GLP-1 craze: Buy Baxter, skip Eli Lilly, strategist says

Novo Nordisk (NVO) was named Yahoo Finance's Company of the Year thanks to the success of its diabetes and weight loss drugs, Ozempic and Wegovy. But there are other ways you can play the GLP-1 hype.

In the latest edition of "Good Buy or Goodbye," Great Hill Capital Chairman and Managing Member Tom Hayes suggests buying Baxter International (BAX). There are a few reasons why Hayes likes the stock including that it has aggressively sold off, the "valuation is tremendous," and that it has potential catalysts for the stock to recover some of its losses.

The stock Hayes is not buying right now is Eli Lilly (LLY). Hayes argues that the stock has already priced in a lot of good news, there will be increased competition, and that there are still questions about what insurance companies will cover when it comes to obesity drugs.

Click here to watch more "Good Buy or Goodbye" or you can watch this full episode of Yahoo Finance Live here.

Video Transcript

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JULIE HYMAN: It's a big noisy universe of stocks out there. Welcome to "Good Buy or Goodbye," brought to you by E-Trade from Morgan Stanley, our goal to help cut through that noise to navigate the best moves for your portfolio. Today we're examining an investment topic that has gained traction in the back half of the year. It's weight loss drugs. It's hard to avoid the term "Ozempic," especially after a number of celebrities admitted to using the drug.

As quickly as the buzz came, the narrative also has turned to overhype. So how should you play it? I'm here with Tom Hayes, Great Hill Capital chairman and managing member. And so let's get to your buy stock within this theme. That is Baxter international, which is more on the device side of the equation. Of course, companies like this, and you can see it on the stock chart, have been hit really hard by this weight loss drug craze. And as you point out, that's one of the reasons to like it maybe.

THOMAS HAYES: Absolutely. This stock is down 65% since its 2021 high. It's down because of the Hillrom acquisition. They used a lot of debt on that. It's underperformed expectations. But we're starting to see that turnaround. Margins are improving sequentially. So that's very good.

Then they had the supply chain issues from COVID. Like all these companies, they built up their inventory tremendously at high cost. They've been working through that inventory for the last two quarters. So we're starting to see the margin expansion . There and then, of course, the GLP-1 fears. That was the final nail in the coffin. You saw it on the lower right side of that chart.

JULIE HYMAN: Yeah. We can take it back for a real quick.

JULIE HYMAN: Yeah, look at this. Right here.

JULIE HYMAN: Yeah, most definitely.

THOMAS HAYES: That was when everyone was saying, everyone's going to lose weight. No one is ever going to get a medical procedure again, because we're going to be healthy. But the problem is even if they're correct and we lose all that weight, we all go out and play pickleball. And we have knee problems. We have shoulder problems. We have hip problems. We play golf. We get more active.

So those are the three reasons that it's down. We think the valuation is tremendous here, which goes to our next point.

JULIE HYMAN: Yeah. So let's talk about the valuation a little bit, valuation and performance, as you point out. And you're looking specifically at the price to sales ratio as a measure of valuation. Obviously, you've seen that come down also.

THOMAS HAYES: Yeah. It's trading at 1.2 times sales. This is very, very low historically and just absolutely. It's also trading its historic PE multiple, Price-to-Earnings multiple. Historically, it's been about 19 times, because this has been a grower. This business is compounded capital return on invested capital of double digits for decades now. So this is a proven business.

But the PE multiple is trading down to 12 times next year's earnings, in opposition to its average multiple of 19 times. And that's largely due to the kidney business. The renal care business is the slowest growth division. And they're going to spin that out to shareholders. So--

JULIE HYMAN: So you think that should unlock some value. And just to point out to our viewers, this is about, I think, a 10-year chart here or nearly so. So it shows you definitely over the long term just how low that price-to-sales ratio is on a comparative basis. And so you mentioned one potential catalyst for recovery. That is the spin-off of that renal business. What are some of the other potentials?

THOMAS HAYES: Well, a couple of things. First off, they sold off the biopharma business. They got $4 billion of that. So that's going to help them deleverage. That's been a weight the interest expense. That's going to take about $180 million a year of interest expense out of the business.

The key thing about that renal care spin is that once you take the slowest growth division out of the equation and that spun to shareholders, what's remaining Baxter Co-- remainco, that's going to start to trade rerate at a higher multiple, because it has a higher growth rate. Management is expecting prospectively that it's going to grow revenues at 4% to 5%. The margins are improving sequentially as we work through the supply chain issues. So we really like the story.

We think Baxter can work its way back to $60 over the next 12 to 24 months. So it's a longer-term play. There'll be some bumps in the road along the way. But we do think the GLP hype is a little overblown here.

JULIE HYMAN: OK. So we like to ask people what the biggest risk then is for that bullish case here. And you're saying maybe it has to do with pricing power.

THOMAS HAYES: Yeah. I think management has in their assumption of the long-term topline growth rate of 4% to 5%, that they're going to have some pricing power. And the risk to that is they have competition that have similar products out there, and they don't innovate quickly enough. But they've shown a track record of innovation, even on the pharma side with their launches, their injection business, et cetera. So we're pretty confident that this is not going to come to bear, but it's something to keep in mind as a risk.

JULIE HYMAN: OK. So that's your good buy looking at this whole weight loss universe. Let's talk about the stock you're saying adios to in this scenario. And that is Eli Lilly, which is your goodbye in this scenario. So let's walk through the thesis on this one. You say it's already priced for perfection. So maybe not a lot of room for error.

THOMAS HAYES: That's correct. So it's priced in a lot of really, really good news. It's historically traded at about 27 times earnings. It's trading at 48 times next year's earnings as opposed to Baxter, which is trading at 1.2 times sales. This is trading at 15 times sales. This is unprecedented. You're paying for-- not 15 years of profits, you're paying for 15 years basically of revenue.

And we understand the growth. We understand the valuation. But this is really just gotten too ahead of itself, even if you believe all the good things are going to happen.

JULIE HYMAN: Right. And we should just mention there, actually happened to have been some news today on Eli Lilly. Zepbound, which is their specific weight loss drug that is basically counterpart to Mounjaro, the diabetes drug. There was a new study that came out and said people who were on it, once they were off it for a year, they gained back half of their weight. Now there's still a lot lighter than they used to be. But nonetheless, that was hitting the stock a little bit in today's session. So just something to think about as well for folks.

So competition with lower prices is one of the other things that you're looking at.

JULIE HYMAN: Yeah. Expectations or these type of drugs, the GLP-1s, number one, you've got to pay the $1,000 or $1,400 a month, or it starts to come back, both on this one. And it's expected on the other ones. But it's expected that the price of these drugs is going to erode from $14,000 a year down to $3,000 a year over the next decade. And it's going to become a MeToo product. There are already multiple companies that make similar drugs. So there's going to be more and more enter the fray.

JULIE HYMAN: Well, and then there's the question of, OK, and who exactly is going to pay for it when you're looking at this thing? Let's go here. So in other words, is insurance going to cover it?

THOMAS HAYES: Yeah. And so far, the jury is still out, because, if you look at the excess cost of a diabetic is about $9,000 a year for the insurance companies. Right now some of these top tier drugs are $14,000 to $18,000 a year. So the math equation doesn't work just yet. That might get better.

But best case scenario, they're expecting the analysts, and you heard before, about 15% of the morbidly obese people will be on it within 10 years. So that's kind of a relatively small portion of the population. If you think about the top 10% of households, 190,000 of income, if they're self-payers, $14,000 a year is a lot of money. And what about the other 90% of the population that may need it?

JULIE HYMAN: Yeah. OK. So what could go right for Eli Lilly and therefore wrong for your thesis here? If we can get that to come up, I think we're a little-- oh, there we go. Insurance coverage begins to accelerate.

THOMAS HAYES: Yeah. I think as the costs come down, the equation may improve for insurance companies to start to cover it. They may say if we put them on this at $5,000 a year or $7,000 a year, we're going to have to pay for a lot less procedures down the road as their health gets better.

The other thing is they have an Alzheimer's drug that's expected to be approved. Maybe the results will be better than expected. That could be a complete game changer.

So there are some positive catalysts here certainly that could change this thesis. And we do think it's going to continue to put out great products. It's just we're not willing to pay this current price.

JULIE HYMAN: And just quickly, do you have positions in either Baxter or Lilly?

THOMAS HAYES: We own Baxter. We have no position in Lilly.

JULIE HYMAN: OK. Thanks a lot, Tom. So let's sum up what you have told us here today. You're telling investors buy Baxter International based on the stock recently selling off. It's becoming cheaper on a valuation basis. And there are some catalysts for recovery. On the other side, you're saying avoid Eli Lilly. It's already priced for perfection. The stock could face competition from those with lower prices. And there are some problematic assumptions regarding pricing and how much insurance is going to cover.

Tom Hayes, thanks so much for coming in. Appreciate it.

THOMAS HAYES: Thanks so much, Julie.

JULIE HYMAN: And thank you so much for watching. "Good Buy or Goodbye." We're going to be bringing you new episodes three times a week at 3:30 PM Eastern.