Eli Lilly (LLY) and Novo Nordisk (NVO), the dominant players in the anti-obesity medication market, are both richly valued, with their shares having been bid up by the potential growth of the market for these medications in the coming years. The market for anti-obesity drugs was perhaps $3 billion in 2023 but is expected to grow to $80 billion to $100 billion by 2030. Certainly, the world’s population is becoming more over-weight and obese with each passing day, and the US leading the way. In the States, over 70% of the adult population has a BMI of 25 or more, considered either over-weight (BMI of 25-30) or obese (over 30). There is little doubt that the market opportunity for addressing anti-obesity is huge. Reducing obesity comes with enormous benefits to society too, reducing mortality and morbidity. If people become less obese, this has collateral effects into other sectors like fast food restaurants and snack food companies. This article – the final instalment of my work on anti-obesity drugs – will focus on the valuation of the shares of Eli Lilly and Novo Nordisk. Do the richly priced shares of these pharmaceutical giants reflect fair-value, or are they are over-bought because the euphoria of the opportunity (i.e. momentum) has gotten ahead of the companies’ respective intrinsic values, even considering the market opportunity?
To provide some context before digging in, the forward P/Es of LLY and NVO are 60.2x and 39.1x, respectively, against an average of the pharmaceutical industry of 21.2x and of the S&P 500 of around 20.4x. Another industry surrounded by euphoria – tech and specifically artificial intelligence – has experienced a similar run based on a bright outlook. However, the “mother of all AI companies” NVIDIA (NVDA) – which has had a remarkable run in the last year with the shares up 244% – currently has a forward P/E ratio of 35.7x, less than both LLY and NVO. You have to think hard about these valuations generally in terms of the opportunity, but I find it rather remarkable that NVDA is significantly cheaper than LLY and slightly cheaper than NVO when comparing the forward P/E ratios. Relatively speaking, which of these companies offers the best chance for further appreciation in the future?
My experience with both LLY and NVO has been telling as far as my own bias. I held LLY for many years, unloading the shares last May when the price hit $400/share. I thought the valuation then was getting stupid, which in fact shows how stupid I was in retrospect. It’s a trade I regret. Since then, I have bought into NVO, and I have also re-entered LLY with a very small position. My logic for NVO was that I see and believe in the opportunity for anti-obesity drugs, and NVO – as you will read below and in the prior series of articles on this topic – is much more of a pure play as far as weight-loss drugs. It is also important to note that my largest position in the healthcare / pharma sector is JNJ, which I consider completely boring but safe. The way I look at it is that NVO provides some sizzle, and JNJ provides stability.
Finally, I should note that there are Street analysts and investors on the buyside that will know much more about LLY and NVO than me, so you are reading the opinion of an “arm chair quarterback” so to speak. I also do not have the resources or time to dive deeper, but I think I am presenting a fair and balanced picture…..or at least I hope so! Also, you should not consider this to be investment advice as I am not a financial advisor; ta
ke it in with a grain of salt, and keep in mind that I unfortunately unloaded LLY at half its current price less than one year ago!
Financial comparison: LLY and NVO
The table below presents summary financial data for Eli Lilly and Novo Nordisk, the two pharmaceutical giants that are dominating the market for anti-obesity drugs. Note that NVO’s financial data is reported and presented in Danish Krone (middle column). The right-most column in the table below converts NVO’s results in DKK to US Dollars so it can be compared to the results of LLY, keeping in mind that LLY reports under US GAPP and NVO under IFRS.
As the table illustrates, the companies are of very similar size in terms of revenues, although LLY is much larger in terms of total assets. NVO is more profitable at the gross profit level all the way down to the bottom line, most likely a reflection of its greater reliance on higher margin diabetes type 2 and anti-obesity medications, which collectively accounted for 93% of NVO’s 2023 sales (vs LLY at 58% of 2023 sales).
As far as R&D expenditures, LLY spends more than NVO, but this is spread over a variety of different drugs in development in different categories, whereas NVO is much more focused on its core diabetes and anti-weight loss drugs with an extension into cardiovascular therapies. The same sort of assumptions can be made about capital expenditures, where LLY invests more although the investment is more broadly spread.
In terms of balance sheet strength, both companies have long-term debt outstanding, but NVO’s net leverage is lower. Both companies are highly rated – NVO is rated A1/AA-, and LLY is rated A1/A+. As a result, both have ready access to the capital markets in a variety of formats. NVO returns more cash to shareholders by virtue of having a higher dividend yield and engaging in larger share repurchases. Also keep in mind that NVO’s voting control is held by a Danish foundation, which means the company is “safe” from raiders that might become displeased with the company’s direction or performance in the future.
Valuations
The table below presents some valuation metrics for the two companies, alongside similar metrics that are available for IHE, an ETF (iShares) that tracks the pharmaceutical sector. As you are looking at the table and the commentary below, keep in mind that LLY is 22% of the IHE index. NVO, which is not listed directly in the US, is not in the index (or the ETF).
Share price performance
The share price performance of both LLY and NVO have been similar since the end of 2022 – both have roughly doubled. This performance far exceeds the performance of the IHE ETF, which has appreciated 14.1% over the same period. LLY and NVO have also far out-performed the S&P 500 index, which has increased by 33.3% since the end of 2022. The graph below shows the growth, noting that it is of mid-session on March 18th:
The performance of both companies so far in 2024 is similar, in that the share prices of LLY and NVO have appreciated far more than the share price of the pharma index per the IHE ETF. It is also worth noting, however, that the share prices of both pharma giants are off of their highs reached during the first week of March.
Dividends / share repurchases
NVO has a higher dividend yield than LLY, although both companies have dividend yields that are lower that the pharmaceutical industry overall as expressed by IHE. This reflects the sharp appreciation in the share prices of the pharmaceutical giants over the past few quarters, since both companies have historically paid (and steadily increased their) dividends over many years. NVO is more aggressive in terms of share repurchases, meaning that overall, NVO returns more cash to shareholders than LLY.
Valuation multiples
Both LLY and NVO have traditional valuation multiples that are substantially higher than the market generally, and higher than the IHE ETF (keeping in mind that LLY is 22% of the IHE). The forward P/E ratio of LLY is half the company’s trailing P/E ratio, reflecting the fact that analysts are expecting the bottom line of the company to double this year (compared to 2023). The company’s management has provided guidance for 2024 that is in line with analysts’ expectations. It is important to remember that Zepbound – LLY’s anti-obesity medication – was just approved by the FDA on November 8, 2023, so sales of this product were only in LLY’s result for a few weeks of 2023. The sharp uplift in 2024 expected earnings at LLY contrasts with NVO’s expected 2024 bottom-line result, which is also expected to increase but not as significantly as LLY’s. One reason is that sales of NVO’s anti-obesity medication Wegovy were included in the company’s full year results for 2023, since the medication was approved by the FDA in 2021. The difference in the PEG ratio also tells a story, suggesting that LLY’s expected five-year growth rate is projected to be much higher than NVO’s in the coming years. The question is can LLY live up to these grandiose expectations, as the stock is fully-priced for strong and consistent bottom-line growth.
Analysts and shorts
StarMine from Refinitiv (consensus of eight analysts firms, per Fidelity Investments’ website) has NVO’s rating at 3.4 (out of 10), considered neutral. The short interest is only 0.15%. The same data source has LLY’s rating at 5.9 (out of 10), also considered neutral but higher than NVO. LLY’s short interest is 0.57%, higher than NVO’s but also likely a reflection of the greater liquidity in LLY’s shares which are directly listed on the NYSE, as opposed to NVO’s shares which are ADRs. My instinct in that analysts have a hard time pinning a “sell” on either company in spite of their valuations, since momentum is such an important factor currently driving equity prices.
So which company is better? (not investment advice or a recommendation)
Both LLY and NVO are richly priced or – in other words – are priced to perfection. Any stumble for any reason by either company could put their share price under immediate pressure. Moreover, at these rich valuation levels, the shares are also vulnerable to general weakness in equity markets, because companies with shares that are deemed to be the most over-priced would be the first to get hammered. Having said this, the high valuations of both LLY and NVO reflect the opportunity at hand – the world is becoming more over-weight and obese, and the potential opportunity to address this problem is enormous.
The case for NVO
If you would prefer more isolated exposure to anti-obesity medications on the basis that the untapped market is huge and growing, NVO is a more pure play in this respect because of:
Its heritage in developing diabetes and anti-obesity medications, along with its know-how and reputation in these therapies,
Its investment in R&D and manufacturing is more narrowly concentrated on these product areas, and
Most importantly, NVO’s top-line sales are dominated by diabetes and anti-obesity medications (93% in 2023).
NVO has the support of the Danish foundation that has voting control of the company, another source of “cheap” capital (via grants) to go alongside access to capital in the debt and equity markets. NVO also returns more money to shareholders than LLY through a higher dividend yield and a greater amount spent for stock repurchases. However, given its more narrow focus across the board, NVO is more exposed to anything that might adversely affect the growth of anti-obesity drugs or the company’s profitability, including competitive risks that might emerge as other companies attempt to develop viable products to compete with Wegovy.
The case for LLY
If you prefer a more well-rounded pharmaceutical company that also happens to be a major player in diabetes and anti-obesity medications, then LLY might be a better stock for you. Unlike NVO, LLY is investing in other medication segments aside from diabetes treatments and anti-obesity medications, including oncology and immunology, areas in which NVO is not directly involved. This arguably spreads investment in R&D and capital expenditures across a wider spectrum of therapies, but it also lessens the company’s dependency on weight-loss drugs. LLY is also directly listed on the NYSE meaning that the shares are more liquid and receive more focus from US investors compared to NVO, which is a Danish company with ADRs listed in the US.
In summary, I believe that LLY’s shares carry higher risk because of their lofty valuation, recognising that the company is a large and more well-rounded pharmaceutical company (than NVO) that also happens to be a co-leader in the exciting market for anti-obesity drugs. LLY has multiple revenue streams that can power this company’s future growth, and any disappointment for any reason in anti-obesity drugs would be diluted because of this.