Novo Nordisk: Making money while saving lives

Novo Nordisk is a pharmaceutical company based in Denmark. It sells drugs to manage diabetes, obesity, hemophilia and growth hormone disorder. Let's look at the numbers:

2006 - 2015 Revenue Growth: 15% CAGR
2006 - 2015 EBITDA Growth: 19.2% CAGR
2006 - 2015 EPS Growth: 22.9% CAGR
2006 - 2015 Debt: Negligible
2006 - 2015 Net Margins: 16% - 32%

The numbers are salivating. What's even more impressive is that the company has been paying about about 20% - 45% of net income as dividends. So they definitely have way more cash than they can put to use.

The Why

I don't have a very complete picture into why they have been so profitable in the past 10 years, but here is my hypothesis:

1. Oligopoly: The insulin industry has only a few players and NVO is the biggest one by market share. Along with NVO, there is Ely Lilly and Sanofi. NVO supplies about 50% of the world's insulin by volume. So this is an oligopoly with rational pricing.
2. Scale Advantage: being the biggest player has its advantages. Net income has increased more than revenue because of margin expansion because the fixed costs in this business are limited.
3. Barriers to Entry: This is because of a few reasons.
1. It is unattractive for a smaller competitor to come in because prices for insulin are already quite low (it is a high-volume business).
   
   “It’s important to know that the insulin market is a high-volume, low-price business compared with many other pharmaceuticals,” says Jesper Brandgaard. - 2012 AR
   
   In the insulin market, biosimilar competition is not a new phenomenon for Novo Nordisk. For decades there have been and still are local insulin producers in some countries, but their attempts to grow internationally have so far failed. The insulin market is very different from those for other biologic medicines, Jesper Brandgaard reiterates: “Insulin is a high-volume, low-price business, so it doesn’t have the same appeal to biosimilar producers as other biologic medicines. Even when some of the modern insulins lose their patents it will be very difficult for biosimilar producers to achieve the economies of scale that established insulin producers have. Furthermore, to be successful a new producer with global ambitions must also be able to deliver the products in sophisticated pen systems, which further adds to the up-front investments needed and increases the total manufacturing costs.” - 2012 AR
2. Some of the newer insulins have patents like Tresiba.
3. It takes a lot of R&D and government approvals, etc. to bring a new drug to market. It's just not worth it for other companies to enter this market.
   It is interesting that their most popular drugs (like NovoLog/NovoRapid) are actually off-patent. And yet there is little generic competition. Why?
   The reason for this based on chemistry: insulin is a long and complex protein. Unlike small molecules that have a fixed chemical formula that can easily be identified and copied, insulin does not. In fact, two batches from the same manufacturer can have molecules that are different. So, in order to prove safety to the FDA, generic manufacturers have to go through the approval process all over again (they cannot re-use the proven safety of a small molecule drug). I believe this is the reason we have not seen generic insulins even though it was discovered in 1922.

As volumes have increased, their margins have expanded from 16% to 32%.

Industry Trends

The industry trends are very favorable looking to the future. 387 million people have diabetes today vs. ~700 million estimated in 2035. According to the "Rule of Halves" mentioned in the annual report, about half of the diabetics in the world are diagnosed, of which about half receive care, of which about half achieve treatment targets.

So there is a long runway ahead of this company.

Why I think profitability will persist in the future

We invest for the future, so it is important to assess future profits. I think NVO will continue to be highly profitable because:

1. Barriers to entry as mentioned above. Specifically, since insulin is not a small-molecule drug, we will probably not see a generic anytime soon. Since its discovery in 1922, there has not been a generic insulin on the market in the US.
2. Newer drugs like Tresiba have patent protection until at least 2022, and they have a pipeline of future drugs.
3. As volume increases, they should be able to increase margins even more.

Capital Allocation

This is a business that is a cash gusher. So what do they do with the cash? About 40% of Net Income is given out as dividends, and some of it is used to repurchase shares. Share count has gone down 21% in the past 10 years. R&D is already taken care of in Net Income and CapEx is quite low (10% or so of Net Income).

Management Quality

I like management with discipline, and I see some signs of that in their annual reports:

"In May 2010, the Greek government announced temporary price cuts of up to 27%. As a consequence, we made a decision to temporarily withdraw some products from the Greek market" - 2010 AR

Also, management is paid about 1% of Net Income, which is not too bad.

Valuation

Because this is such a great business, it has always been valued at a premium to S&P500. However, due to a recent sell-off, it is trading at around the same multiple as the S&P500 (20x earnings). I think it is a great time to be a shareholder of this wonderful business.

CHKP - Selling virtual security

I'll start with the 10-year figures:

2006-2015 Revenue: 575M - 1630M = 11%

2006-2015 Net Income: 278M - 686M = 9%

2006-2015 EPS: 1.17 - 3.74 = 12%

2006-2015 Net Debt: 0 - 0

These numbers look quite impressive. Even though net margins have decreased over the years, there is still solid revenue and net income growth.

Note that this company does not capitalize software development cost and I like that. I could not find glaring accounting shenanigans in my brief look. Contrast this to Cerner, where the real net income drops a lot if you do not capitalize software development cost.

What they do

Checkpoint sells security-related software to businesses: firewalls, public and private cloud security software, etc.

Capital Allocation

This company is engaged in my type of acquisition plan: acquiring partial ownership of a business they understand very well. Aka, buying back their own shares. This is much better than acquiring terrible speculative software companies that do not produce profits. Note that they have made acquisitions of other companies, but at a small scale.

Because the company is very capital-light (capex is 3% of net income), it can use almost all the net income (and then some) to repurchase its own shares.

CEO

Gil Shwed is the founder/CEO of this company. He seems passionate about this field and holds several patents himself. I really like his compensation:

"Mr. Gil Shwed, Chief Executive Officer and Director. Cash compensation expenses recorded in 2015 consisted of $14.0 in salary expenses, and $12.7 in benefit costs. Mr. Shwed requested to forego his salary and bonus for 2015, as he has done for the past several years." - 2015 Annual Report

He also owns 17% of the company.

The future

This is a company in a fast-changing industry (technology). Moats in this industry are fleeting and companies need to be nimble to protect them.

I believe this company can stand out from the crowd because of the following reasons:

1. CEO is brilliant and thinks like an owner.
2. They have patents.
3. They have relationships with customers.

However, a complete change in landscape (like Cloud offerings including security bundles) may take away the pie this company has been consuming.

Valuation & Final Thoughts

Currently going for about 20x earnings. I think I may bite and take up a small position that I can increase in case the price moves downwards.