Unlike artificial intelligence (AI) where the profit potential is still very much unknown for many companies, the money-making potential of weight-loss drugs is there for all to see. Danish company Novo Nordisk’s (DK:NOVO.B) dominance of this market has a lot of attractions, but has its share price run up too far, too fast?
Dominant force tackling the obesity crisis
Not so long ago, Novo Nordisk looked as though it had run out of growth. Its leading position supplying insulin to treat diabetes had created great profits, but a maturing and commoditised end market for the product saw its profits and share price largely treading water.
Then came a breakthrough with two blockbuster drugs: Ozempic to treat diabetes and weight loss, and Wegovy as a weight-loss drug.
These products are known as glucagon-like peptide 1 (GLP1) drugs. The magic ingredient is semaglutide, which brings with it many health benefits.
Firstly, it helps keep blood sugar levels within a healthy range, which is needed to treat diabetes. However, it also helps with weight loss by promoting a feeling of fullness after a meal. The most striking benefit for the patient is psychological as it reduces thoughts about food.
Wegovy is estimated to reduce a person’s body weight by up to 15 per cent and has attracted celebrity endorsements from the likes of Tesla boss Elon Musk. The drug is currently being sold in 10 countries around the world.
The need for these drugs is largely beyond dispute as years of diets and exercise advice has failed to stop the world’s population getting fatter. According to the World Obesity Federation, half the world’s adults are expected to be obese or overweight by 2035.
As it stands, Novo Nordisk is dominating the diabetes and weight-loss market. It has just over a third of the diabetes drug market and over half of the GLP1 market by value. However, GLP1’s share of the diabetes market is still only just over 6 per cent and sales are expected to soar.
Novo Nordisk’s only major GLP1 competitor at the moment is US drug giant Eli Lilly (US:LLY). Its respective weight-loss and diabetes drugs, Zepbound and Monjaro, are also expected to thrive in the years ahead.
Great profitability with growth draws investors in
Novo Nordisk’s financial results have all the hallmarks of an outstanding and dominant company. On key measures such as operating profit margins, return on capital employed (ROCE) and free cash flow margins, its performance is stellar.
As sales growth is expected to stay strong for many years to come, the benefits of operating leverage on its cost base are set to keep on pushing its margins even higher.
The mix of high profitability backed by a dominant position in a growing market are the kind of characteristics that many investors love.
It is therefore no surprise that this combination has led to rampant buying of Novo Nordisk shares, which have delivered outstanding returns to investors over the long haul. A UK investor would have received average annual returns of over 25 per cent for the past decade.
Could Novo Nordisk be too profitable for its own good?
At the moment, the GLP1 market looks like a cosy duopoly between Novo Nordisk and Eli Lilly. The high prices being charged for the drugs and the high profits being made by the companies look as though they are being valued by investors on the basis that they are set in stone and cannot be threatened.
Could it be that investors are being too optimistic?
Surging demand has come up against a shortage of semaglutide and a lack of manufacturing capacity to produce the injectable pens that patients use to administer the drugs.
If the very bullish growth forecasts of investment analysts are to be met, then large quantities of the drugs need to be produced. Novo Nordisk is investing heavily to ramp up capacity in Denmark and has also recently splashed out $16.5bn (£13.1bn) to buy drug manufacturer Catalent (US:CTLT) so that it can boost its production of Wegovy.
However, it is the price being charged for Wegovy and Ozempic that is attracting the attention of US politicians in what is the drug’s biggest market.
Prices are eye-wateringly expensive and are still not covered by the majority of US healthcare insurers. The potential costs over the years ahead have created a financial timebomb for US healthcare costs which are already under severe pressure.
Without insurance, a monthly supply of Wegovy is $1,349 and Ozempic is $935. This has led to charges of profiteering from US senators such as Bernie Sanders, who chairs the US Senate Committee on Health, Education, Labor and Pensions.
These costs are way in excess of what is paid elsewhere, with Wegovy costing $125 in Denmark and around $90 in the UK.
A study by scientists in the JAMA Network journal has estimated that Ozempic could be made for less than $5 per month with a profit margin. Sanders is calling for Novo Nordisk to reduce the Ozempic price to $155 per month, but this is not going to happen any time soon.
However, this does highlight the risk that prices and margins for the drugs could come under pressure if the sales volumes expected are to be achieved.
Can competition put pressure on Novo Nordisk’s prices and profits?
A basic rule of economics is that high levels of profitability attract competition. Ozempic and Wegovy are protected by patents until the early 2030s, but Novo Nordisk’s share price is very sensitive to news on potential competition for its blockbuster drugs.
Recent news that Amgen (US:AMGN) had some encouraging trial results with its MariTide weight-loss drug led to a sharp sell-off of Novo Nordisk shares. This was despite very little detail being released on how effective it might be.
Other big companies such as Pfizer (US:PFE) and AstraZeneca (AZN) are looking to develop their own weight-loss products. Biotech companies such as Viking Therapeutics (US:VKTX) have also posted encouraging trial studies.
The fact that many of these potential rivals are looking to develop pill treatments does get around the problem of the cost of injectable pens while also reducing the dosage frequency from weekly – as with Wegovy and Ozempic – to monthly.
However, Novo Nordisk and Eli Lilly have a substantial head start. Getting a new drug to market takes time, while producing them at scale may not be easy.
Semaglutide is more than just a weight-loss drug
While competitors look to get a piece of the market, Novo Nordisk continues to invest heavily in order to develop new products and strengthen its competitive edge.
It has other weight-loss drugs in its pipeline, including Amycretin which is taken as a pill and is potentially more effective at promoting weight loss – 13 per cent more than Wegovy – after 12 weeks.
Cagrisema is another weight-loss drug in development. It combines Wegovy with cagrilintide. It is expected to go from a position of few sales currently to more than $5bn by 2028. Separate cagrilintide sales are expected to be as high as $4bn by the same date, according to FactSet.
Additional excitement is being generated by the other potential benefits of semaglutide. Studies suggest that it reduces the risk of cardiovascular events such as cardiac arrests and strokes by as much as 20 per cent. It could also be used to treat kidney disease, Alzheimer's disease and conditions such as fatty liver.
Novo Nordisk is also showing potential in other treatment areas such as haemophilia. Its Mim8 antibody has been found to benefit patients with haemophilia A, a condition where blood doesn't clot properly.
Results from the company’s recent late-stage Frontier 2 trial showed that Mim8 was better at preventing bleeding episodes versus other treatments previously used for haemophilia.
Should the potential of these development drugs become commercially viable, then there are grounds for thinking that there could be significant profit forecast upside potential for the company.
Are investors ignoring the potential side effects of weight-loss drugs?
Novo Nordisk’s GLP1 drugs have well publicised side effects, such as nausea, vomiting, constipation and depression. They also have to be taken indefinitely to maintain the benefits, which come with possible and as-yet unknown side effects.
This does not seem to be worrying investors right now, but it is a risk that arguably needs to be taken into account.
Reassuringly expensive or overvalued shares?
At the moment, analysts expect NovoNordisk to deliver many years of strong earnings per share (EPS) and cash flow growth.
Over the next three years, EPS is expected to grow at a compound average rate of nearly 23 per cent with continued strong growth thereafter.
It is therefore no surprise that the shares are highly valued. At DKr921, they trade at 36 times next year’s forecast EPS. This represents a substantial upwards rerating from the low 20s rating that was typical before the launch of Wegovy in 2021.
For many companies, such a high valuation would be seen as too expensive. The counter-argument is that such an outstanding global business with such as growth outlook should be richly valued.
Bulls will point to Eli Lilly’s even punchier valuation of 49 times next year’s forecast EPS as evidence that Novo Nordisk shares could be cheap. However, just because a rival’s shares are even more expensive may not mean that another company can be similarly valued. Eli Lilly also has other growth avenues such as its breast cancer treatments.
In the case of Novo Nordisk, its current high valuation arguably requires forecast upgrades to justify it. None were forthcoming following its first quarter results last month, which suggests a lot of expected momentum and growth have been priced in.
The shares are likely to remain very sensitive to newsflow on trial data from its own drugs and that of rivals. However, the main concern is that the shares are priced for perfection and perhaps do not take into account the risks of disappointment.
Affordability still remains a big barrier to a large take-up of its drugs in the US, and the sustainability of the current high pricing cannot be taken for granted.
Long-term side effects that could lead users to discontinue taking the drugs could also have a major impact on the valuation of the company.
The fact that Novo Nordisk is an outstanding business is not in question, but its high valuation and strong share price performance suggests that now is not a great entry point.
But it does look very worthy of a place on most investors’ watchlists at the very least.
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