From waistlines to bottom lines – investment implications of weight-loss drugs

From waistlines to bottom lines – investment implications of weight-loss drugs

Novo Nordisk and Eli Lilly were among the best performing stocks of 2023, mainly due to the success of their GLP-1 weight-loss drugs.¹ At the same time, the shares of snack companies and certain medical devices, especially ones that specialize in cardiology and diabetes, were punished.

On the surface, this is not surprising given the effectiveness of this new class of drugs and the prevalence of obesity and diabetes, which are among the fastest growing chronic conditions in the world. An alarming 24 percent of the world’s population will be classified as obese by 2035, up from 14 percent in 2020.²

But we believe the answers to critical questions about GLP-1s will help determine the sustainability of success that some stocks have enjoyed thus far: How many people will be on the drug, and at what price? And who will pay for it? Which pharma company will be the winner of the R&D race?

As part of our research process, we stress tested the portion of our investable universe that could be impacted by new weight loss drugs – mainly pharmaceuticals, medical devices, and consumer staples – against various GLP-1 penetration scenarios. Our research analysts engaged with senior managements of our holding companies, and our investigative analysts spoke with sources including nutritionists, health policy economists, bariatric specialists, and patients. We then quantified the potential impact on future sales.We concluded that even if the penetration levels rise to the higher end of the plausible range, we would not see a material change to the growth outlook of our portfolio holdings.

Are today’s leading GLP-1 drugmakers good long-term investment opportunities?

Drug-discovery pharmaceutical companies do not generally fit our long-term, quality growth investing paradigm, as one blockbuster drug is hardly a durable business model. We are willing to sacrifice fast growth for a tighter range of potential outcomes.

Given the rising popularity of Novo Nordisk’s Ozempic and Wegovy, it has become the most valuable health care company in the world with a market cap of over USD 500 billion. Similarly, Eli Lilly’s stellar stock performance last year was driven by sales of its drugs Zepbound and Mounjaro. At this time, we do not have the degree of certainty in the long-term earnings trajectory that our approach requires in order to invest in these companies, for two key reasons:

1. Wide band of plausible scenarios around the ultimate level of sales for the drug category given uncertainty around insurance reimbursement. Insurance will likely expand reimbursement, which is positive for volume growth, but it also means prices would have to drop. Indeed, at the current price, the drug is not affordable to most employers. Already, we have seen many health plans, both public and private, grapple with the cost; most have denied coverage. Even if it is true that these drugs may pay for themselves over the next 30 years (an assumption that also factors in so-called quality of life benefits, in addition to direct future medical cost reductions), current employers won’t be responsible for the ultimate costs. That means they will focus on the short-term and intermediate-term costs over potential long-term benefits.

Only a small share of people can afford to pay out of pocket. The rest of the potential market would have to be reimbursed by the government or employer health plans. Instead of the blue-sky scenario that all overweight people will take GLP-1s, we are then left with the more realistic forecast: That the drug would likely be reimbursed only for those whose health outcomes depend on it most – and, at reduced prices.

2. Competitors are innovating and seeking market share. Novo Nordisk and Eli Lilly have invested billions in R&D for these drugs and they are the incumbents in the obesity market. The best scenario for Novo Nordisk and Eli Lilly is that they continue to successfully innovate (thus making the generic/biosimilar threat less relevant) and outpace their competition.

Novo Nordisk and Eli Lilly’s injectable solutions are currently the most effective version of the drug. But they are not the only players – at least a dozen rivals are investing in the development of next-generation medications in the category. The market’s evolution depends on the development and scaling of more effective oral treatments. As is the case with most drug innovation, it is impossible to know at this stage which companies will develop the most effective and safest drugs in the category over the next several years.

Setting the record straight on Abbott Labs: GLP-1s are complementary to its CGM device demand

GLP-1 drugs may offer other significant health benefits in addition to weight loss. In August 2023, Novo Nordisk announced that one of its clinical trials showed a 20 percent relative risk reduction in major adverse cardiovascular events in a high-risk obese population. While it was already understood that obesity had some relationship to cardiovascular disease, this was the first clinical trial to demonstrate a statistically significant medical benefit. A subsequent clinical trial showed efficacy in slowing down the progression of chronic kidney disease, and future trials will test the impact of GLP-1s on ailments such as osteoarthritis and sleep apnea.

These trials drove concerns that GLP-1s could present a headwind to medical device demand. However, the headline results overstate the potential impact. First, obesity is just one risk driver of medical ailments, and factors such as diet, behavior, environment, and genetics are also contributors. Churn is also a factor if patients are unable to stay on GLP-1s for an extended period. Finally, the larger medical device companies tend to be more diversified with different business lines. These factors lead us to conclude that the potential headwind to category growth will be modest even in a scenario where GLP-1 adoption becomes more widespread than expected.

One category that was originally perceived to be disproportionately impacted by GLP-1s is diabetes. Of the medical device companies we own, Abbott Laboratories was perceived as having the greatest risk from GLP-1s due to its Libre product, a continuous glucose monitor (used to manage diabetes. The concern was that fewer diabetes patients would lead to less demand for these monitors. Indeed, the opposite is true: It turns out that people with diabetes have better adherence – i.e., wear their sensors more days – when using the Abbott monitors in combination with GLP-1 therapy as compared to using these tools alone. And those using the Abbott tools appear to adhere to the GLP-1 therapy longer. The use case is symbiotic, not exclusionary.

Even if GLP-1 drugs lead to a reduction in the overall number of patients with diabetes, these monitors are in the early stages of penetrating the base of type 2 diabetics. Abbott’s monitors have only recently received reimbursement for type 2 patients taking basal insulin and are also applicable for earlier stages of diabetes as well. The machines also provide real time feedback, which is important for shaping behavioral changes that help delay the progression of disease. This data is also transmitted to the doctor who can then better monitor how the patient is faring.

Diverse products and geography shield Nestlé from adverse impact

Some Wall Street analysts estimate that GLP-1 drugs could reduce calorie intake by as much as 20 percent per person and, depending on the number of people on it, that could mean a reduction in calories of up to 2-3 percent in the United States. This creates a worry for food companies, especially ones that make candy, salty snacks, or sugary cereals.

From an investment point of view, we do a company-by-company analysis of geographic exposure and product mix. Geography matters because the obesity rates and the ability to pay differ by country. Research shows that certain products with high salt, sugar, and fat are consumed less on GLP-1s, and are substituted with healthy proteins and vegetables. So, product mix is also key.

Nestlé is a core Vontobel Quality Growth holding. Despite being the world’s largest food company, it has a wide range of products, many of which should not be affected by GLP-1s, such as infant nutrition, pet food, coffee, and water. In fact, other business lines – protein supplement shakes and vitamins – could get a boost from people on the drugs who, because of lower calorie intake, may not be getting proper nutrients. Also, as a global company, sales are not overly dependent on countries where much of the population may end up on these products anyway.

Consider an extreme scenario: 10 percent of the world’s population starts taking these drugs in five years. With a 2 percent-a-year incremental penetration rate, multiplied by 25 percent lower calories, and multiplied by the percent of revenues that is Nestlé’s food business (34 percent, including nutritional food) we can estimate the magnitude of the headwind. This math gets us to a 0.17 percent hit to volumes each of those years. We assume Nestle will grow sales at about 5 percent a year, meaning this headwind is small. And of course, while the US might hit that level of penetration, it’s unlikely that other countries will do so quickly. This estimate also excludes any benefit from products consumed by patients on GLP-1s. Thus, Nestlé’s diversified portfolio of products and global footprint shield it from adverse GLP-1 trends.