Over the last month we sold two positions – Novo Nordisk (Novo) and RELX. We maintain a rigorous sell discipline. We sell when the quality of an investment deteriorates, there’s a change in strategy which we view as adverse, the outlook deteriorates in an unexpected manner, or when we believe the valuation becomes too high for the likely prospects. Too high is measured in relation to the mid to long-term cash flows, the potential worst case and to our other available opportunities. In this instance, while we rate both businesses highly, their valuations became too demanding in relation to our growth forecasts, and when measured against the rest of our portfolio. We reinvested the proceeds in other businesses where we expect higher returns.
We first bought Novo in December 2016 at a price of DKK237 and sold the last of our shares in June 2024 at DKK987. It was a company that we had followed for many years but felt the shares were too expensive. Diabetes is sadly a growth business and Novo had a large market share, high and stable margins and an interesting new product pipeline. After the share price fell by over 40% in the space of 11 months over US drug pricing concerns, we invested.
The discovery that the semaglutide molecule (which is a GLP1 agonist: helping stimulate insulin production and reduce blood sugar) not only gave diabetes sufferers a better treatment option, but could also trigger weight loss, opened a completely new market in weight loss and resulted in a re-rating of the shares.
Over the years we were asked why, given our value orientated investment style, we still owned Novo. The reason was that our research and high probability of a Best Case result (we usually spend more time on Central and Worst Cases) led us to conclude that consensus forecasts were too low.
For a while, even we were too conservative, as GLP-1 drugs, which are currently dominated by Eli Lilly and Novo gained new approvals for many other indications such as cardiovascular risk and chronic kidney disease. More indications are likely to follow.
However, spectacular growth encourages competition and new players are entering the market. The strength of demand has resulted in product shortages, but these will ease as the incumbents add capacity and new entrants bring choice and competition.
We have a Sell Process for a reason! It is to stop managers ‘falling in love’ with a business and believing that momentum, rather than the fundamentals, will keep prices moving upwards. Although our numbers remained consistently ahead of consensus, we had not added to our position for many years. Even if Novo held a 50% market share and the size of the addressable market reached $125bn by 2030, we would still find the shares to be expensive. The reality is likely to include new entrants and pricing pressure from additional capacity.
We know we can never expect to buy at the bottom or sell at the top. Novo is a fantastic company that is currently earning extraordinary returns on capital and will continue to do so for the foreseeable future. However, the shares appear fully priced on our estimates.
We first bought RELX in October 2020 at £17.80 when the shares were trading on a 17x 1Y FWD PE. Although this was within its long-term range of valuation, we thought it missed the earnings opportunity for RELX. There were three main reasons for us to be more optimistic:
- In 2020 the smallest division, exhibitions, was hit hard by covid, travel restrictions and cancellations. However, as is the case for many high-quality businesses, they came out stronger at the other end of lockdowns. In the case of RELX’s exhibition business, this resulted in higher margins due to more efficiencies.
- Another overhang on the shares was the concern of the industry moving towards open access and away from subscriptions. RELX was perceived as reluctant to change its business model which could result in market share losses. Even if it did change, there was fear it would hurt profitability in the long run. However, profitability is not impacted by the way articles are submitted and published. Due to the high quality of journals RELX publishes, the company continues to see an increase in article submission every year, both for open access and for pay for read. We felt the concerns about RELX’s business model becoming weaker were overdone.
- We saw the biggest upside to earnings in the coming years from the implementation of data analytics, or as we would now say AI. RELX started this process in the early 2010s within its Risk and Legal divisions. We could see how the time saved for the legal profession or the competitive advantage in the insurance sector could help RELX gain market share and expand its offering over time with more value-add services.
When we invested in RELX in 2020 the assumed growth rates for sales, EBIT and EPS were a predictable 4% / 6% / 8% respectively. Today, they are more like 6% / 8% / 10%.
So, if the company is showing a better growth profile than when we bought it, why are we selling the shares? Again – valuation. We bought the shares on 17x Y1 FWD PE. We sold the last of them on over 25x Y1 FWD PE in July 2024.
Yes, we believe RELX is a better company today. Yes, we believe the growth in coming years will be stronger. However, in order to generate a double digit return on cash invested today, by year 5 they would have had to grow their earnings per share by 21% or more, each year. We don’t view this as a likely outcome. Even in a best case we think around 12% is already demanding from current levels.
If RELX’s valuation multiple continues to expand the shares could of course keep doing well regardless of earnings growth. But that becomes a different game, and one we don’t want to play. One only has to look at companies like Nike, Estee Lauder and Reckitt Benckiser to see how ephemeral high valuations can prove. Missing out on future gains can be painful, but it is less painful than making valuation your enemy rather than your friend!
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