Danish pharmaceutical company Novo Nordisk (founded in 1923) is a global leader in diabetes care with 52% of the insulin market share. As of November 2008, it had a market capitalization of $33 billion. Novo Nordisk focuses on diabetes care, haemostatic agents, hormone replacement, growth disorders, obesity, and inflammation therapies. It has a strong pipeline of new drugs for diabetes care, including two new insulins due in early 2009. The company aims to increase its market share in diabetes care and expand into related areas like obesity and inflammatory diseases.
Novo Nordisk is a Danish multinational healthcare company of $ 33 billion of market capitalization.
It operates in two main segments: Diabetes care which contributes to 73% of their sales and Biopharmaceutical. Overall, Novo Nordisk is the leader in the global insulin market with 52% of world market share.
To sustain it, they spend 17% of their revenues in research and development. Actually 2 new drugs are due the next year and are more efficient than their competitors. Therefore, Novo Nordisk has a good pipeline to replace one of his main drugs which is going off of patent in 2010 in the USA. (14% of revenues)
Their strategy is to expand their leadership in patented modern insulins which have barriers to competition from generics and higher margins. They also explore opportunities in obesity therapy. Moreover, Novo Nordisk is implementing partnerships with Universities and is looking for investments in Biopharmaceutical companies. Finally, they want to expand their presence in emerging countries like China, India and Brazil where they already have research centers and plants.
Concerning the management, the top executives are all Danish and promoted from Novo Nordisk since 2000, that date corresponds to an increasing stock price and gives credibility to the team. Indeed Novo Nordisk has 25% of insiders’ ownership.
Their main competitors are Eli Lilly, Wyeth, Pfizer and Sanofi Aventis which is emerging as the very main competitor. The generic competition in Human insulin is fierce but the firm is moving towards patented modern insulins. The Novo Nordisk R&D expenses are in line with those of its competitors and the company enjoys higher return on assets and higher capital efficiency. Their competitive advantages are their leading positions in emerging countries and modern insulins, their better anti-diabetes drugs which provide less risk of weight gain and more predicable results.
In local currency, Biopharmaceuticals’ revenues increased by 12% and Diabetes Care’ revenues increased by 17% in 2007. Moreover the world insulin market is quickly growing with increasing volume and price. The first key growth driver is modern insulins with 29% of growth. As you can see in the chart, Novo Nordisk is the leader with 45% of market share, and is likely to continue gaining market share thanks to its new drugs.
Novo Nordisk has 56% of market share in the huge and increasing American insulin market. Furthermore, insulin market in emerging countries is growing by 21%. China is the key growth driver in that segment with 50% share of growth and a penetration rate of 5%. Novo Nordisk has more than 70% of market share there and is massively investing in China. So Novo Nordisk is really well positioned.
As you can see in the chart, the arrival of the new team corresponds to an increase of operating profit margin and ROIC thanks to productivity gains. The operating profit margin reached 30% last quarter and the return on invested capital amounted to 22%. Overall, Novo Nordisk is enjoying a good profitability despite substantial sales from off-patent human insulin and it is likely to increase that profitability with the focus on modern insulin.
Novo Nordisk has also a low financial risk thanks to its low leverage. Indeed its debt asset ratio amounts to twenty six percent and its interest coverage ratio amounts to thirty five. Novo Nordisk solvability is also good thanks to the levels of its quick ratio, its important amount of cash and its significant operating cash flows. Last but not least, Novo Nordisk can draw its significant credit line and has not to refinance its debt soon. With low financial risks and important flexibility, Novo Nordisk is in a good position to weather the storm and to invest.
However, I have some concerns about the emerging strong competition of Sanofi Aventis, the likely increasing price competition in non patented human insulin, the rising research and developments costs, and the currency rate risks. But finally, Novo Nordisk has a low exposure to patent expiration and a low financial risk profile with predicable cash flows hence the good ratings from Standard and Poor’s and Moody’s. Indeed its default probability is very low with 0.26% within 5 years.
The average annual total return to shareholders is really high with 17%. As you can see, despite the crisis, it has never been negative during two years in a row.
Novo Nordisk has clearly outperformed the SPY index for a long period of time with a cumulative total return of 187% for ten years versus 20% for the SPY index.
But Novo Nordisk has also a greater annual volatility of 30% in average versus 18% for the SPY index.
To valuate the company, I used the three stages model. The first stage is based on a recession scenario with high cost of capital and lower return on invested capital. The second stage is based upon a successful execution of Novo Nordisk strategy with growing sales in emerging countries and in modern insulins. Finally the third stage is based on an average return on invested capital and cost of capital with a low growth. With that model, I found that the stock price is undervalued by 35%.
I also did a Valuation under an unlikely stress case. For that I decreased the return on invested capital, the sales, the capital efficiency and I made the recession last two years. In so doing, the stock price is still undervalued by 2%.
Given the undervalued price, the leading positions in high growing segments, the high profitability and the really healthy financial condition of Novo Nordisk, I recommend to buy 20 shares of Novo Nordisk With the latest stock price, Novo Nordisk is even more undervalued
