It’s been a long time coming, that’s for sure. For what seems like a geologic epoch investing in drug stocks has been about finding an attractive dividend and avoiding getting killed when the patent on a best selling drug expired.
Growth? Forget about it.
But that looks like it’s changing–for some parts of the sector, anyway. For some drug companies, these are actually exciting times. And given the problems that some of the sectors that led the market upward in the first quarter look they might have in the second quarter, the excitement couldn’t be coming at a more welcome time for investors.
Exciting? Drug stocks?
Sector leader Novo Nordisk (NOVOB.DC in Copenhagen and NVO in New York) and upstart Amylin Pharmaceuticals (AMLN) are in a pitched battle to see who will take the biggest share of growth in the market for diabetes drugs.
At the very end of February a panel of advisers at the U.S. Food and Drug Administration voted 20-2 that the benefits of Qnexa, a weight-loss drug from Vivus (VVUS) outweigh the risks. An approval of Qnexa or competing drugs from Orexigen Therapeutics (OREX) and Arena Pharmaceuticals (ARNA) could put the first weight-loss drug on the market in 13 years.
A new class of drugs to fight hepatitis introduced by Merck (MRK) and Vertex Pharmaceuticals (VRTX) only last year is already looking at a challenge from a new group of therapies from Bristol-Myers Squibb (BMY), Gilead Sciences (GILD), and Johnson & Johnson (JNJ).
You might notice that the three potential drug opportunities that I’ve just mentioned have three things in common. First, they all target chronic rather than acute conditions. People with diabetes or hepatitis don’t die immediately after getting the disease. Like the people who live with obesity, they struggle to manage their condition and to extend their healthy lives. Second, the market for each of these groups of therapies is huge. The National Institutes of Health calculates that 18.8 million people in the United States have been diagnosed with diabetes. (Another 7 million with the disease, the Institutes of Health estimates, haven’t been diagnosed.) As many as 1.4 million people in the United States live with chronic hepatitis B, according to the centers for disease control. Another 3.2 million have hepatitis C. The World Health Organization estimates that in the world 170 million people are chronically infected with hepatitis C. And third in each case a treatment does exist but it’s either extremely expensive, difficult to administer, or ineffective—and perhaps all three.
Let’s me use the diabetes story to sketch in why the drug sector is exciting again. It’s an especially good example since it also ties in directly with the weight-loss drug story. (I’ll have to leave hepatitis to another day.)
Denmark’s Novo Nordisk is the big dog in diabetes. The company has been in the commercial insulin market since 1923 and controls about 24% of the diabetes market by value. Annual 2011 sales came to $11.7 billion.
The growth story at Novo Nordisk is a result of a combination of what has been called a global epidemic of diabetes and a new generation of modern insulins. In a 2008 study the Centers for Disease Control estimated that the incidence of diabetes in the United States had climbed by 90% between 1995-1997 and 2005-2007. The increase, the study posited, was a result of an aging population—since diabetes incidence increases with age—and increasing obesity. Those demographic trends aren’t limited to the United States: the World Health Organization estimates that there are now 350 million people in the world with diabetes. Add those demographic trends, which don’t look like they’re about to reverse anytime soon to a market shift from human insulin toward modern insulin analogs that offer greater efficacy, safety, and convenience and you’ve got quite a growth story—especially if modern insulin analogs cost roughly the same to produce as human insulin but sells for roughly 150% as much.
Novo Nordisk saw sales climb 11% in 2011 with operating profit up 18% and earnings per share growing 22%. The stock trades at a price-to-earnings ratio of 23 on projected forward 2012 earnings. The company has an extremely conservative balance sheet with $2.84 billion in cash and cash equivalents against just $390 million in short- and long-term debt. Right now the company’s payout ratio is about 45% and the shares pay a 1.7% dividend yield. For 2012 the company has authorized $2.1 billion to repurchase shares.
But markets that provide companies with 34% operating margins (in 2011, which was actually up from the 29% average for 2007-2011) attract competition. Novo Nordisk is facing a potentially hard charge from a small biotech Amylin Pharmaceuticals and its product Bydureon. The newly introduced drug is the first in the GLP-1 diabetes drug category to require once-a week injection. Novo Nordisk’s Victoza, Bydureon’s main competition, requires once-a-day injection.
The potential for Bydureon led Bristol Meyers Squibb to put in a $3.5 billion bid to buy Amylin last month. Not a bad price, you might think, for a company with $651 million in 2011 revenue and that has yet to show a profit. But the San Diego company turned down the bid saying it was too low.
The bid and the news that Amylin had turned down $3.5 billion were almost immediately leaked to Bloomberg by anonymous sources. One theory, and this makes sense to me, is that a big investor in Amylin leaked the information in an attempt to make sure that the company sells to someone. It would be very hard now, the theory goes, for Amylin to strike a deal in which it kept U.S. marketing rights to Bydureon for itself since such a deal would bring in so much less than the $3.5 billion offered by Bristol Myers that the stock would tank on the news. That would put the board in the awkward position of justifying a decision that cost shareholders big bucks. The Medical Technology Stock Letter, which has recommended Amylin since it was a $12 stock, notes that this theory gains credibility from the fact that activist investor Carl Icahn owns 10% of Amylin and has been very vocally critical of the board for turning down the Bristol Meyers Squibb offer. The Medical Technology Stock Letter thinks a $30 offer—from Bristol Meyers or some other big drug company—would get the deal done. The shares closed at $24.12 on April 5.
But Novo Nordisk didn’t get to be where it is in the diabetes market by rolling over whenever a challenger made a move. (The company has grown its share of the diabetes market (by value) from about 18% in 2001 to 24% today. (Nothing like growing share in a growth market.) On April 2 Novo Nordisk played a classic “freeze-the-market” move by announcing that it would decide whether to develop a once-a-week version of Victoza (or some to use some other candidate in its pipeline) by August. Yes, you got it right: Novo Nordisk would decide by August. Think announcements like that are silly? It wiped 5.4% off Amylin’s share price on April 2.
But that’s not the last arrow Novo Nordisk has in its quiver. One of the reasons that Victoza has been able to gain share so fast in the diabetes market—159% sales growth in 2011—is that it helps control obesity in diabetes patients taking the drug for that disease. (This is a property of all GLP-1 diabetes drugs including Victoza and Bydureon.) Why not, then, Novo Nordisk management thought, submit Victoza for approval as a weight-loss drug?
That has put Novo Nordisk smack in the midst of a race with drug companies such as Vivus, Orexigen Therapeutics, and Arena Pharmaceuticals to get the first FDA-approved weight-loss drug to market in 13 years. The weight-loss drug story that you might remember stems from 1997 when the FDA forced the withdrawal of the fen-phen diet drug from the market after research showed links to heart damage and strokes.
The race hit an unexpected speed bump, when on March 29, an FDA advisory panel recommended by a 17-6 vote that companies developing weight-loss therapies for the U.S. market do trials to assess heart risks.
Before that vote Vivus was expecting word from the FDA on Qnexa by April 17. Now no one is quite sure what the schedule might be: The panel recommended post-approval tests for heart risks so that wouldn’t delay a decision on Qnexa. After the panel’s vote, an FDA spokesperson said that the decision wouldn’t have any effect on applications already filed. Vivus competitor Arena is expecting that its drug loracaserin will go before an advisory panel on May 10 with an FDA decision by June 27.
Positive FDA action on either drug would create a big pop in the company stock since the company would become an immediate candidate for a buy-out bid from a big drug maker. For example, Cowen & Co. values a post-approval Vivus at $40 a share. (The stock was one of the few to buck the downward market trend on April 4 and 5. The shares closed April 5 at $22.53.)
But while Novo Nordisk trails when it comes to a schedule for approval—the company expects to submit Victoza for approval as a weight-loss drug by the end of 2012—it does have two critical advantages that may make it the effective leader when 2013 comes around. First, Novo Nordisk already agreed when Victoza was approved by the FDA in 2009 to do cardiovascular outcome trials. The company is in a position to be the first to produce actual data that indicates its drug is heart-safe. Novo Nordisk thinks the outcome of its post-approval cardiovascular trials might even come out with a better result. There are indications, the company says, that GLP-1 drugs are beneficial to the heart. That’s never been statistically proven, the company notes, but that could be an outcome of the post-approval trials. (The GLP-1 story is extremely odd involving, as it does, proteins found in Gila monster saliva. Look it up if that kind of thing is your cup of, well, Gila monster saliva.) Second, Novo Nordisk already has big marketing effort selling Victoza. The company won’t need to build a marketing team and get it up to speed if and when the FDA gives its approval.
Like all the other targets Wall Street is projecting for these stocks, take this one with a grain of salt too—but Citigroup has projected that approval of Victoza as a weight-loss drug could be worth $5 billion in U.S. sales alone to Novo Nordisk by 2017.
I don’t need that projection to get me excited about this drug stock—or indeed the whole diabetes and weight-loss sector. Yes, for me, excitement is back in the drug sector—or at least this part of it.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Novo Nordisk as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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