2013, A Year Of Turmoil For Eli Lilly

| About: Eli Lilly (LLY)

2013 has not started favorably for Eli Lilly and Company (NYSE:LLY). As a matter of fact, 2012 did not end very well for them either. Full-year revenues declined to $22.6 billion from $24.3 billion in 2011. The PPS is up 15.5% in the past 3 months and about 8.5% YTD, but very little of Lilly's news releases have been positive. Total pharmaceutical sales in 2012 were $19.93 billion and animal health sales were $2.035 billion. While the company's animal health sales grew 21%, total pharmaceutical sales were down 9% YOY. Lilly did put some of its money to work in 2012 as its total cash declined to $4.019 billion, but total assets increased 2% to $34.40 billion. The number of worldwide employees increased back to 2010 levels after a loss of about 400 employees was seen worldwide in 2011. This trend may reverse in 2013 as a Canadian court decision has stripped the patents from several of Lilly's highest grossing products and could cost the company up to $1 billion in sales and several hundred jobs, while Lilly has already cut about 280 jobs in the past from Canada.

The company cut R&D spending by 1% and marketing by 7% in 2012, which has and will continue to help its bottom line. The 1% reduction is quite small compared to similar companies, who are more aggressive with their outsourcing policies to Contract Research Organizations. Lilly topped analyst estimates on earnings in Q4, but expectations were set very low. Q1 and Q4 income both decreased 4% and sales 1% in Q4. Full year revenues declined 7% in total. A 7% decline in full year revenues was actually much better than Bristol-Myers Squibb (NYSE:BMY), but Lilly only had to deal with one patent exclusivity loss, Zyprexa. BMY was able to provide shareholder returns while both Plavix and Avapro, two of its highest grossing products, suffered a heavy loss in sales revenues due to loss of exclusivity.







2012 EPS




Mkt Cap

$62.08 Billion

Lilly currently has very few products ready to replace Cymbalta, Humalog and Zyprexa. Only the Byetta service, Forteo, Cymbalta and Effient experienced double-digit percentage sales increases in 2012, while more than half of Lilly's currently approved products declined in sales. Cymbalta, its top grossing product, will also lose its exclusivity in December 2013, leaving a 22% loss in revenues from one product. Cymbalta will bring in around $5 billion in 2013 as it did in 2012, but will lose almost about 90% of its revenue in 2014. Humalog will only have 5 months of exclusivity in 2013 and will decline 30% in sales in 2013, causing revenue losses of about $680 million. In 2012, Forteo experienced 21% increase in sales, while Effient and Cymbalta increased sales by 51% and 20% respectively. With Cymbalta coming off its patent exclusivity at the end of 2013 and Zyprexa revenues continuing to dwindle, it will be hard to see where Lilly's EPS and revenue growth will come from in 2013/14.

Dwindling sales from Gemzar, Reopro, Vancocin, Zyprexa, Symbyax, Actos, and several Metabolics will offset the growth seen in 2013 by Cymbalta (ending exclusivity in 2013) Effient, and Forteo. Furthermore, Effient will not see drastically increasing revenues due to recent post-marketing trials results, which essentially backfired. The trial showed that Effient was no more effective than now generic Plavix, which is much cheaper. Lilly's sales on this product may not see $1 billion revenues annually as 2012 only provided worldwide sales of $585 million. This was quite disappointing for Lilly as many thought leaders were touting the product's safety advantage over Plavix. With these trials results published in Q3, sales were essentially flat quarter over quarter from Q1 to Q4 in 2012 for Effient ($115 million Q1 vs. $120 million Q4). Furthermore, with US sales at $3.9 billion, Lilly stands to lose 15% of its revenue post-December 2013 with loss of Cymbalta exclusivity. Zyprexa US sales also decreased 83% to $360 million in 2012 from $2.5 billion in 2011. While Japanese sales have drastically increased, they will provide nowhere near the revenue growth required as 2012 Japanese revenues were only $585 million. Also, with more diabetes products coming to market, Humulin will also see increased competition and therefore revenues will continue to slowly decline.

Five out of the last six drugs that have come through Lilly's pipeline have either been rejected by the FDA or failed their Phase III trial outright. 2012 was a horrendous year in the clinic, with 2 of the biggest failures (Pomaglumetad methionil mGlu2/3 and Solanezumab) coming from Eli Lilly. Solanezumab, an amyloid beta antibody, which was similar to Bapineuzumab (Johnson & Johnson (NYSE:JNJ) and Pfizer (NYSE:PFE) did not meet both cognitive and functional primary endpoints in either of the two EXPEDITION Phase III trials. MGlu2/3, a Metabotropic glutamate 2/3 (mGlu 2/3) receptor agonist, used for acute schizophrenia, also was halted mid-phase III study as it was analyzed that it was unlikely to show positive efficacy. Writing off both of these molecules cost Lilly about $750 million in R&D costs. 2013 has not also not started very well for Lilly's pipeline as Tabalumab, an anti-BAFF (B cell activating factor) monoclonal antibody, had its phase III Rheumatoid Arthritis trial stopped due to lack of efficacy. The Phase III program for systemic lupus erythematosus, ILLUMINATE, will continue, but the FLEX-M and FLEX-V programs for RA have been halted. Lilly does have two other molecules in its autoimmune pipeline in late-stage clinical development for several conditions, however. The others molecules are ixekizumab, an anti-IL-17 monoclonal antibody, for psoriasis/psoriatic arthritis, and baricitinib, a JAK1 and JAK2 inhibitor being developed in collaboration with Incyte Corporation, for RA, psoriasis and diabetic nephropathy.

Ramucirumab, a stomach cancer drug, has also not done as well as expected in its Phase III trials, either. Ramucirumab is a human monoclonal antibody, immunoglobulin G1, which targets Vascular Endothelial Growth Factor Receptor 2(VEGFR2). This blocks VEGF from binding to VEGFR2, thus slowing down the process of angiogenesis (the creation of blood vessels in a tumor from previous vessels) and in theory strangling tumors causing reduction in growth. Lilly currently has 6 Phase III ramucirumab trials in progress for several different cancers. The REGARD trial is a Phase III randomized, double-blinded study of ramucirumab and best supportive care versus placebo and best supportive care in the treatment of metastatic gastric or gastroesophageal junction adenocarcinoma has the primary endpoint of overall survival and secondary endpoint of progression-free survival. The study's early results showed that overall survival time increased to 5.2 months from 3.8 months. This increase in overall survival time was statistically significant but well below analyst estimates and will most likely affect prescription habits if FDA approved. Adverse events were infrequent, however, with hypertension (12%) being the most common. ISI Group estimates this drug could potentially bring in $600 million annually for this indication, but with current study results, this target is certainly lofty. The approval chances are very high, but will most likely not bring any 2013 revenue as Lilly's meetings with the FDA would be in late 2013.

Questions are currently being asked about Lilly's now solo venture with LY2605541, as Boehringer Ingelheim gave the rights back to Lilly in early January. LY2605541 is expected to be a competitor of Sanofi-Aventis' (NYSE:SNY) Lantus, a $6.5 billion drug worldwide. This drug has the potential to replace the loss in revenues from Cymbalta, but with Boehringer Ingelheim bowing out of this partnership, the product's potential efficacy and future market cap are certainly questionable. Lilly is well positioned to have several of its drugs approved in 2014 with the fact that its pipeline is aimed at Oncology and Metabolics, but these market spaces have become more crowded during the past year with a record number of approvals.

If Lilly does want to reach its targeted GAAP EPS of $4.10-$4.25, (an increase of about 11-14%) it will certainly need to reduce shares (currently about 1.12 billion shares outstanding) with its expected $1.5 billion repurchase program to increase EPS. $400 million of this buyback has been completed in 2012, reducing Outstanding Shares to 1.117 billion. Assuming a $53 share price, the further purchase would reduce the O/S count by 20.7 million shares. Furthermore, assuming 0% sales growth in 2013 (close to what's expected by CEO John Lechleiter), and a reduction of 20.7 million shares, GAAP EPS of $3.71 will be obtained. I estimate that to reach a targeted EPS of $4.05, Lilly will need to further reduce its bottom line to $5.0 billion spent on R&D and $6.5 billion on marketing/advertisement, with cost of sales remaining the same and litigations etc. remaining around $250 million for 2013. This doesn't seem realistic for Lilly as it expects to spend $5.2-$5.5 billion on marketing/advertising and $7.2-$7.5 billion on R&D. I believe that Lilly is not currently overvalued, but its 2013 earnings will continue to slump as its top grossing products come off exclusivity. With this expectation, I cannot see the share price increasing beyond $55 in 2013, with my target at $50 by early 2014. The moderate dividend yield would make this a stock to hold if you already own it, but I do not believe it is a good buy until more products are approved by the FDA.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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