The Novo Nordisk share price has surged 227% in 5 years but could have plenty more upside thanks to blockbuster weight loss drug

The Novo Nordisk share price has gained 6.5% so far for 2023, is up 42.65% over the last twelve months and 227% over 5 years. The pharmaceutical company, which is narrowly specialised in diabetes and weight loss treatments, is now Denmark’s most valuable firm with a market capitalisation of a little over $250 billion at the time of writing.

The company’s valuation has been steadily, and strongly, rising for several years now. While it sells a strong portfolio of diabetes treatments as well as being the world’s biggest maker of insulin, the recent surge in value owes more to the successful process of clinical trials and subsequent regulatory approval of its new weight loss drug Semaglutide, sold under the brand name Wegovy.

In early March The Economist published a cover story and special report titled “New drugs could spell an end to the world’s obesity epidemic”. The article expressed excitement at what it sees as the potential of Wegovy, as well as a rival drug by U.S. pharma giant Eli Lilly due to go on sale later this year. And put the potential value of the market for the category of weight loss drugs at $151 billion a year by 2031.

With Elon Musk publicly claiming to have used Wegovy to positive effect and the drug reportedly becoming a Hollywood craze, the hype is ramping up.

Should investors be looking at Novo Nordisk or has Wegovy’s expected impact on the company’s future revenues already been priced in?

How does Wegovy work?

Semaglutide, or Wegovy, is a glucagon-like peptide-1 (GLP-1) receptor agonist that works by mimicking the effects of a hormone called GLP-1. The hormone is naturally produced in the body and helps to regulate blood sugar levels and can also help to reduce appetite.

When semaglutide is injected into the body, it binds to GLP-1 receptors in the brain, which leads to a reduction in appetite and an increase in feelings of fullness. This helps to reduce food intake, which can ultimately lead to weight loss. In clinical trials, semaglutide has been shown to result in significant weight loss in people who are overweight or have obesity – 10% to 15% more compared to patients given a placebo.

The drug is administered as a once-weekly injection and is intended to complement a reduced-calorie diet and increased physical activity. While not a miracle cure for obesity and part of a comprehensive weight management program that includes diet, exercise, and behavioural therapy, the difference it makes is generating a stir.

In addition to its effects on appetite and weight loss, semaglutide has other beneficial effects that make it a useful treatment for people with type 2 diabetes. Studies have shown that semaglutide can improve blood sugar control and reduce the risk of cardiovascular events in people with type 2 diabetes.

Does Novo Nordisk still have strong upside potential despite recent gains?

It wouldn’t be a huge surprise to see the Novo Nordisk share price add to its recent gains in coming months, with regulatory approval of Wegovy in new territories – it’s currently available in the USA, Denmark and Sweden. The UK’s drug cost-effectiveness watchdog NICE released a statement this week that it would soon be available through the NHS. Other major markets are expected to follow.

However, investors should tread carefully at the current valuation. At a share price of 1003 DKK in Copenhagen and $141.46 on the NYSE dual listing, the market looks like it has already priced much of the earnings potential uplift and recent hype around the breakthrough weight loss drug into the company’s market capitalisation.

Novo Nordisk has a trailing twelve month Price to Earnings (PE) ratio of 33 compared to an historical average of roughly 15. That means new investors would be paying more than double the historical price relative to earnings. That’s doesn’t preclude upside potential, stocks with brighter looking prospects than peers often trade at significantly higher multiples, but it does indicate buying into the stock now means paying a relative premium.

There is also an argument the pharma company’s trailing 12-month earnings per share (EPS) of 3.68 does not justify the stock’s current price. However, trailing PE ratios do not factor in the company’s projected growth rate, which is expected to be significant thanks to revenues generated by Wegovy.

So how does the Novo Nordisk’s share price look based on a 12-month forward-looking PE-to-Growth (PEG) ratio? It currently stands at 1.49, with a good PEG ratio generally considered to be lower than 1.0, suggesting the stock could be currently overvalued.

However, these ratios are simply indicators and offer no guarantees on future share price performance. Tesla’s 12-month-forward-looking PEG is, for example, 1.91 compared to an average of 1.62 for the U.S. automotive sector and it has spent most of its corporate history well above the average. Despite that, the stock has delivered huge returns for investors over the past several years.

But how does Novo Nordisk compare for value to pharma stock peers? Comparisons in the pharma space are messy as most companies have a different focus. Novo Nordisk is pretty much a pure play on diabetes care and the weight loss sector. There is no other pharma company of a similar size that can say the same.

However, it still makes sense to look at Novo Nordisk in the context of pharma peers. It has performed particularly well in terms of Returns on Capital Invested (ROCE) over the past decade compared to rivals, beating its closest rivals by almost 300%.

Source: SeekingAlpha

A major threat to Novo Nordisk is competition for Wegovy in the form of U.S. peer Eli Lilly’s tirzepatide, which is a direct competitor that will go on sale late this year. In trials, tirzepatide has shown even better results than Semaglutide and the U.S. company’s product is likely to be favoured on its domestic market – the world’s biggest for obesity treatments by far.

To justify its current valuation, Novo Nordisk will need to deliver average double-digit growth every year for the next decade. While that is certainly possible, it leaves little margin for error.

That’s reflected by the 12-month share price targets of the 26 analysts surveyed by the Financial Times who cover Novo Nordisk. The median price target for the next year indicates a relatively modest upside of just 3.8% and a downside of over 30% if more pessimistic analysts are proven right. The optimists, however, see potential upside for the stock of almost 23%.

Source: Financial Times

Despite that, as many (10) rate the stock as ‘outperform’ as ‘hold’ and 5 consider it a ‘buy’ compared to 2 as ‘underperform’ and a single ‘sell’ rating.

In conclusion, Novo Nordisk is a high quality pharmaceutical firm with a focus on a fast-growing segment, diabetes care and weight loss. However, while its long term prospects look good and the market for Wegovy is expected to be large and grow, the stock is not an obvious bargain at its current valuation.

Buying in at this point likely means being late to the party when it comes to the big returns delivered over the past few years. On the flip side, dividends will be expected to show healthy growth over coming years as Wegovy brings cash flowing in despite strong competition expected from Eli Lilly and it could make a solid long term contribution to an investment portfolio.

However, if analysts quoted by The Economist as tipping the market for GLP-1 drugs like Wegovy as potentially reaching $150 billion by 2031 are right, Novo Nordisk’s growth would be expected to be significant. Even with competition, a healthy share of that theoretical future market, worth almost the value of today’s spending on cancer drugs, would be expected to see the Danish company’s valuation soar.

A general market slide could offer the opportunity to buy a dip over the months ahead.

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