Recently, we wrote more detailed articles on Air Products and Chemicals (NYSE:APD) and Eli Lilly (NYSE:LLY). However, given the importance we believe substantial insider purchases should have, we are presenting abbreviated versions of the above articles in the context of insider purchases of $1 million or more. LLY had one executive purchase over $1 million of LLY stock in 2014. For APD, the incoming CEO purchased several million dollars in APD shares in late 2013 and mid 2014. We believe these substantial insider purchases are a significant signal to investors that these shares will perform well in the intermediate and long term.
LLY is one of our favorite major American pharmaceutical investments. Recently, major pharmaceutical companies have experienced "patent cliffs" for some of their best selling drugs. No company faced a greater patent cliff than LLY. The most significant portion of LLY's patent cliff is taking place this year (2014). We believe the shares will continue to reward shareholders with share price appreciation and an over 3 percent dividend yield. LLY discovers, develops, manufactures and sells pharmaceutical products worldwide. The company operates in two divisions; human pharmaceutical products and animal health products. LLY's research and development spending has been over $5 billion a year in recent years, equaling about 23 percent of sales. LLY's research and development budget is among the highest in the industry, as the average is about 17 percent of sales. The company presently has an R&D pipeline of over 50 new chemical entities (or new molecular entities or new biotech entities).
LLY reported second-quarter 2014 adjusted earnings per share of 68 cents, 41 percent below the 2013 second quarter. Second-quarter 2014 revenues fell 17 percent to about $4.9 billion, reflecting generic competition for LLY's best-selling drugs Cymbalta and Evista in the U.S. (due to the U.S. patent expiration for such drugs). Second-quarter revenues fell 17 percent due to lower volume. The lower volume was due to the December 2013 U.S. patent expiration for Cymbalta and the March 2014 U.S. patent expiration for Evista. U.S. revenues fell 30 percent to about $2.38 billion, reflecting the loss of patent protection on Cymbalta and Evista. Eli Lilly's animal health division revenues were about $601 million (up 11 percent). LLY maintained its 2014 guidance of $2.72 to $2.80 per share on revenues of $19.4 billion to $20.0 billion.
Million dollar insider purchase
One of the most positive signs to a potential investor in a company's stock is an insider purchase of shares on the open market that is substantial and not just a mandatory token purchase required by the company. Earlier in 2014, an insider made a substantial purchase of LLY shares on the open market. On May 12, 2014, LLY director Jackson P. Tai bought 17,157 shares of the stock on the open market. The stock was purchased at an average price of $59.19 per share, for a total transaction of $1,015,522.83. Following the transaction, the director now directly owns 32,180 shares of the company's stock, valued at about $2 million.
Analysts' views and our views
As expected that LLY's second-quarter results would be adversely affected by the patent expirations for its best-selling drugs Cymbalta and Evista. 2014 is seen as a transitional challenging year given the dramatic sales decline for the two LLY best-sellers. Products such as Humalog, Trajenta, Cialis, Forteo and Alimta and the animal health business, however, should help partially offset the impact of the dramatic sales decline of two important drugs. In addition, analysts are encouraged by LLY's product pipeline progress, particularly for diabetes, where it has several compounds in late-stage trials. LLY is expected to return to revenue growth in 2015. Currently, eight analysts have a "hold" rating on LLY, ten have a "buy" rating and one has a "sell" rating. The price targets among analysts range from $60 to $72 a share.
We believe that LLY is an excellent long-term investment for any investor. LLY's 2014 earnings represent an earnings trough due to its major patent cliff, and earnings are expected to rise again in 2015. LLY's earnings are expected to be $3.14 in 2015, giving the shares a price-to-earnings ratio of 19.3, based on the current price. We believe that LLY shareholders will continue to be rewarded by an over 3 percent dividend and share price appreciation. A recent $1 million purchase of LLY shares by a LLY insider at about $59 a share gives us greater confidence that an investor in LLY shares will continue to be rewarded.
Air Products and Chemicals
Air Products & Chemicals is one of the largest global producers of industrial gases, and has a large specialty chemicals business. The company has 4 divisions set forth as follows: 1) merchant gases (40 percent of sales; 43 percent of profit) sells atmospheric gases such as oxygen, nitrogen and argon; process gases such as hydrogen and helium; and medical and specialty gases, along with certain services and equipment; and 2) tonnage gases (33 percent of sales; 33 percent of profits) provides hydrogen, carbon monoxide, nitrogen, oxygen and syngas; 3) electronics and performance materials (22 percent of sales; 20 percent of profits) provides specialty and tonnage gases, specialty chemicals, services, and equipment to the electronics industry; 4) equipment and energy (4 percent of sales; 4 percent of profits) includes cryogenic and gas processing equipment for air separation, natural gas liquefaction, helium distribution, and hydrogen purification.
Second quarter earnings
APD posted 2014 fiscal third-quarter earnings from continued operations of $1.46 a share, up about 7 percent from $1.36 a share from the same quarter a year ago. Net income from continuing operations increased 9 percent to $314 million in the quarter from $287.8 million recorded in the year-ago quarter. Revenues rose 3 percent year over year to about $2.63 billion driven by higher volumes across all businesses. Revenues from the merchant gases division increased 4 percent from the year ago quarter to $1.077. Sales from the tonnage gases division declined 1 percent from the year ago quarter year to $835 million. Revenues from the electronics and performance materials division increased 9 percent from the year ago quarter to $618 million on increased volumes. In the equipment and energy division, sales were up 1 percent from the year ago quarter to $104 million. APD revised their fiscal 2014 earnings guidance and now anticipates earnings from continuing operations to be in the range of $5.72-$5.77 per share versus its previous guidance of $5.70 to $5.85 per share.
Activist investor activity
In July 2013, activist investor Bill Ackman initiated a 9.8 percent stake in APD. The Board of Directors of APD agreed to enter discussions with Mr. Ackman on how to improve APD's business so that their performance would be more in line with competitors. The company then hired a new CEO, Mr. Seifi Ghasemi, who then stated that APD needs to change its corporate culture and to make better investment decisions. At APD's last earnings conference call the new CEO indicated that, in his first public comments, the company will focus on projects that generate more cash flow and on improving returns on invested capital. The CEO summed up their conference call statements by stating that APD can retake its position as an industry leader with a strategy that he will describe in greater detail in mid-September 2014. Mr. Ackman believes that APD's shares could rise to $200 in 3 years.
Million dollar insider purchase
In August 2014, an insider made a substantial purchase of APD shares on the open market. On August 1, 2014, APD's recently appointed CEO Seifi Ghasemi bought 25,000 shares of the stock on the open market. The stock was purchased at an average price of $131.19 to $133.55 per share, for a total transaction of $3,317,000. This is in addition to his October 2013 open market purchase of 15,000 APD shares at an average cost of $108.09. Following the transaction, the director now directly owns 77,026 shares of the company's stock, valued at about $10 million.
Analysts' views and our views
Analysts have ratings from neutral to buy with price targets for APD in the range of $105 to $150. Analysts note that APD management has cut the upper end of 2014 fiscal year guidance to $5.70-5.85 (down from earlier guidance) and issued 2014 fiscal third quarter guidance in the range of $1.42 to $1.47.
We agree with analysts for the most part. With a new CEO with a history of improving profitability through divestitures, APD is likely to benefit from the CEO's yet-to-be announced new action plan. Shares of APD are trading at a forward price to earnings ratio of 20.7 based on fiscal year 2015 earnings estimates. With an activist investor pressuring APD and a new CEO who has purchased millions of dollars of the company's stock, we believe that APD investors will continue to be rewarded.
Disclosure: The author is long APD, LLY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.