Is Eli Lilly A Good Stock To Buy Now?

Apr.17.12 | About: Eli Lilly (LLY)

By Guan Wang

Jim Simons' Renaissance Technologies is one of the best hedge funds in the world. It returned roughly 33% last year while many other hedge funds were struggling to break even. One of the largest positions in Simons' latest 13F portfolio is Eli Lilly (LLY), in which Renaissance Technologies had over $300 million invested. When a hedge fund as successful as Renaissance Technologies buys in to that degree, we pay attention.

Plus, a lot of other hedge fund managers are also bullish about Eli Lilly; at the end of last year there were 32 hedge funds with Eli Lilly positions in their 13F portfolios, up from 25 hedge funds at the end of last September. Besides Simons, Cliff Asness, Israel Englander, Ken Griffin, and Jacob Gottlieb were also in favor of Eli Lilly. Should investors follow these hedge fund managers and invest in Eli Lilly?

Let's check it out by taking a closer look at this drug manufacturing company.

Eli Lilly's best-selling drug has, historically, been the antipsychotic Zyprexa. Sales of Zyprexa were $5.0 billion in 2010 and $4.6 billion in 2011. However, Eli Lilly lost its U.S. patent protection on Zyprexa in October last year. Undoubtedly, the patent expiration is going to largely hurt Eli Lilly's revenues over the next couple of years. Analysts estimate sales of Zyprexa to drop by 65% in 2012. The sharp decline in Zyprexa sales will also put pressure on Eli Lilly's margins as Zyprexa is a high-profit pipeline.

In addition to Zyprexa, Eli Lilly is also faced with impending patent expirations on a few other drugs. In total, these expirations are expected to decrease the company's sales by about $7 billion from 2010 to 2014. However, we think the company will be able to counter the negative impacts of patent expirations.

In order to boost its sales, Eli Lilly has been devoting significant resources to research and development. Last year, its expenditure on R&D was $5 billion, or around 21% of its sales. This ratio is higher than that of most of the other drug companies, but it seems to have paid off. As of January this year, Eli Lilly had 22 compounds in Phase II trials and 14 compounds in Phase III or under regulatory review.

Many of the new drugs are developed through Eli Lilly's R&D alliances with other pharmaceutical companies such as Takeda and Boehringer Ingelheim. Eli Lilly formed the alliance with Boehringer in early 2011, planning to develop new oral diabetes drugs. We like this deal as we think it will further strengthen Eli Lilly's strong position in diabetes treatments. With the development of new drugs from this alliance, Eli Lilly's sales will be largely bolstered.

We are also bullish about Eli Lilly's sales of animal health products. Eli Lilly's animal health division has been making acquisitions to expand in recent years. Last year, it bought the animal health business of Janssen Pharmaceutica NV. Then, in late January this year, Eli Lilly announced that it had signed an agreement to acquire ChemGen, a company specialized in developing innovative feed enzyme products. Helped by the acquisitions, sales of animal health division should be rising over the next couple of years.

Analysts expect Eli Lilly to make $3.17 per share this year and $3.60 per share next year. This puts the company's forward P/E ratio at about 12.4, vs. the industry average of 17.3. However, the number is still a bit higher compared with a few of its main competitors. For example, Pfizer (PFE) has a forward P/E ratio of 9.7 and Sanofi's (SNY) forward P/E ratio is 9.3. These two companies are also more popular among hedge funds when compared with Eli Lilly.

As of Dec. 31, 2011, there were 69 hedge funds with Pfizer positions (check out our previous article about Pfizer) and there were 62 hedge funds with Sanofi positions (check out our previous article about Sanofi). Moreover, Eli Lilly's earnings are expected to be deteriorating on average over the next five years. Analysts expect its earnings to decline at around 8% annually, while Pfizer's and Sanofi's earnings are expected to grow at 2%-4% per year. As such, we do not think Eli Lilly is as attractive as its major competitors at this moment. We prefer Pfizer.

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