Are Investors Putting Too Much Faith In Novo Nordisk?

It is hard to be too critical of Novo Nordisk (NYSE: NVO  ) , as this Danish biopharma specialist practically mints money with its leading franchises in diabetes, hemophilia, and growth hormones. The company is facing more challenges than it has in the past, though, as biosimiliars and new formulations threaten to change the insulin market and reimbursement pressures become more visible. It is hard to call Novo Nordisk underpriced, but a stock that looks poised to generating market-matching returns behind the security of good economic moats does have some appeal on a risk-adjusted basis.

An unusual disappointment
Novo Nordisk rarely misses estimates, but it looks like business was a little weaker this quarter than analysts expected. Revenue rose 2% as reported (and 7% in local currencies), missing the average sell-side guess by 3%. Most of that was due to underestimated currency impacts, but there was an underlying 1% operational miss in the diabetes business.

Diabetes revenue rose 1% as reported and 6% in local currencies, with noticeable weakness in Europe due in part to reimbursement pressures. Modern insulin sales were very mixed, with Levemir up 21% against a 3% decline in NovoRapid and a 2% decline in NovoMix, the latter two of which can likely be tied back to their exclusion from Express Scripts' formulary. Victoza sales were up 9%, while "Other" declined 22% on generic competition to Prandin.

Biopharma sales were fine, rising 5% in Danish kroner and 10% in local currencies as NovoSeven sales growth of 11% outweighed a 2% decline in Norditropin.

Novo Nordsk also earned back some lost revenue through better than expected margins. Gross margin improved 1.1 percentage points on better mix (beating expectations by 0.4 percentage points), and operating income rose 6% to beat expectations by about 2%.

And an equally unusual guide down
Management's guidance for the year is going to lead sell-side revenue targets down probably around 2%, and that's not something that happens very often here. Foreign exchange is having a bigger negative impact on Novo than expected, but the company's management also made some concerning comments regarding a slowing GLP-1 market.

As Novo's share as seemed fairly steady against AstraZeneca's Bydureon/Byetta and Victoza sales growth does seem to be slowing, I can understand the concern. With Lilly moving closer toward to US approval of its GLP-1 drug dulaglutide, a drug which showed top line non-inferiority to Victoza in the AWARD-6 study, Novo could be looking at more pressure here in the relatively near future.

A mostly positive pipeline update
Novo's news on its pipeline was generally pretty positive. The DEVOTE outcomes study for Tresiba is enrolling faster than expected and management believes it will be able to conduct an interim analysis in mid-2015, possibly accelerating approval by a year.

Novo also announced that it intends to begin a Phase IIa proof of concept study for an oral insulin (NN1953) in the first half of 2015. As a reminder, Novo will also be reporting phase 2 data on an oral form of semaglutide (GLP-1) in 2015.

On a less positive note, Ryzodeg missed the mark on a non-inferiority study comparing it to NovoRapid. Novo Nordisk also announced that despite strong Phase III data, it won't be filing its long-acting Factor VIII drug N8-GP until 2017/2018 due to supply constraints. Data suggests that this will be a viable competitor to Biogen Idec's Eloctate, but by the time Novo reaches the market Baxter will likely have its long-acting FVIII drug on the market as well.

Last and not least, Novo has an under-followed and generally unnoticed de novo effort under way in inflammatory disease, with three compounds in Phase II testing for rheumatoid arthritis and Crohn's disease. These drugs would only add about $1 per share in value at this point, but it could be the beginning of something that turns into a meaningful business down the line.

Times are changing in diabetes, or are they?
There is a lot of talk of change and challenges in the diabetes market. To be sure, reimbursement pressure is a very real issue, as seen by Novo Nordisk losing its place in Express Scripts' formulary to AstraZeneca and Lilly. There is also the rising threat of biosimilar substitution, though Sanofi did file suit against Lilly for its attempt to market a biosimilar Lantus and more than one company has abandoned biosimilar insulin as too challenging.

The bottom line
Novo Nordisk could have some upside from oral GLP-1 (a drug that could be a multibillion-dollar drug like Januvia) and oral insulin. I think the company won't have the most explosive potential return in the drug space, but there are some opportunities when you consider the company's strong market share (near 50% in insulin), focused pipeline, and demonstrated history of strong returns on capital.

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