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Trade of the Day: Novo Nordisk (NVO)

As obesity spreads, so will diabetes -- and with it, a growth opportunity for big pharma

   

Mexico, it was just announced, has just surpassed the United States in obesity rates. The adoption of unhealthy diets, sedentary lifestyles and the diseases that are caused by them appear to be growing in direct proportion to the rise of the middle class worldwide.

Normally the issue of obesity is framed in terms of what can be done to reverse the epidemic. As an investor, however, you may want to look at these trends positively and consider the companies that have potential to grow because of them—Novo Nordisk (NVO) being one.

As a therapeutic market, diabetes is an attractive area for pharmaceutical companies because it requires constant therapy, there are high barriers to entry and the demographics of aging populations mean that diabetes is expected to affect over half a billion people worldwide by 2030. Novo Nordisk is the world’s leading manufacturer of diabetes drugs with approximately 50% share of global insulin volumes.

First, the Bad News

Despite sustaining a four-year uptrend, the stock has stalled over the last 12 months. A big part of this underperformance came February 11, 2013 when the FDA requested additional clinical data on NVO’s new long-acting insulins, Tresiba and Ryzodeg. Because compiling the required data may take two to three years, the stock fell from $192 to $165. The news hit, however, at a time when the stock was on a tear and merely erased a month and a half of gains. Since that time the stock has oscillated in a range of +/- 9% and currently sits near its year-end 2012 price of $163.

According to sales reps for NVO, the company has said internally that they still expect to have Tresiba and Ryzodeg to market within a year and a half. Analysts think this is optimistic and don’t believe that they will be available before the end of 2015.

Additionally, two of NVO’s biggest competitors in diabetes care—Sanofi (SNY) and Eli Lilly (LLY)—sparked strong momentum at the American Diabetes Association (ADA) conference in June. Both presented compelling data regarding upcoming drugs in their pipeline.

And the Good News? Expansion

Against this backdrop, how should investors view the potential for NVO stock appreciation? The schedule for NVO’s new drugs is locked in for the next few years and essentially controlled by FDA requirements and the timetable to conduct new clinical trials. Hence the Street isn’t anticipating any new catalysts through 2015 and beyond. This makes NVO a story about expanding sales and growing market share in areas it already dominates.

Fortunately, the company still maintains one of the top suites of diabetic drugs in the industry, including NovoLog, which did $2.7 billion in sales last year. The patent on NovoLog is set to expire next year, however; creating a bioequivalent poses a formidable challenge for generic drugmakers and therefore sales for NVO from this channel should remain strong.

NVO also has one of the most profitable lineups in the industry. With a net profit margin of 28.3% and a track record of expanding its net margins over the last 9 years, the company has become the second highest in profitability in the entire pharma space. NVO also has a dominant market share, especially in emerging markets. Due to the oligopoly nature of the business and the relatively high barriers to entry regarding the introduction of new drugs, NVO’s solid foothold in China, Japan, India, and South America should equate to further growth with its current offerings.

NVO has grown sales at 14% over the last 9 years, earnings at 21%. Analysts expect a CAGR for earnings between 2013 and 2018 of 15% compared to a sector average of 6%.

Stock Performance and Near Term Momentum

7 24 13 nvo 1 300x177 Trade of the Day: Novo Nordisk (NVO)
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On a weekly chart, NVO’s performance has reflected this robust growth in earnings. Since the beginning of 2009, the stock has returned over 200% even with its setbacks this year. This is compared to about 60% for the NYSEARCA Pharmaceutical Index (DRG)  and 93% for the S&P 500.

However, the stock faces an inflection point. Since the negative FDA announcement in February, rallies have failed to produce any higher highs and the current price sits just underneath a downward sloping trendline going back to its 12 month high just before the announcement. This points to bearish pressure in the near term, possibly back down to the $150 level where it has found support this year.

7 24 13 nvo 5 300x180 Trade of the Day: Novo Nordisk (NVO)
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Backing out to a five-year time frame, NVO has exhibited a strong uptrend and the recent pullback to $150 at the end of June brought the stock back to this long term trendline. Combined with the short term pattern of lower highs the stock is forming a symmetrical triangle, generally considered a continuation pattern in the context of a longer term uptrend.

Nevertheless, a breakout can occur in either direction and a break below $150, putting in a lower low, would indicate that the four-year uptrend is exhausted and a new downtrend could be forming. If this stock breaks definitively above $170 and marks a higher high, this would reaffirm the long term uptrend.

Recommendation: NVO is at a make-or-break point that offers opportunities in both directions. A break above $170 should be treated as a bullish breakout from the current descending wedge pattern with an initial profit target at $195. We recommend new bullish entries at the 170 mark.

If the stock breaks $150 to the downside, then the long term trend has been broken and it should be treated as a short entry opportunity. $130 is our initial target if that bearish breakout occurs. This seems to be the more unlikely scenario, but could present very attractive profit opportunities to the downside.

Options Alternative: Option traders may want to strangle the trade with the 150 puts and 170 calls. This is biased a little to the upside but could be profitable either direction if the stock moves enough. This is an expensive trade, and traders should err on the side of buying too much time than too little. At this point we recommend considering the January 2014 LEAPS for the strangle.

InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.  Get in on the next trade and get 1 free month today by clicking here.

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