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Stability makes Eli Lilly a pharma standout

A strong product portfolio and coherent growth plans justify the company's premium price tag
July 7, 2022

Logic would suggest that in periods of economic turmoil, the pharmaceutical industry might offer a safe haven for investors. When consumers feel burdened by inflationary pressures, they will first look to cut spending on discretionary items, such as new clothes or electronics. Prescription drugs, on the other hand, are not luxuries that can so easily be done away with.

Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points
  • Earnings forecast to rocket
  • No imminent patent-expiry concerns
  • Pipeline focused on high-growth areas
  • Above-industry growth
Bear points
  • Rich forward multiple
  • Drug trial risks

But while demand for medicines may prove resilient in a recession, the risk profile of the sector’s largest names is decidedly mixed. In fact, many are grappling with the imminent loss of patent exclusivity on some of their best-selling drugs. This means that cheaper, generic versions will soon become widely available and erode profits. Future revenue growth wholly depends on bringing new products to market via the notoriously rigorous and expensive three-stage clinical trial process. 

Among its peer group, Indianapolis-headquartered Eli Lilly (US: LLY) has some of the lowest exposure to the so-called “patent cliff” – and it’s already developing several therapies that could address some of the biggest health problems of our age. If investors are willing to look beyond the company’s premium pricing and toward its excellent medium-term prospects, they may just find a stock whose defensive qualities can push it yet higher.

 

Pipeline prospects

Among Eli Lilly’s most promising products is a type 2 diabetes drug called tirzepatide, which was approved for use in this context in the US in May. Though originally intended to improve blood sugar control, tirzepatide has also proved to be effective as a weight-loss therapy in ongoing trials. Results of a phase 3 study published last month showed that around 90 per cent of patients treated with the drug lost at least 5 per cent of their body weight, which is the threshold for clinical meaningfulness.

The study’s authors called this an “unusually substantial degree of weight reduction” for an anti-obesity medication. Invasive and high-risk bariatric surgery has long been deemed the most effective weight loss treatment available and other medications have largely foundered in clinical trials. With adult obesity now more common than under-nutrition worldwide, the market for an effective weight loss drug is significant. 

Analysts are bullish about tirzepatide. BMO Capital Markets predicts eventual peak sales of $14bn (£11.6bn), including $6bn from the treatment of obesity. Wells Fargo is more optimistic and stated in an April note that it expects the drug to become an $18bn franchise at its peak – with $7.5bn brought in from the weight-loss segment alone. 

Promising as it is, tirzepatide must first receive the approval of the US Food and Drug Administration (FDA) before it can be used to treat obesity. This means it could be years until the drug comprises a good chunk of group sales. In the meantime, investors should keep an eye on the progress of donanemab, a treatment for Alzheimer’s with a greater capacity for a positive impact on the income statement in the near term. 

The drug was granted Breakthrough Therapy status by the FDA last year because preliminary evidence suggests it offers substantial improvements over other available Alzheimer’s treatments. The designation means donanemab is eligible for an expedited review process by the regulator. Though this sounds like good news for shareholders, the outlook is complicated by questions around the clinical efficacy of the drug and others like it.

Donanemab is one of several drugs in development that aim to slow the progression of Alzheimer’s disease by destroying clumps of amyloid proteins in the brain. According to the amyloid hypothesis, which is not universally accepted by scientists, it’s the buildup of these proteins that leads to the development of the disease. Last year, a Phase II trial demonstrated that donanemab could clear away amyloid plaques. Whether this significantly slows cognitive decline is another matter.

Analysis of the trial showed that the cognitive capabilities of participants declined more slowly than those who received a placebo, albeit by a modest amount. Investors will have to wait for the release of phase 3 trial data in the second quarter of next year for more information. In the meantime, rivals Biogen (US:BIIB) and Roche (CH:ROG) are working on their own anti-amyloid drugs, for which new trial data will be available this year. 

“If it’s shown that those drugs work, or that they might work but aren’t super stellar home runs, it’s probably good news for Lilly because then it shows that targeting [amyloid proteins] is a valid thesis in Alzheimer’s,” says Evan Seigerman, a senior pharma equity analyst at BMO Capital Markets. “If they totally fail and there’s no efficacy whatsoever, then I think there could be some pressure on Lilly’s shares.”

 

Profit in the present

There is, of course, some risk of failure in every drug trial. Across the sector, only one in 10 drug candidates makes it through trials and regulatory approval to the market. However, prospective investors should not only look at the strength of a company’s pipeline, but at its existing products and near-term revenue prospects. In this regard, Eli Lilly looks highly stable compared with peers with greater patent cliff exposures.

The company’s greatest strength is its diabetes portfolio – with its two highest-selling drugs, trulicity and humalog, targeting the disease. The former boasted global sales of $6.5bn in 2021. While generic competitors for trulicity could reach the market by 2027, new drug tirzepatide is poised to make up for lost revenue (even in the event that it isn’t approved to treat obesity). 

LLY product sales forecasts ($mn)Dec '24EDec '25EDec '26EDec '27E
Donanemab1,1292,1652,4122,160
Humalog1,9731,8591,7151,644
Jardiance2,6222,9053,0023,129
Other10,22410,13912,12812,191
Taltz.3,1733,3753,5043,739
Tirzepatide (GIP/GLP-1)2,9484,6825,7796,216
Tirzepatide (obesity)5641,6982,8414,788
Trulicity8,0207,8717,1895,601
Verzenio (Abemaciclib)3,8064,5705,1565,417
     
EPS ($)11.6714.6016.9218.00
P/E (x)27.822.219.218.0

Source: FactSet

Competitors – including Merck (US:MRK), Pfizer (US:PFE) and Bristol-Myers Squibb (US:BMY) – each have up to four key products facing patent exposure before the end of the decade. This means they’re under greater pressure to fill gaps in their portfolio than Eli Lilly. Though analysts at Wells Fargo think stock-pickers should remain on the sidelines while the donanemab saga plays out (or a “better entry point” emerges), they used a June note to clients to highlight what they view as the fundamental strengths of Eli Lilly’s business.

The company is “hitting a trifecta of 1) above-industry growth, 2) holistic growth with no major IP concerns, and 3) margin improvement,” Wells Fargo’s pharma team wrote. For other investors, including the growing cluster of pharma-focused fund managers buying the shares, these factors likely outweigh any potential volatility that could be brought about by disappointing donanemab trial results.

Still, there’s no escaping the fact that Lilly’s shares look expensive priced at 34 times’ next year’s earnings forecasts, especially compared with peers such as Pfizer (9x) or Bristol-Myers Squibb (10x). Proponents would argue the premium price reflects the company’s underlying quality, and consensus projections that earnings will rapidly ascend to $14.60 a share by 2025.

“The risk that Lilly is unable to grow revenues and continue to sustain its business model is far lower than, say, Bristol-Myers Squibb,” said BMO’s Seigerman. “Bristol is going through a loss of exclusivity right now with [cancer treatment] revlimid and its business is not as clear cut as Lilly’s. That’s what starts to drive the multiple.”

While the company faces its fair share of risks, the de-risking of a substantial portion of near-term cash flow sets the company apart from peers. Unburdened with looming patent threats, and buttressed by an excellent development track record, it looks well placed to recycle bulging profits back into drug candidates and share buybacks.

In an industry with strong economic moats and all-weather economic resilience, Eli Lilly stands out. And in the current climate, stability should be enough to get enthused about.

 Company DetailsNameMkt CapPrice52-Wk Hi/Lo
Eli Lilly and Company (LLY)$309bn$324.7133,085c / 22,020c
Size/DebtNAV per share*Net Cash / Debt(-)*Net Debt / EbitdaOp Cash/ Ebitda
964c-$13.9bn1.4 x89%
ValuationFwd PE (+12mths)Fwd DY (+12mths)FCF yld (+12mths)EV/ EBITDA
361.2%2.5%30.6
Quality/ GrowthEBIT MarginROCE5yr Sales CAGR5yr EPS CAGR
28.8%31.0%5.9%18.9%
Forecasts/ MomentumFwd EPS grth NTMFwd EPS grth STM3-mth Mom3-mth Fwd EPS change%
-10%19%10.9%0.3%
Year End 31 DecSales ($bn)Profit before tax ($bn)EPS (¢)DPS (¢)
201922.36.19604258
202024.57.23793296
202128.38.48816333
f'cst 202229.18.68837381
f'cst 202330.59.80946420
chg (%)+5+13+13+10
Source: FactSet, adjusted PTP and EPS figures 
NTM = Next 12 months   
STM = Second 12 months (ie one year from now) 
*Includes intangibles of $12bn or 1,219c per share