Novo Nordisk: A supreme cash flow machine
No, it is not overvalued.
Let us imagine a perfect cash flow machine floating in the void. A machine like this would have growing revenues. It would then take this revenue and generate 85% gross margins. Since the machine is well oiled, it would efficiently convert that gross margin into a 35% net margin. Free cash would then flow out of a spout before being carefully packaged for you, the shareholder.
Novo Nordisk (NVO) is this machine. Long-term ROIC is consistently in the 30-60% range. I will explain why current valuations are attractive given the supreme quality of this business. Despite a market cap approaching the GDP of Denmark, Novo still has a long runway given the size of its potential obesity market. I will conclude by responding to common bearish themes.
The Ultimate Product:
Why do most people go the gym? For the majority of common folk, the answer is to improve their appearance. Becoming healthier is usually a secondary byproduct of this process. One must always consider human vanity and the need for social approval. This is the advantage that weight loss medications have; they allow us to improve both our appearance and our health. There will an endless demand for this type of product. Furthermore, one must keep taking GLP-1 medications (like Ozempic) in order to retain most of their benefits, resulting in a continuous revenue stream.
The majority of Novo’s revenues currently come from diabetes medications including insulins, it has the most extensive diabetes portfolio in the world. Semaglutide is the compounding star of Novo’s business. It is also known as Ozempic (for diabetes) and Wegovy (for obesity/weight loss). The list of clinical indications for this medication is large and continues to expand with each trial:
Diabetes (Type 2)
Obesity, reduction in weight - Ref
Chronic Kidney Disease (reduction of renal failure in diabetics) - Ref
Heart Failure, reduction in symptoms in patients with HFpEF - Ref
Reduction of cardiovascular death (in obese patients) - Ref
Reduction in knee pain related to osteoarthritis (in obese patients) - Ref
Fatty Liver Disease (NASH) - Ref
That is probably the most impressive list you will ever see in the pharmaceutical world and it is matched with a fantastic safety profile. At lower doses, semaglutide has been used for almost 10 years in diabetes care. The scientists involved in the discovery of GLP-1 mechanism will almost surely win a Nobel Prize at some point. GLP-1 medications are providing tremendous benefits to society.
“Imitation is the sincerest form of flattery…”
- Oscar Wilde
With a product this good, an entire industry of copycats has emerged. Public companies such as Hims & Hers (Ticker: HIMS) have been using a loophole to manufacture GLP-1 medications while bypassing Novo’s patent. This was possible during a period where the FDA declared semaglutide as a medication “in shortage.” This designation has recently been removed. The imitators will be banned from producing semaglutide in the next few months and this should be a positive revenue catalyst for Novo as it ramps up its manufacturing capacity. In Dec 2024, it acquired three manufacturing facilities from Catalent located in Anagni (Italy); Bloomington (USA); and Brussels (Belgium).
Valuation:
Debts increased in late 2024 due to the acquisition of businesses and manufacturing facilities, primarily Catalent for $16.5 billion. This is an investment in future production capacity, which will pay dividends over the next few years.
Market cap is $390B. If we subtract total liabilities from the current assets (ignoring the long-term assets) we get -$23B. Therefore, enterprise value is conservatively $413B.
Net profits were $14B and increased roughly 20% y/y. Profits have consistently grown in the 20% range the last few years.
So we are paying roughly 29.5x earnings at current prices.
The company is not cheap by most valuation metrics, but to me this is a fair value price for an excellent company in an otherwise overvalued market. We are paying 29x earnings for a business with over 20% growth and tremendous returns on invested capital. Most DCF modeling will indicate this is fair value as well. Its main competitor Eli Lilly trades at a PE ratio of 75 and is overpriced in my opinion.
Novo announced a dividend increase of 21% this year. This is the mark of a company that is doing well. I position my portfolio to be diversified across industries and geographies. The health and pharmaceutical industry is often insulated from headwinds in other sectors of the market. NVO is my pharmaceutical pick.
Management has its eye on the prize. I was impressed with the CEO’s calm and diplomatic responses during his 2 hour testimony before the U.S senate hearing (i.e grill session).
Below are my responses to bear arguments I have read.
Common Criticisms:
RFK Jr. is going to target the pharmaceutical industry and weight loss drugs.
This type of argument is highly speculative. He commonly describes obesity as a U.S epidemic which would work in their favor. I don’t put much weight on this (pun intended). Some new outlets report that he has softened his stance.
Trump is going to put tariffs on pharmaceuticals.
Novo should be able to bypass tariffs by manufacturing in its U.S facilities. It announced a 4.1 billion dollar expansion of its North Carolina site in 2024, which will be completed 2027-2029. A new filling site was also acquired in Bloomington (Indiana) in 2024.
Eli Lilly’s has a superior product in Tirzepatide (Monjaro).
Both companies have excellent products and I believe this will be a duopoly. Tirzepatide facilitates slightly better weight loss and has more proven benefits in HFpEF and sleep apnea. Semaglutide has greater evidence in general cardiovascular outcomes. I think the net clinical differences here will be marginal. From my point of view, Novo has a first mover advantage as patients and physicians are more familiar with Ozempic, which has become a household name. Both products are supply constrained and the market is big enough for both to dominate.
What will happen when the semaglutide patent expires?
Generic options will be available and margins will decrease in the 2030s. Novo will likely continue to manufacture and sell Ozempic/Wegovy in large volumes, similar to its legacy insulin business. Next generation obesity products will be the new drivers of growth including Cagrisema, Amycretin and combination products. Novo is well positioned to continue to lead this space based on its patent portfolio, accumulated clinical evidence, manufacturing scale and its abundant access to capital.
Real Risks:
Lack of insider buying right now.
U.S Medicare Price negotiations are targeted for 2027. This may lower the prices of Ozempic/Wegovy, but it is unclear how much this will impact the bottom line. I anticipate lower prices may be counteracted by higher revenue volume.
Their patent in China will expire in 2026 unless they win their appeal to have it extended for other indications.
Loss of market share to new entrants (unlikely in the near-term).
- Stock Doctor
Disclosure: I have a small long-term position in NVO. I will consider adding to this position in the future.
Disclaimer: This article is for informational and educational purposes. This is not financial advice. Investors should always do their own due diligence.