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Ole Hansen
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Article / 12 April 2012 at 7:33 GMT

Novo Nordisk shares can be a play on 'obesity exposure'

Equity Analyst
Denmark

Let’s face it, the world is growing older and getting fatter. With economic expansion and increasing standards of living comes more meat-filled diets that basically make us fat. So the capitalistic question to ask yourself is: How do I make money from this?

Well, there are multiple ways of doing this.  You can invest in ‘assisted living’ companies, but you can never get the true ‘obesity exposure’ from these stocks. You can also invest in drug companies that try to combat obesity, but these tend to be diversified companies which dilute the ‘obesity exposure’. The purest play way to profit off of the world’s excess is through a diabetes company, and there is no purer play than Novo Nordisk.

A little background on diabetes

The prevalence of diabetes is driven by Type 2 diabetes, which is about 90% of all diabetes. The main driver for Type 2 diabetes are lifestyle factors such as obesity, lack of physical activity, poor diet and stress, which sounds like the average Westerner’s life.

In fact, the diabetes care market has grown by 11% per year in the past 5 years. This is not expected to change as our lives are prolonged and our waistlines expand. As Western culture and western habits are transmitted to growing economies, the expansion in diabetes can be expected in  countries like China and India. While insulin consumption per inhabitant has increased by 47% in the US, 61% in Germany, 77% in the UK, 87% in Japan, in the past 10 years, it has exploded in China with an increase of 1300%. This is highlighted by the estimate that China currently has the highest population of Type 2 diabetes in the world.  It affects an estimated 10% of the population, even higher than in the US.

Currently Novo Nordisk has a 51% global market share, which has been steady for the past 6 years. And it has a 63% market share in China, but because China is relatively underpenetrated, the Chinese market only amounts to about DKK 4.5 bn per year, less than 7% of Novo’s revenue. This is important because although the Chinese market is currently relatively small, brand loyalty tends to be very strong in diabetes medicine. If Novo can continue dominating the Chinese market, it should be a massive boon for the company or for any diabetes company.

Novo Nordisk is best play on diabetes because more than 75% of its sales and 65% of its operating income come directly from diabetes medicines. The company currently trades at a forward P/E of 24 which makes this stock a growth play, and why shouldn’t it be? The company has by far the biggest market share among a few other participants, and because the company’s main focus is diabetes, unlike Sanofi and Eli Lily, the company can focus all of its energy unto the diabetes field, which is a great strategic, intangible advantage.

Saxo Bank Equity Research

If we assume that the market continues to grow at 11% and that Novo Nordisk maintains its global market share of 50% then we can quickly estimate that Novo’s top line should keep growing in the 10-11% range. And because of its scale, we can conservatively estimate that the company’s bottom line will grow at around 13%. Therefore the stock which trades at a trailing P/E of 27 (leading or forward P/E of 24) and if my growth assumptions are correct is trading at a respectable forward P/E of 16 in 2016.

The company currently trades at the upper range of its historical P/E levels, which is represented below with a valuation chart from Saxo Bank Equity Research. Although this stock is a bit too rich for my blood, growth investors will nevertheless appreciate the secular growth of diabetes (appreciating diabetes might be the wrong word) and company’s dominant position.

Saxo Bank Equity Research Valuation chart

Although I completely love the company, the price of the stock is a bit too much for me. I will be waiting and praying for it to trade closer to P/E of around 20 to make this a value buy. Although I might miss a good investment in process, I also refuse to pay too much for growth.

6y
Mac Mac
Although diabetes is on a rapid incline and looks set to stay, is Novo Nordisk not taking a bit of risk by having the majority of their sales dependant solely on one medical condition? I'm sure our diets won't change overnight and admittedly there is money to be made in the meantime, but what about that age old saying "don't put all your eggs in one basket"? If and when we all get to grips with nutrition and health this company may be left high and dry....
6y
Matt Bolduc Matt Bolduc
Well for a shareholder, you can just easily diversify your portfolio, so I personally would't want Novo to diversify. If they did I would just buy another pharmaceutical. People can diversify by themselves, I don't they need a company to do it for them.
I personally believe that CEOs like big diversified companies simply because of their size, and given that CEO salary is linked to company size this makes perfect sense.

Additionally, most diversified companies do tend to trade at a discount in general and tend to do better when they are broken up.
6y
Mac Mac
Thanks for the feedback. Very valid point about diversifying your portfolio rather than seeking diversified companies.

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