• Nishlen Govender, Portfolio Manager, Citadel

Tired of Aspen? We have a drug (company) for that


Most South African investors will be well acquainted with Aspen, the global pharmaceutical business founded in Durban that achieved its position as a market leader through the purchase of drug franchises from global peers across key therapeutics such as anesthetics, oncology and blood clotting.


However, investors who believe that pharmaceutical businesses, or healthcare businesses in general, represent attractive investment opportunities needn’t limit themselves to the one global pharmaceutical business available on the Johannesburg Stock Exchange (JSE). South Africa represents just 1% of the global economy, and there is a plethora of other businesses available offshore including hospital groups, managed care providers, and biotechnology and pharmaceutical companies.


One such company that merits further consideration is global drug company Novo Nordisk, one of the largest insulin providers in the world.


Originally starting as two separate companies, Novo and Nordisk each developed their businesses over time across areas such as insulin production, blood clotting and even penicillin. Novo started selling insulin in the United States in 1981, while in 1983 Nordisk introduced the Nordisk infuser – a pump that led to a refillable injector that looked like a fountain pen, which released small quantities of insulin. In 1989 the two companies merged, thus bringing together the world’s second and third largest insulin providers into one diabetes conglomerate in order to compete against then number one provider Eli Lilly.


Fast forward to 2019, and the company is now widely recognised as the provider of choice for diabetes treatment. Novo Nordisk holds a 45% share of the insulin market achieved through innovations such as slower acting insulin, longer lasting insulin and improved methods for injectable insulin, as well as its work towards the creation of an oral insulin medication which should achieve regulatory approval in 2019.


Insulin currently provides 81% of its revenue in a market that is growing rapidly – 450 million people suffer with diabetes globally, and rising obesity levels means that this number is expected to compound.


Although future returns are not guaranteed, rising demand and a firm commitment to innovation has also meant that the company’s share price has significantly outperformed the S&P 500, the benchmark for US equities which itself has achieved significant performance over time.

Source: Citadel (2019) *Both rebased to 100 and presented in US dollars


Industry challenges


However, despite Novo Nordisk’s position as a company in a compelling industry with a significant market share and a demonstrated history of market leadership, its share price reached its highest level in 2015 – a level that it has struggled to breach in the subsequent years.


This price resistance stems from a perceived risk to drug pricing, and the threat that competitors could in time encroach on its dominant position in the treatment of diabetes.


Many, for instance, will be aware of increased pressure on drug companies over pricing in recent times, especially in the US where pharmaceutical companies have previously taken advantage of limited regulation to increase drug prices. Infamous cases such as Valeant and Martin Shkreli’s Turing Pharmaceuticals immediately come to mind, although other companies have likewise introduced steady price increases on much needed and life-saving products.


Novo Nordisk itself has benefitted from the US operating environment, although it should be noted that the company has consistently introduced significant innovations to warrant higher prices, resulting in exponentially better provision of insulin to diabetes sufferers, even while the average time between treatments has lengthened.


Still, the market, led by the Democratic Party, has campaigned against the “threat” of continued drug price hikes. Likewise, the American healthcare system itself has placed increasing pressure on the margins of drug companies through mergers between pharmacy benefit managers (PBMs), healthcare providers and insurers.


Additionally, pharmaceutical companies face the threat of lapsing patents on their drugs, resulting in generics and biosimilars that hold the potential to erode companies’ market share and profits over time.


How does Novo Nordisk stack up against these threats?


This said, the company has dealt with industry threats admirably, wielding essentially two key strategies.


The first strategy has been to take the intellectual property inherent in insulin production, and use it to create drugs that can aid consumers in associated industries.


So far, the company has augmented its insulin drugs to function in areas such as haemophilia, growth disorders and obesity. And although obesity management drugs represent just 3% of its current revenue, it is worth noting that obesity already affects 650 million people worldwide and counting.


Diversifying into different industries has not only provided the company with risk protection, but harnessing the capabilities of its current pipeline also means that it hasn’t needed to spend significant funds on new research and development.


The second key strategy has involved adapting and innovating its current portfolio of drugs.


One such example of this is the drug Victoza, a blood sugar medication which is now attracting a label upgrade owing to its ability to also reduce cardiovascular issues.


This has extended the drug’s patent life and justifies the higher cost that the drug may carry, while simultaneously protecting the company’s margin and providing some protection from competition in the near term.


Perhaps of even greater interest is the company’s new oral semaglutide – a drug that represents a huge step forward in the treatment of diabetes, potentially enabling patients to take insulin medication orally instead of injecting themselves.


Additionally, its strategies have separated the company from its peers, and should secure the company’s status as a class leading company for years to come.


Citadel thus currently values Novo Nordisk in dollars at $46. We generally assign margin of safety and momentum values to businesses to give a sense of when we would definitely purchase stock in a business as well as a value that represents an area where we would consider selling. For Novo Nordisk our margin of safety value is $41 while our momentum value is $55.


Given that this is a stable company with distinct market leadership in a defensive sector, we continue to hold the stock even though it is close to its momentum value (it is currently trading at $51). This avoids selling too quickly which we have found erodes significant value through time.


Ultimately, there aren’t any alternatives that truly match the investment exposure that one would receive with Aspen. But Novo Nordisk has, with just one other company, owned the lifecycle of insulin production through history, steadily growing its portfolio through innovation, and has developed a flourishing pipeline of new products that will create exciting opportunities in new industries.


So for those looking for more options or an investment to complement Aspen, Novo Nordisk might just be the answer.


ENDS


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