A Tale of Two Pharmas: Can Obesity Firms Continue Their Outperformance in 2024?
Obesity and diabetes companies soared this year, while the rest of pharma did poorly
In pharma, you can take a larger slice of the healthcare pie than your peers, but you are still constrained by the size of the pie. No matter how good your cancer or diabetes drug is, healthcare systems will still have to keep paying for heart disease and rheumatoid arthritis treatments too.
That, in a nutshell, is why the divergence of obesity-diabetes companies from the rest of the industry in recent years can’t go on forever. In 2023, Eli Lilly LLY 1.90%increase; green up pointing triangle and Novo Nordisk NVO 0.97%increase; green up pointing triangle have risen more than 50% each, to become the two largest pharma companies by market capitalization, with their combined value now hovering around $1 trillion. By comparison, the rest of the industry badly underperformed the market, with the NYSE Arca Pharmaceutical Index rising a measly 4% compared with 24% for the S&P 500.
The difference in market caps implies that these two companies will consume a disproportionate amount of our healthcare dollars. But in the long term, one drug category cannot crowd out every other area in medicine because payers have budgetary ceilings and drugs wind up facing competition.
Analyst estimates show sales revenue for Novo and Lilly each growing by at least 15% in 2024 thanks to surging demand for their obesity drugs, known as GLP-1s. Sales for Novo’s Ozempic and Wegovy and Lilly’s Mounjaro and Zepbound are expected to nearly triple from about $22 billion this year to $57 billion in 2028, according to FactSet. No one in the industry comes close to such growth. And both companies are working on the next generation compounds that might continue delivering growth even when the patents of those drugs expire.
But while the obesity opportunity is real, these aren’t magical solutions to America’s unhealthy eating habits. There are still plenty of questions about their safety, insurance coverage and how long patients will be willing to stay on them.
While the obesity darlings won’t necessarily lose momentum soon, it is reasonable to bet that the much cheaper but still growing crop of pharma companies like AstraZeneca AZN 1.28%increase; green up pointing triangle, Merck and Johnson & Johnson JNJ 0.13%increase; green up pointing triangle will start to close the gap. Even industry laggards like Pfizer PFE 0.70%increase; green up pointing triangle and Bristol-Myers Squibb BMY -0.47%decrease; red down pointing triangle, down 45% and 28% respectively this year, should start to rebound.
That is partly down to valuation. Lilly at this point looks like a tech company, with a price to forward earnings multiple of 47. The industry average is 16. Bristol Myers, the laggard, fetches just seven times earnings.
AstraZeneca has one of the strongest growth profiles outside of the obesity duo. Analysts on FactSet see the company delivering 10% sales growth next year. It is also expecting a number of catalysts including data from breast cancer and early-stage lung cancer trials that could unlock share-price upside, note Berenberg analysts. Jared Holz, a healthcare-equity strategist at Mizuho, recommends Merck, pointing to consistent earnings beats and active business development. “There are companies now that may not have as exciting of a story to tell as the obesity category, but they are trading at a fraction of the valuation with plenty of room to grow,” says Holz.
One reason obesity won’t go away as the main story is that it is such a clean narrative. America is suffering from an obesity epidemic and the drugs have demonstrated they can help reduce the incidence of things like kidney disease, heart attacks and even addictive behaviors. By contrast, it is much harder to sell a generalist investor on more niche areas like Novartis’ NVS 1.18%increase; green up pointing triangle radioligand therapy or Merck’s pulmonary arterial hypertension drug.
Another reason Lilly and Novo won’t necessarily sell off next year is momentum. These drugs are just starting to take off, which makes for great quarterly comparisons. Jefferies healthcare strategist Will Sevush explains that while valuations could become detached from reality, the market doesn’t tend to correct until the key product that is driving share gains starts to plateau. “When they’re beating every quarter and analyst estimates are going higher, usually those stocks tend to work,” he says.
He points to how Gilead’s GILD 0.53%increase; green up pointing triangle stock quadrupled between 2012 and 2014 due to excitement over its hepatitis C treatments. The stock only peaked in 2015 when the company started missing analyst estimates and facing competition from an AbbVie ABBV 0.17%increase; green up pointing triangle drug. In the case of Eli Lilly, Mounjaro has beaten estimates in five of the last six quarters, according to FactSet. And the obesity version of the drug, Zepbound, just received Food and Drug Administration approval, so Lilly remains fairly early on in the cycle. Meanwhile, there is no major competition on the horizon to Novo and Lilly for the next few years.
The upshot is a more subtle message to healthcare investors: Don’t count on a total mean reversion. But after a year of extraordinary divergence, a more diversified approach that includes some less exciting, but still solid, names makes more sense.