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Eli Lilly (NYSE:LLY), the $25 billion in sales, pharmaceutical company, is currently at a crossroads which will dictate the future direction of its share price over the next 2 years. Like all drug development companies, future success always depends on the next new blockbuster drug.

Wall Street has been discounting shares during the past 3 years and I am now looking for catalysts to drive the share price higher, despite declining sales and profitability. With the bad news already known and potential good news unknown, Eli Lilly's valuation for a contrarian investor, with a 2-4 year time horizon, may prove to be a good investment opportunity. At current price levels, the unknowns are not reflective in the stock. Eli Lilly's stable low growth profile, expense reduction initiative and strong cash flow generation make shares a low risk investment. Growing international exposure and its animal health business are additional catalysts that I feel are currently being discounted. The current legislative environment will turn favorable once the Supreme Court decision on mandatory healthcare is found likely unconstitutional and provide additional near term catalyst that will propel healthcare stocks higher.

Purchasing Eli Lilly shares at or below $38 creates an opportunity and provides a margin of safety. Current sentiment are that Eli Lilly's shares are bleak, as reflected by its 10 price to earnings multiple and 11 times multiple for 2013. Over the next two years, I believe shares will appreciate by 20% from current levels. Once additional information becomes evident from the trials of Solanezumab (Phase III), the potential upside is 10% by year's end and an additional 10% by next year. Currently, with over $7 billion in free cash, the 4.7% dividend yield is safe and growing international sales will help fund the development programs. Patient investors will be compensated until further information on trials are discussed by the third quarter of this year.

My assumption is that by fiscal year 2014, incremental sales will increase by $4 billion, which would equate to earnings of $4.80 per share, meaning shares are currently trading just 7 times price to earnings for 2014. My assumption shows expenses associated with manufacturing and R&D increasing 4-6% respectively, as development ramps up the next 2-3 years. While a continued favorable pricing environment and additional favorable FX benefit can make these assumptions conservative two -four years out.

Patent expirations, on top selling drugs, are the main reason why Eli Lilly trades at a relative discount to the overall market. Over 50% of company sales are at risk by 2014, however this is a known fact and already priced into the shares. The company's top selling antipsychotic drug Zyprexa contributed to over $5 billion in worldwide sales or 22% of the company's total in 2010. Now being off patent, expectations for Zyprexa sales are approximately $2 billion. But in its latest quarter, Wall Street reacted positively to news that the pace of deterioration on Zyprexa was lower than expected. Furthermore, excluding Zyprexa impact, overall U.S. volume in the rest of the business was up 2%, while price realization was up 4%. Both variables are bullish developments when none were being expected.

Lilly, over the next several months, will see an abundant amount of news flow regarding development studies and this will capture investor interest. Some color on future catalysts: Currently there are 12 potential new medicines in Phase III alone, eight of which are targeting very lucrative oncology, diabetes, neuroscience and autoimmune disease categories. An additional 21 indications are in Phase II trials and Lilly is optimistic some of these indications approvals will get the company back to growth with their stated 2014 timeframe. Its leading indication Solanezumab, which targets Alzheimer's disease, has potential to be an instant billion dollar blockbuster medication. Currently, there are no treatments for Alzheimer's disease, and if Solanezumab trials indicate any positive news, shares will respond positively. Additional data for Solanezumab will be made by the third quarter. Positive results of endpoints in the trial will measure the success by evaluating the impact of improving cognitive and daily activity functions in trial patients.

Other promising candidates in the pipeline include dulaglutide - long-acting GLP-1 analog that will compete with Amylin's (AMLN) Bydureonm (potential $1 billion dollar drug) and compounds under development by GlaxoSmithKline (NYSE:GSK), Novo Nordisk (NYSE:NVO) and Sanofi (NYSE:SNY). An investigational SGLT-2 inhibitor (empagliflozin), oncology indication ramucirumab, Cialis and tamsulosin for men with benign prostatic hyperplasia, ixekizumab, and anti-IL-17 monoclonal antibodyfor moderate to severe plaque psoriasis, and Phase III trials this year for an oral JAK1/JAK2 inhibitor for rheumatoid arthritis in partnership with Incyte (NASDAQ:INCY). JAK is moving into Phase III later this year, and hopes to differentiate its product from Pfizer's (NYSE:PFE) product by being more JAK1/JAK2 selective, while the Pfizer molecule is more a pan-JAK molecule. In total, estimates for Lilly's development pipeline could be worth $4 billion to $7 billion in incremental sales by 2017.

Each year through 2014, Eli Lilly is guiding revenues to be at least $20 billion, net income to be at least $3 billion, and operating cash flow to be a minimum of $4 billion. The insulin franchise continues to be a market leader and valuable asset going forward with expiration minimal. While the international segment which accounted for 46% of sales last year continues to show very strong momentum going forward. Given these known and unknowns factors, pessimism is already reflected in the stock prices. Therefore, any positive news will have doubtful investors reevaluating the valuation on shares. Until then, shareholder value will be returned through other channels.

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

Source: Eli Lilly's Valuation May Prove To Be A Good Investment Opportunity