Novo Nordisk – Great company but also a great investment ?
Novo Nordisk is a company which has been on my radar screen for a long time. The company is well-known and clearly a “high quality” company. A quick list of why the company is a favorite of many investors and has delivered 22% p.a. over the last 20 years:
+ market leader in insulin /diabetes care
+ significant growth opportunity despite significant global market share
+ customers/ patients are “locked-in”
+ market grows automatically (Emerging markets obesity etc.)
+ well-managed, manager salary relatively modest, good incentives
+ organic growth, no goodwill, no debt
+ ~100% earnings to cash conversion
This clearly has been not gone unnoticed by the market, the valuation is clearly not cheap despite an almost -20% drop since the beginning of the year:
Market Cap: ~110 bn EUR
P/E 2015: 22,2P/E 2016: 20,6
Interestingly, based on trailing P/Es etc. Novo is slightly cheaper than most large Pharma companies like Novartis, despite earning significantly better margins and “Returns on everything”, however it looks like that for the other players the market expects better growth.
Novo has also some issues which, according to my understanding are the following:
- growth targets reduced, especially no further margin improvement expected
- Margins well above historic average – mean reversion ?
- Analyst consensus is still high
- potential technological changes in the diabetes care market
- market share already very high
- cost pressure from insurers (some new products for instance were rejected in Germany as too expensive)
Despite the negative points I have mentioned (and which they share with almost any pharmaceutical company), Novo is clearly a very very good company with a “real moat”.
The big question: Is it a good investment then ?
Personally, I find Novo is a difficult case. First, I have little experience with pharmaceutical companies. It is not an easy industry and there is high regulatory risk.
Secondly, Novo is a well researched company. As a large cap market leader, it is well covered (37 analysts at Bloomberg), analyst consensus is still positive with an average target price of ~380 DKK per share.
The only reason why I actually look at it is that Rob Vinall, a great value investor had laid out the case very well almost 2,5 years ago. This is how Rob summarized his thoughts on valuation:
At the time I bought our stake, Novo Nordisk was trading at around 18x my estimate of2014 net income. Though cheap compared to where the Company has traded historically,this is not generally considered to be a level that gets the average value investor’s pulse racing.From the perspective of the long-term business owner, I believe it should. Novo Nordisk belongs to that rare class of business which does not require capital togrow. Thus a not particular sexy sounding 18x earnings translates into an altogetherpunchier yield of just over 5%, made up approximately half in dividend and half in share buy backs. There are very few non-cyclical companies in Europe with a 5% yield at the moment and none with Novo Nordisk’s business quality.Furthermore, the Company is growing rapidly. Historically, it has grown its revenues at alow double digit rate and its earnings at a high double digit rate in Danish Krone.Fundamentally, the market structure and drivers are unchanged even if the stock market has temporarily taken a more pessimistic view of the future. There is no reason to believe that the future will not look a lot like the past. The company itself has a long-term guidance of 15% operating profit growth.Taking the cash return and growth in business value together, it does not seemunrealistic that the long-term owner can expect an annual return of close to 20%. Even at a fraction of this amount, the ownership experience should prove highly satisfactory a ta time when decent opportunities are otherwise scarce.
But 2 important assumptions have changed:
- The price is higher than back then. I guess Rob had bought the stock around 180 DKK (18 times 2014 profit of 10 DKK), Now, despite the drop in the stock price and a 50% increase in profits, the stock trades at ~21 times 2016 earnings, a lower “yield” than back then (~4.5%)
- Novo Nordisk itself has lowered it’s growth targets to ~5-8% at least for 2016. So the times of double-digit profit growth seem to be over for the time being.
So when Rob was investing back then at 20% p.a. expected yield (5% “current” + 15% growth), the same calculation right now would rather look like the following:
4,5% “Current” yield + 6,5% (mid-point) growth = 11% “expected yield”.
Not bad for a high quality company like Novo but not that great either. This has to include currency risk as well as any regulatory risks or technological disruptions.
Clearly, the overall yield level has dropped as well since 2013~2% p.a. in EUR for long maturities. But in any case, at the current valuation, the stock is less of a bargain than back then. Is the stock still a bargain ? At the moment, valuations for high quality stocks are in general very rich. One could argue that maybe 8-10% in the current environment would be Ok for Novo. But with an “implied yield” of 11% there is not a lot of “margin for error” if anything bad happens to Novo.
What could make the stock interesting again ?
Well, that’s simple: Either a lower stock price or higher growth. Maybe management has low-balled growth ? Who knows. Maybe the market over reacts if the next quarters don’t look that good ? According to Bloomberg, analysts officially still expect double-digit earnings per share growth well into 2019. Even adjusting for share buy backs, this will be difficult to achieve based on the growth rates communicated by managment.
For me, the stock would become more interesting at around 250 DKK under the current growth assumptions. I think I would also like to see more negative comments from analysts.
Clearly in the current market with Central banks piling into stocks, anything could happen, but speculating on a further multiple expansion in my opinion is not “value investing”.
If I would be a large cap fund manager who needs to invest (and maybe work for a Central bank), Novo still looks attractive. For me personally however I think that the stock currently is not attractive enough despite its quite obvious qualities.