Novo Nordisk’s struggle to maintain strong growth amid the competition in the insulin market, which accounts for more than half its sales. The company has a strong track record when it comes to return on research invested, comparing favorably versus Sanofi and other major pharma players. That said, the departure of the CEO and the apparent intentions to expand efforts in new insulin technologies and other frontiers could possibly mark a directional shift for the company. Value Line continues to look for expansion of the diabetes business … issue took a hit following loss of a contract with Express Scripts and lowered guidance … creating a potentially favorable entry point for patient investors.

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