By David J. Phillips
Notwithstanding management promulgations to the contrary, investors remain circumspect about Eli Lilly's (NYSE:LLY) ability to successfully navigate hurdles to earnings and cash flow growth following the loss of market protection of top-selling drugs in the next twelve months, including its flagship antidepressant Cymbalta (December 2013). Investor misgivings are reflected in a stock chart, which shows how the share price of the Indianapolis-based drug maker has underperformed key competitors like Johnson & Johnson (NYSE:JNJ) and Pfizer (NYSE:PFE).
LLY Total Return Price data by YCharts
In addition to the $4.99 billion blockbuster Cymbalta, which accounted for 22% of the $22 billion in 2012 global product sales, the company will witness patent expiry of its $2.4 billion mealtime insulin Humalog (June 2014) and the $1.0 billion osteoporosis medication Evista (March 2014).
LLY R&D Expense TTM data by YCharts
Having spent $5.28 billion on Lilly R&D in 2012, up from $4.88 billion in 2010 - and with approximately 60 potential new drugs in human testing - management is confident that post-2014 it can mitigate the adverse impact of these patent expirations and return the company to resumption of profitable growth through a combination of cost-controls (layoffs and co-product terminations) and successful commercial launch of innovative molecular entities, currently either in late-stage research or awaiting FDA regulatory review.
Unfortunately, an analysis of the most-heralded of these products suggests that the timing of peak sales for these drugs could substantially lag the loss of up to $8 billion, or some 36% in revenue, due to generic intrusion:
--A new drug application (NDA) for empagliflozin has been submitted to the U.S. FDA for the treatment of type 2 diabetes in adults, and a decision is expected in the first quarter of 2014. Similar to J&J's canagliflozin (Invokana), empagliflozin is one of a new class of glucose-lowering drugs, the oral SGLT2 inhibitors, which work by increasing urinary glucose excretion, with a consequent lowering of plasma glucose levels. Despite a weight-loss advantage over the hugely successful DPP-IV inhibitors, such as Merck's (NYSE:MRK) sitagliptin (Januvia), the SGLT-2 inhibitor class, including Lilly's drug, are unlikely to replicate the $2.6 billion commercial success of Januvia until the completion of post-marketing surveillance trials to monitor reported adverse safety issues (including malignancies, pancreatitis, bone-density loss, and cardiovascular outcomes).
--Efficacy studies suggest that Lilly's long-acting glucagon-like peptide-1 (GLP-1) analogue dulaglutide - an injectable once-weekly treatment for type-2 diabetes anticipated to undergo regulatory review later this year - could easily compete against Novo Nordisk's (NYSE:NVO) $843 million liraglutide (Victoza); however, the FDA will likely require post-marketing safety trials that could slow prescriber acceptance of this promising diabetes drug, too.
--Lilly's immunosuppressant Ixekizumab, a promising treatment for psoriatic arthritis, could grab a significant slice of a $3.6 billion market, according to analytics firm Decision Resources. However, the launch of up to three competitors in the same space prior to Lilly's own launch in late 2014 could negate prospects for a successful commercial launch.
--In the first quarter of 2013, the company initiated a rolling submission to the FDA (fast track review!), for the monoclonal antibody Ramucirumab as monotherapy in second-line gastric cancer. Although disease-free progression and improved overall survival are encouraging, real commercial success could likely come with eventual use in other types of cancers. Dependent on study data in advanced breast cancer patients, peak sales potential could exceed $3 billion, according to a recent Citigroup report.
The high probability of commercial delays with late-stage products coupled with visible development failures - e.g. discontinuation of research programs for the experimental lymphoma drug enzastaurin and tabalumab, a promising monoclonal antibody being studied for rheumatoid arthritis (both due to lack of efficacy) - suggest that guidance of $3 billion in net income and operating cash of $4 billion for 2013 will be cyclical peaks until 2016, at a minimum!
Notwithstanding an unfunded pension hole of $2.14 billion, the company does have sufficient financial flexibility to weather likely margin erosion in 2014 and 2015. As of March 31, earnings could cover fixed charges almost 44 times, according to regulatory filings. Additionally, only nominal debt needs to be refinanced prior to 2016; and, the company holds more than $4.6 billion in short-term liquidity - more than enough to buy its way out of its earnings trough?
Until the company can address the upcoming "earnings trial," however, despite a comparatively low PE ratio, Eli Lilly remains a classic value trap - trading squarely on historical reputation.
LLY Forward PE Ratio data by YCharts
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. I have no business relationship with any company whose stock is mentioned in this article.