Stock of the week - Novo Nordisk (09.08.2024)

• Worsening global obesity problem 
• 2Q24 results 
• Mixed outlook for full year 2024.
• Results compared to peers
• A look at valuation
• A look at the chart 

Novo Nordisk (NOVOB.DK) has been one of the biggest winners in the European market in recent years. The company grew by 60% in 12 months, becoming the most valuable company in the European market in terms of market capitalization. Underlying the company's rapid growth was primarily the prospects of the anti-obesity drug market. Are Novo Nordisk's increases sustainable, or is the company now too overvalued? Let's take a closer look at the company's performance, as well as its current valuation and technical situation. 

Worsening global obesity problem 

Novo Nordisk has hit ideal ground with drugs primarily used to treat diabetes, which have also proven to do very well in combating obesity in patients who use them. Obesity is becoming one of the leading global health problems and is often referred to as a "disease of civilization." Although people now have access to both extensive dietary knowledge resources and it is still popular to showcase healthy lifestyles on social media, the wealthening of societies and the shift toward increasingly sedentary lifestyles is making obesity a growing problem. According to the Centers for Disease Control and Prevention, in the US alone, the number of states where more than 40% of adults are obese (ie. have a BMI of more than 30 kg/m2 - it's worth noting that BMI is not a perfect measure of obesity, especially when it comes to overweight measures, as for people who regularly participate in sports and record rapid growth in muscle mass, the reading will be inflated due to greater muscle mass, not fat, however, when surveying the general population, the index is a good enough tool to show general trends and its extremly high values usually cover only people with obesity) has increased from 0 to 22 in just 11 years.

Currently, according to 2022 data, no state presented a percentage of obese adults below 20%. Accompanying the worsening phenomenon of the growing number of obese people is also a series of negative health consequences in the form of increased risk of heart disease, heart attacks, or diabetes. Hence, it can be seen that trends both globally and in the U.S. are laying the groundwork for continued high demand for Novo Nordisk's products (and those of competing companies, including the U.S.-based Eli Lilly, among others), and data published from the companies indicate that at present any problems lie not in demand, but insufficient supply. 

Mapy ukazujące procentowy udział dorosłych z BMI większym lub równym 30 kg/m2 w USA w latach 2011 (lewa) i 2022 (prawa). Źródło: Centers for Disease Control and Prevention 

2Q24 financial results  

Novo Nordisk reported 25% year-on-year revenue growth in 2q24 to DKK 68 billion (Danish kroner, about $9.8 billion), about 1% below analysts' consensus forecasts. The revenue growth rate was slightly below the average for the last 10 quarters, which is 27%. However, the revenue growth rate continues to remain relatively stable, which is particularly positive in view of the still growing comparative base. 

Source: XTB Research, Novo Nordisk

Among the segments, the company recorded the strongest revenue growth in the obesity treatment segment (+35% y/y), where revenues are primarily supported by the still booming sales of Wegovy (+55% y/y). Despite such strong momentum, revenue from this drug came in more than 16% below expectations at DKK 11.7 billion ($1.7 billion). The slowdown relative to expectations (and the dynamics of previous quarters; 2Q24 was the first quarter since the drug's release in which Wegovy sales grew at a rate of less than 100% y/y) caused a negative market reaction, as Wegovy currently remains the company's most closely watched drug. Investor attitudes toward anti-obesity drugs can be compared to the sentiment around artificial intelligence, which is currently one of the key aspects drawing investor attention to the performance of technology companies.

Interestingly for Novo Nordisk, for the time being, the biggest challenge in keeping Wegova sales at high levels is not at all weakening demand, but mainly insufficient production capacity. The company is trying to offset the supply constraint with dynamic investments in drug factories. Novo Nordisk plans to spend $4.1 billion to build a new factory in North Carolina, which is expected to be completed around 2027-29. In addition, the company is buying up smaller factories to increase the supply capacity of its drugs. 

Along with maintaining the double-digit growth rates of its two most important segments, continued stronger revenue growth from obesity treatment is forecast in the coming quarters, which will result in an increasing share of sales from this segment in the company's total revenue. Source: XTB Research, Bloomberg Finance L.P. 

The company also showed a lower-than-expected operating result of DKK 25.9 billion ($3.7 billion) in 2Q24, a year-on-year increase of 8.6%. Thus, the company's operating margin fell below 40% for the first time in 10 quarters. Such a strong decline in operating profit growth was due to a one-time impairment related to the end of Phase 3 clinical trials of a kidney segment drug candidate. However, it should not affect the company's long-term performance at the operating level. Nonetheless, the impact of the write-down also has its effect in lowered forecasts for operating profit growth throughout 2024. 

2Q24 FINANCIAL RESULTS:

• Revenues: DKK 68.06 billion, estimated DKK 68.72 billion
  • Obesity Care segment revenue DKK 13.90 billion, estimated DKK 15.37 billion
    • Saxenda DKK 2.25 billion, estimated DKK 1.68 billion
    • Wegovy DKK 11.66 billion, estimated DKK 13.66 billion
  • Diabetes Care segment revenues DKK 50.18 billion, estimated DKK 49.33 billion
    • Ozempic DKK 28.88 billion, estimate DKK 29.74 billion
• Sales and distribution costs: DKK 14.93 billion, estimate DKK 16.4 billion
• R&D expenses: DKK 16.17 billion vs. DKK 7.13 billion y/y, estimate DKK 12.93 billion
• EBIT: DKK 25.93 billion, +8.6% y/y, DKK 27.36 billion estimate
  • Operating margin 38.1%, estimate 40.8%
• Net profit: DKK 20.05 billion, estimate DKK 22.64 billion
• Adjusted earnings per share: DKK 4.49, estimated DKK 5.04 

Mixed outlook for 2024 

Novo Nordisk updated its forecasts for 2024, which turned out to be mixed. The company raised its expectations for full-year revenue growth (in constant currency terms) to 22-28% (vs. 19-27% previously). On reported sales growth, the company expects about 1 p.p. lower than on a constant exchange rate basis (previous forecasts assumed the Danish krone to be stable on foreign exchange markets and to maintain the same growth rate). 

At the operating profit level, the company lowered expectations to 20-28% y/y growth (vs. 22-30% previously). At the same time, it expects higher free cash flow of DKK 59-69 billion vs. DKK 57-67 billion previously. 

Results compared to Eli Lilly 

For Novo Nordisk, Eli Lilly remains the most significant competitor for now. Although the first successes at the clinical trial level are also already being recorded by Viking Therapeutics, for now Eli Lilly remains the most important benchmark for the European company. 

In 2Q24, looking at the market reaction to the results alone, Eli Lilly's result seems much better than Novo Nordisk's. Revenue growth in the key segment of diabetes drugs (which in Eli Lilly's case also includes obesity drugs) was almost 50% in 2Q24. For Novo Nordisk, the revenue growth rate of the anti-obesity drug segment was 35%. The difference can also be seen in the growth rate of operating profit, but in the case of 2Q, these values should not be directly compared due to one-time events weighing on the European company. It's also hard to compare the revenue dynamics of key drugs, as Zepbound and Mounjaro from Eli Lilly have been on the market much shorter than Wegovy or Ozempic from Novo Nordisk. Due to the development of the anti-obesity drug market, we can see that Zepbound's revenue growth rate is much faster than Wegovy's right after launch.

When analyzing longer trends, it can be seen that Novo Nordisk (despite lower earnings growth this quarter) is showing more stable and higher growth than Eli Lilly. The European company's average annual revenue growth for the past three years beats the American company's sales growth rate by as much as 9 percentage points. The situation is similar at the level of operating profit, the rate of which is much lower for Novo Nordisk this year (9% versus Eli Lilly's 18%), while looking at a longer period (average annual growth for 3 and 5 years) we can see that the difference tilts to the side of the European company. 

Above all, however, the difference can be seen at the level of free cash flow, where Novo Nordisk presents a strong 19% CAGR (for the last 3 years) and 25% CAGR (for the last 5 years), while Eli Lilly records a decline in 3 and 5 year terms. 

The difference can also be seen in margins, which are higher for Novo Nordisk, although the company is likely to perform below its averages for the past 3 years this year due to one-time impairments and negative currencies impact. 

 

Source: XTB Research, Bloomberg Finance L.P.

If we look at fundamental value ratios, they mostly indicate that Novo Nordisk is undervalued relative to Eli Lilly. On both the P/E and forward P/E ratios, the European manufacturer is significantly undervalued compared to Eli Lilly. EV-based ratios also indicate a more attractive valuation for Novo Nordisk. Eli Lilly's high ratios are primarily due to the market's anticipation of the company's earnings growth potential. After adjusting the P/E for EPS growth over the next 2 years (PEG ratio), the value of the ratio for Novo Nordisk is 1.89x, and for Eli Lilly is 1.41x (the lower the PEG, the less overvalued the company, with values below 1 being considered the most favorable). 

Selected Novo Nordisk vs Eli Lilly multiples. Source: XTB Research

Source: XTB Research, Bloomberg Finance L.P. 

Comparison of Eli Lilly and Novo Nordisk's quotations. Source:  XTB Research 

Look at the valuation 

We will look at the valuation of the company using the two most popular valuation methods: the discounted cash flow method - DCF and the multiple valuation. We want to emphasize that these valuations are presented for informational purposes only and should not be considered a recommendation or target price. 

DCF

It is worth noting that the DCF method is based on a number of assumptions, a change in each of which significantly affects the valuation effect. In the case of Novo Nordisk, we decided to make a detailed forecast for a 5-year period. At the level of revenue growth, we assumed a value of 25% due to the still rapidly growing sector of obesity treatment drugs, which should still result in strong revenue dynamics in the coming years. At the same time, we believe that it will be harder for the company to maintain the dynamics of the last 3 years due to the higher base. We have assumed an operating margin slightly above the 3-year average at 44%. The weighted cost of capital over the forecast period has been set at 9%. Other values are based on 5-year averages. 

For residual values, we assumed revenue growth of 4% and a WACC value of 9%. 

With these assumptions, the valuation result is a share price of DKK 1020.56, which is 14% higher than the last closing price. 

As the change in individual parameters has a significant impact on the final valuation effect, below we present matrices showing the change in value depending on: the change in operating margin and revenue growth assumed during the forecast period (matrix 1), and the change in the residual value of revenue growth and weighted cost of capital (matrix 2). 

Valuation dependence on the change in the value of revenue growth and operating margin over the forecast period. Source: XTB Research 

Valuation dependence on the change in WACC and revenue growth over the residual period. Source: XTB Research 

Multiples

Valuation using multiples compares the value of the company being valued against other companies operating in a similar industry. The limitation of this method of valuation is, in particular, the selection of companies and their difference in size and nature of operations from the company being valued.  This limitation is particularly apparent when analyzing Novo Nordisk because of the company's dominant position in the anti-obesity drug market, which is currently the most important component of the company's valuation. 

In the case of Novo Nordisk, we decided on a comparison group consisting of the companies: Eli Lilly, Astra Zeneca, Roche, Novartis, Sanofi, Bayer and Pfizer. The valuation ratios adopted are: P/E, Forward P/E, P/BV, P/S, Forward P/S, P/FCF, EV/S, Forward EV/S and EV/EBITDA. 

We conducted the valuation for three variants: mean, median and market capitalization adjusted ratios. Due to the large difference between the size of the companies, it is the last method that seems to best reflect the comparison of Novo Nordisk to the other companies, however, the difference between the company and the others included in the peers group further implies a strong overvaluation of the company. The comparison of Novo Nordisk's ratios to the other companies implies price per share: 

• Mean: 415,57 
• Median: 295,69
• Cap. Weighted: 769,2 

The average valuation implies a price of DKK 493.49 per share, which is almost 45% lower than the last market price. 

Novo Nordisk's multiple valuation. Source: XTB Research, Bloomberg Finance L.P. 

Look at the chart

The first reaction to Wednesday's Novo Nordisk results was a strong discount to the company, which pushed the stock price to its lowest since March of this year, thus interrupting the strong upward trend that had prevailed since the beginning of this year. However, it seems that the stock price correction was temporary, and the bulls are taking control of the share price again. The company bounced off the support level at around DKK 807 and broke out through the first resistance near DKK 862. The price is near the consolidation level from April. If it breaks out above this sphere, the next important level will be the exponential 100-session moving average (EMA100) near DKK 903. If this level is also pierced, the next important resistance that traders should pay attention to is at DKK 930. 

Source: xStation