💉 Business Overview

🎯Key Metrics

Total: 8.5/17

• +2 ✅✅ Projected Operating Margin: 43.88%
• +1 ✅ Projected 5-Year Revenue CAGR: 11.93%
• +2 ✅✅ Last 5-Year ROIC: 54.60%
• +1 ✅ Estimated Cost of Capital: 7.54% (lower than ROIC)
• +1 ✅ Last 5-Year Shares Outstanding CAGR: -0.89%
• -1 ❌ Projected 5-Year EPS CAGR: 8.49% (given the easiness that the companies have in manipulating these numbers, below 10% represents a negative)
• +0 ⚠️ Projected 5-Year Dividend CAGR: 6.45%
• +1.5 ✅ Estimated Debt Rating: Aa3
• +2 ✅✅ Morningstar Moat: Wide
• -1 ❌ Morningstar Uncertainty: High

Novo Nordisk is the leader in obesity and diabetes treatments. Its wide moat is reflected on its stellar operating margin. It also returns on its invested capital (ROIC) more than 5 times its cost of capital which is very good and shows its efficiency and intelligence in capital allocation.

However, there’s a lot of uncertainty surrounding the company, namely on the obesity segment, that amounts to most of its revenue. Its growing competition on that space will probably reduce the overall margins and increase the risk of disruption for this business.

Let’s check below if its current valuation is justified.

📈Business Valuation

To calculate the intrinsic value of the company I’ll use multiple methods:

• Discounted Cash Flows (DCF) – Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value using the estimated cost of capital;
• EPS Growth – the fair value is estimated by projected the Earnings Per Share CAGR for the next 5 Years and then, given its current and historic values of PE, come up with a PE for the 5th Year. This will give us its price 5 Years from now using the formula: Price = EPS x PE that we then discount using the estimated cost of capital;
• Historical P/E – we assume mean reversion to the historical P/E values;
• Historical EV/EBITDA – we assume mean reversion to the historical EV/EBITDA values;
• DDM – we estimate the price of the company by projecting its dividend payments and growth over the next couple of years, dicounting them to the present day using an estimated cost of equity;
• Historical P/CF – we assume mean reversion to the historical P/CF values;
• Historical Dividend Yield – we assume mean reversion to the historical Dividend Yield values;
• Historical P/S – we assume mean reversion to the historical P/S values;
• Historical P/B – we assume mean reversion to the historical P/B values.

Cost of Capital

I’ve used the latest annual financial statement of the company, the 10-Year Denmark bonds as the risk free rate (I’m valuing the company in Danish Krone – DKK) and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody’s provided a rating for the company I used it as the debt rating.

Cost of Capital: 7.54%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I’ve used: Cost of Capital – The Fair Value Journal. It is and will ever be completely free 🙂

Discounted Cash Flows (Weight: 35%)

I’ve used the latest annual financial statement of the company, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

Some notes on the inputs above:

• Revenue Growth (Year 1) – I’m using here from the next year guidance provided in the annual report (between -5% and -13% with a upper range bias);
• Terminal Revenue Growth – I’m using the risk-free rate (10-Yr bonds of Denmark), because long term the company should not grow more than the rate of the economy. I’m using the risk-free rate as a proxy to it, so the terminal growth becomes it;
• Initial Terminal Cost of Capital – I’m assuming here the cost of capital previously calculated;
• Initial and Terminal Tax Rate – I’m assuming here a value close to its historical averages.

All the other inputs were taken from the financial statement or from analyst projections.

The DCF gives us an estimated fair value of 457.87 dollars for Novo Nordisk.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used analysts estimates.

As you can see from the above Novo Nordisk seems to be undervalued given that its current price of 304.65 DKK is below P10. From these simulations we can extrapolate that there’s more than ~90% probability of Novo Nordisk being undervalued.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF – The Fair Value Journal

EPS Growth (Weight: 25%)

For this valuation method, I’ve used the current EPS and the analysts estimates of EPS growth. I also assumed a 15 PE for the company.

Then again used the Monte Carlo simulations to check what happens when the input values change within a specified range:

Using this valuation method, Novo Nordisk that is currently priced at 304.65 DKK seems to be a little undervalued being currently valued around P20. From this we can extrapolate that there’s around ~50-80% probability that the stock is undervalued.

As before, feel free to try this yourself: EPS Growth – The Fair Value Journal

Historical P/E (Weight: 15%)

The current P/E (Price / Earnings) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 28.62 we can assume a fair value of 438.99 DKK.

For every type of historical and relative valuation you can use the same free tool: Historical / Relative Valuation – The Fair Value Journal

Historical EV/EBITDA (Weight: 10%)

The current EV/EBITDA (Enterprise Value / Earnings Before Interests, Taxes, Depreciation and Amortization) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 22.13 we can assume a fair value of 449.90 DKK.

DDM – Variable Growth (Weight: 5%)

Now we look at a Dividend Discount Model (DDM). This will allow us to value the company, using its dividend payments and the overall growth of it. In this type of DDM we’ll set the dividend to grow at an initial rate that then over time moderates and declines to a given terminal stable growth that will be maintained “forever”.

For the stable growth, I normally use the growth rate of the economy the company is based on, namely the 10-Year bonds of the currency used by that economy country. The same as before, here we’re using the 10 Year bonds of Denmark.

As you can see below I started the dividend growth at 6.45% (analysts expectations) and then slowly the growth moderates to 2.711% (the risk free rate – 10-Yr bonds of Denmark). Also note the use of the Cost of Equity, calculated previously when we also calculated the Cost of Capital.

Why use Cost of Equity and not Cost of Capital as the discount rate for DDM? Its because dividends are paid to equity holders after debt obligations. Since DDM values equity-only cash flows, we use an equity-only discount rate (the Cost of Equity).

Now, as before, let’s use Monte Carlo simulations.

As you can see from the above Novo Nordisk seems to be overvalued given that its current price of 304.65 DKK is around P90. From these simulations we can extrapolate that there’s 90% probability that the stock is overvalued at the current price.

As always take this single output, from this DDM valuation method, with a grain of salt. The fact that the company pays around ~50% of its cash flow in dividends, may mean this method may estimate a lower fair value. This fact was taken into account when I’d set a weight of 5% for this method.

Let’s move on to the other valuation methods to get a clearer picture.

Please be free to use the same free tool I’ve created here: DDM (Variable) – The Fair Value Journal

Historical P/CF (Weight: 3%)

The current P/CF (Price / Free Cash Flow) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 24.75 we can assume a fair value of 440.17 DKK.

Historical Dividend Yield (Weight: 3%)

The current Dividend Yield ratio is above its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 1.70% we can assume a fair value of 568.08 DKK.

Historical P/S (Weight: 2%)

The current P/S (Price / Sales) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 10.43 we can assume a fair value of 454.76 DKK.

Historical P/B (Weight: 2%)

The current P/B (Price / Book) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 21.48 we can assume a fair value of 472.84 DKK.

✍️Summary

Now that we did all the heavy work, let’s take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I will pick a fair value of 322.43 DKK given the uncertainty and volatility surrounding the company and its industry/business.

Overall it seems Novo Nordisk is undervalued or at least a little undervalued at the current prices.

Fair Value: 322.43 DKK