My choice for the best long-term investment in the healthcare space is Eli Lilly (NYSE:LLY), a diversified drug company that sells products in 130 countries worldwide. The stock is currently trading higher by 3.50% after reporting earnings, and is sitting at new 52-week highs after its strong quarter. In recent weeks a number of investors have suggested that Eli Lilly may be too expensive, seeing as how its returned almost 40% in the last year. But compared with other industry leaders, it remains cheap and is seeing among the most consistency despite the patent cliff that has attacked the drug industry. With that being said, I am comparing Ely Lilly to another drug company that is trading at new highs after reporting earnings on Tuesday, Pfizer (NYSE:PFE).
Navigating Through the Patent Cliff
On the same day as Eli Lilly reported its earnings, Pfizer also delivered a beat and traded higher by the same margin. Both stocks have performed particularly well over the last year, have become a popular investment choice as of late, and greatly exceeded analyst expectations. My problem with Pfizer is that as a larger company it has been more affected by the patent cliff. Despite trading with gains of 28.76% over the last 12 months its earnings report reflected revenue loss of 7% for the fourth quarter and 10% for the year, due to several big name products coming off patent.
One factor that is helping the larger pharmaceutical companies during the patent expiration period is that the market has prepared for lost revenue during the last two years. These are stocks that had traded well below worth for years and now that the "patent cliff" hasn't been as dramatic as investors had expected, the market has reacted favorably. As a result, companies such as Pfizer have been able to maintain stock performance with improved margins to counter the lost revenue, keeping sentiment high.
Pfizer is about 3.5 times larger than Eli Lilly and was driven by a number of blockbuster drugs over the last decade. Ely Lilly is more diversified and has done a better job at maintaining sales despite the cliff. During this most recent quarter, Ely Lilly lost just 1% of its revenue year-over-year and 7% for the full year. This compared favorably with Pfizer, and was somewhat unexpected by the market. One of Ely Lilly's biggest loses due to the patent cliff was Zyprexa, which saw almost 50% of its sales decline. However, these losses were countered by strong performances from Cymbalta, which grew 20%, and animal health sales, which rose 18%. Pfizer lost Lipitor to generic competition, however the company believes that a combination of several newly approved drugs such as Xeljanz and Eliquis will help close the gap in lost sales. Overall, considering the market environment, both companies have performed well, but in my opinion, Ely Lilly is the better investment.
A Look at Market Valuation
Keep in mind, Ely Lilly lost 1% of its sales last quarter while Pfizer lost 7%, and that Ely Lilly performed better throughout the entire year in terms of maintaining sales. Pfizer did report strong margins and higher net income but only due to profits from its nutrition unit. Therefore, if sales are what ultimately drive a business, then Ely Lilly has been the better company in 2012 (probably why it has performed better). However, it's also cheaper on a valuation basis. Take a look at several measures of valuation for both companies (courtesy of Yahoo! Finance).
|Market Cap (billions)||$204.24||$61.17|
|Enterprise Value (billions)||$213.60||$57.56|
|Forward P/E (December 2013)||12.11||14.23|
I did not include measures such as PEG ratio because I do not like to make investment decisions based on the outlook for five years when dealing with a biotechnology company, because so much can change. However, the metrics above can provide enough information for us to see current valuation, and for the most part, the two are very similar.
When valuing a company I prefer to look at the enterprise value, as it's more often a fair value for the company. It takes into account cash, equity and debt. Therefore, with Pfizer trading above its market cap and Ely Lilly below, we might assume that Pfizer has the better balance sheet strength. This is also backed up with Pfizer trading with a lower price/book (P/B ratio); this means that Pfizer simply has more assets per value, yet Ely Lilly actually has better returns on its assets and equity, which means that these metrics are misleading to investors. Ely Lilly may have fewer assets compared with its market capitalization, but the company has made better investments and returns more profit on the assets it does own. In my opinion, this is much more important.
The two metrics that move a stock are sales and earnings, or top and bottom lines. According to this chart, Ely Lilly is the cheaper stock when compared with sales, yet it is more expensive compared with 2013's expected earnings. However, the key word is "expected" and both companies just updated and increased guidance.
Looking Ahead & Using Guidance
After earnings on Tuesday, both Ely Lilly and Pfizer issued guidance. Pfizer issued revenue guidance for 2013 between $56.2B and $58.2B, and EPS guidance between $2.20 and $2.30. The consensus was for revenue of $57.55B and EPS of $2.29. Therefore, Pfizer remains in-line with expectations, maybe slightly below on its EPS.
Ely Lilly's guidance was much more aggressive. The company was expected to record revenue of $22.93B and EPS of $3.83 for 2013. However, it guided revenue between $22.6B and $23.4B with EPS between $4.10 and $4.25. Therefore, Ely Lilly's guidance is far and above the consensus, about 10% greater than EPS guidance. As a result, it is far cheaper than its forward P/E ratio will lead you to believe. For 2012, Ely Lilly reported an EPS of $3.66, therefore 2013's between $4.10 and $4.25 would have the stock trading at a significant discount to earnings, and also with modest revenue growth. Meanwhile, Pfizer's guidance suggests that it will have yet another year of falling revenue (although not as drastic) and possibly no EPS growth. Therefore, the consensus is way off in reflecting a forward P/E ratio of 12.11 for Pfizer and a 14.23 for Ely Lilly. These numbers of course take into consideration one-time profits, but based on guidance alone, Ely Lilly is the far cheaper stock.
Both Pfizer and Ely Lilly are seeing some level of revenue declines, yet Ely Lilly's is less substantial, its bottom line growth is more aggressive, its guidance suggests both top and bottom line growth in 2013, it returns higher profits on equity and assets, and finally it's also valued cheaper according to stock metrics. Both stocks are trading at new highs, and rightfully so, but Ely Lilly is better positioned for a great year in 2013 based on these factors alone.
Disclosure: I am long LLY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: All fundamental information was obtained from the linked earning reports within the article. Stock metrics were obtained from Yahoo! Finance