Diabetes Programs Now Crucial For Eli Lilly

Dec.23.13 | About: Eli Lilly (LLY)

Eli Lilly's (NYSE:LLY) long history of turning research into profits makes its current price of around $50 very tempting. The near certain loss of roughly 20% of sales next year combined with a string of costly late stage failures have made watching Lilly's patent cliff struggle a real thriller. It might not be a bloodbath, as diabetes programs offer some hope to one of the last of the big R&D spenders.

What Lilly is losing

Cymbalta generics are likely to give Lilly a fast $5 billion haircut next year. Earlier this month, the FDA approved six generic versions of the company's top seller. During the first nine months of 2013, the drug comprised a hefty 24.3% of total revenue.

Lilly has already braced for the attack from Teva Pharmaceutical Industries (NASDAQ:TEVA) and friends. Earlier this year, the company transferred or cut over 1,500 sales reps while announcing a salary freeze. The only department not being cut is R&D. That would be enough to drive an investor to seek some antidepressants themselves, but the pain doesn't stop there.

Lilly also loses U.S. patent protection of Evista in March 2014. During the first nine months of 2013, sales of the osteoporosis treatment and breast cancer preventer produced sales of $774 million, or about 4.5% of total revenue. Teva made a play for Evista's patent protection in 2010 using a method-of-use offense. It was struck down in a U.S. appeals court. You can be sure that Teva will be ready again for Evista next spring.

What Lilly has on the Bunsen burners

Lilly has fully thrown its hat into the long-lasting insulin ring. On December 20, Lilly and Boehringer Ingelheim (BI) announced the acceptance of their NDA for another insulin glargine product. On the plus side, Novo Nordisk's (NYSE:NVO) Tresiba is unlikely to enter the U.S. market for at least several years while the FDA awaits more convincing efficacy data. Lilly's partnered analogue would still be competing with Sanofi's (NYSE:SNY) long-acting insulin analogue, Lantus, until it loses exclusivity in 2015, then its shiny new version, U300.

The market for Lantus is large enough to warrant the long shot. In 2012, the French giant recorded over $6.7 billion in Lantus sales that are expected to continue rising, especially without Tresiba competition in the US.

Empagliflozin for type 2 diabetes impressed the crowd at the American Diabetes Association's annual meeting this year. Also partnered with BI, it's an inhibitor of sodium glucose co-transporter-2 ((SGLT2)). Unfortunately Johnson & Johnson (NYSE:JNJ), AstraZeneca (NYSE:AZN) and Bristol-Meyers Squibb (NYSE:BMY) are all developing SGLT2 compounds. Even BI clinical development director, Dr. Maximilian von Eynatten, admits "I think probably from a clinical perspective, there is no big difference between the SGLT2 compounds so far, at least from everything we have seen."

Lilly's ace in the hole is dulaglutide, a glucagon-like peptide-1 analog ((GLP-1)), intended as a once-weekly treatment for type 2 diabetes. Peak annual sales estimates range from $1.7 billion to $500 million. Considering the fickle nature of physicians and diabetes patients, investors should hope for the best, and prepare for the worst on this one.

Again, Lilly will compete with Novo Nordisk for market share. Sales of the Danish major's GLP-1 superstar, Victoza, have fallen from blazing fast, to just very fast. Lilly is going to have an uphill battle ahead of it. Of course, Sanofi, and several others, are also doing their best to complicate the market for GLP-1 treatments.

Financial Analysis

Annual R&D spending has slowly increased by about 10% over the past two-and-a-half years to about $5.5 billion. Of the giants, Lilly is one of the last to undergo a serious restructuring. Without a significant reduction, R&D could comprise more than 30% of sales in 2014.

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If the pipeline was producing marketable drugs, Lilly's resolve would be hailed as genius. Costly failures from Alzheimer's drug solanezumab, breast cancer drug ramucirumab, and most recently, antidepressant edivoxetine, should have already forced the company to rethink its policy of high R&D spending. It's getting difficult to tell if beginning a new trial for solanezumab in mild Alzheimer's patients is a calculated strategy, or a refusal to admit failure.

Factoring in the nearly certain $5 billion drop in sales likely in 2014, cutting one quarter of SG&A, but leaving R&D at $5.5 billion gives Lilly a fair value today of just north of $40, using a DCF model. With recent prices near $50, it seems the market is expecting post cliff sales growth of about 12%. That's nearly twice the rate the company's topline has grown in the past decade. It's not impossible, but it's sure to be a nail biter.

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.