Still a Buy, Despite the Tresiba Setback

Nauman is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Shares of Novo Nordisk (NYSE: NVO) are trying to recover from a recent sell-off that occurred after the FDA rejected its new drug Tresiba -- citing lack of a pre-approval cardiovascular outcomes study. Tresiba is an insulin analog, which is injected subcutaneously three-times a week to help control the blood sugar level of those with diabetes. Shares plummeted almost 15% on this disappointing news. But the real question now is if this setback has changed the long-term potential of Novo Nordisk or are the shares still a buy?

This rejection does prove that how serious the FDA has become in recent years when it comes to the safety and risk-benefit analysis of potential new diabetes drugs. I've noticed several recent moves by the FDA that second my opinion -- from Amylin's Bydureon to Bristol-Myers (NYSE: BMY) / AstraZeneca's (NYSE: AZN) SGLT-2 inhibitor Dapagliflozin. The FDA twice declined to approve Bydureon in 2010, with its most serious concern being that the drug might contribute to heart rhythm abnormalities. Similarly, in 2011 the FDA decided not to approve the novel diabetes drug Dapagliflozin until drug-makers Bristol-Myers Squibb and AstraZeneca supply more data on the drug's benefits and risks.

Though Tresiba proved its efficacy, Novo Nordisk was unable to convince the FDA about the safety of the drug. Despite the fact that both Europe and Japan have approved Tresiba, the FDA has now asked for a new study as a prerequisite for the approval. Moreover, Novo got a warning letter from the FDA, citing other facility issues as well. Novo's management now faces a dilemma, as they aren't sure what the next step should be. The major issue is with the design of the study and if that may or may not be completely acceptable to the FDA. Another issue is the length of the trial, as it might take years before the definite results of the study could be known.

I believe, this setback gives Novo's direct competitor Sanofi (NYSE: SNY), a major advantage. Sanofi has Lantus, which is a long-acting insulin that is taken once a day for diabetes treatment. Sanofi is also working on a new follow-on to Lantus, which is expected to launch in 2015. Moreover, concerns about what will happen with Tresiba in Europe and Japan remain.

Nevertheless, the setback for Tresiba is hardly a disaster as Novo has a strong future pipeline and its fundamentals remain strong. I believe, this setback will have a very little effect on the Novo Nordisk's future earnings as it still has the Insulin detemir, a long-acting human insulin analogue for maintaining the basal level of insulin, which the company markets under the trade name Levemir.

Novo Nordisk Current Valuation

Novo trades at 26 times trailing earnings. Analyst expectations are for $8.36 in EPS for the current fiscal year, and the current stock price is 20 times that figure, compared to its peer average of 21x. Novo has an impressive cash flow generation, and when I look at the enterprise value implied by the current stock price, it is 16x trailing EBITDA, in-line with the rest of the industry. The current ratio is 1.90; the firm is liquid. Moreover, Novo pays a dividend that has grown rapidly since it was first started.

<img src="http://media.ycharts.com/charts/567eb3538ebefce1829ea2179514c6e1.png" />

The share count has already fallen from over 640 million in fiscal 2009 to 580 million at the end of 2012, and considering the management's plan to spend a big chunk of the future cash flow on buybacks and dividends, this trend should continue.

<img src="http://media.ycharts.com/charts/db778f0ddb36251cb47da050b740a6ec.png" />

Foolish Bottom-Line

In short, despite the Tresiba setback, Novo Nordisk fundamentals still remain strong and after the discount afforded by the most recent sell-off, shares are certainly approaching an attractive risk/reward zone. All told, I expect a long-term revenue growth outlook of 9% to 10%, along with a steady improvement in the cash flow generation -- Novo can grow its cash flow at a 7%-9% rate for the long term. However, I would wait for the shares to drop to the mid-to-high $150-$155 level, as the shares present an optimal risk/reward there. Sub-$155 is where I will start a long-term position.


MaaniValueGuru has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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