By Matt Doiron
We've noticed in our analysis of hedge funds' 13F filings for the second quarter of the year that a number of managers are taking an interest in Eli Lilly and Company (LLY). Billionaire Stanley Druckenmiller (see more of Druckenmiller's stock picks) and Tiger Cub Andreas Halvorsen's Viking Global both initiated large positions in the stock at 1.2 million and 3.5 million shares, respectively. Renaissance Technologies, D.E. Shaw, and Cliff Asness's AQR Capital Management all increased their positions and now own over 15 million shares between them. Eli Lilly isn't exactly a sleepy little company at a market capitalization of nearly $50 billion, but the volume of increased hedge fund interest surprised us.
Eli Lilly is a pharmaceutical company that works on treatments for neurological conditions (including depression and mental disorders), endocrine problems such as diabetes, a variety of cardiovascular conditions, and cancer. The company also supplies farms with animal health products, such as antibiotics and supplements. Eli Lilly reported setbacks to its business in the second quarter, as revenue fell 10% compared to the second quarter of 2011, while net income fell 23%.
For the first half of 2012, revenue is down 7% and net income is down 14%, indicating that the first quarter was not very good either, but that the second quarter was worse - neither of which is a good sign. Looking deeper into the report, the revenue losses were almost entirely due to poorer business in the neurological segment of the company's business, as the company lost patent exclusivity on the drug Zyprexa, driving down sales volume. Several of the company's top products - including what is now its highest-revenue product, Cymbalta, which is primarily used to treat major depressive disorder and general anxiety disorder - showed revenue increases. Over the course of the first half of the year, about 54% of Eli Lilly's revenue came from the United States.
Eli Lilly, given these results and its 1% increase so far this year, trades at 12 times trailing earnings, putting it in value territory as long as it can at least maintain its business going forward. Sell-side analysts believe it will, and so the forward P/E is 11. Another factor investors should notice is the 4.6% dividend yield the company pays at current dividend levels and prices. Major pharmaceutical companies tend to pay high dividends, but Eli Lilly's is particularly high. Given these two factors, we would say that on a quantitative basis, the company offers good value, and it appears that several successful investors figured out the same thing in the second quarter of the year. The stock rose over the course of the second quarter, but is currently slightly down since the end of June, so if investors get in now, they're not only buying the current numbers, but also buying at a price similar to where the hedge funds bought in.
Other major pharmaceutical companies, such as GlaxoSmithKline (GSK), Pfizer Inc. (PFE), and sanofi-aventis (SNY), tend to trade at higher earnings multiples: in these cases, 14, 17, and 13, respectively (though all have significantly higher market capitalizations). However, the sell-side thinks that all of these companies also have stronger growth prospects than Eli Lilly and so their forward P/Es converge between 10 and 11, putting all four pharmaceutical companies at about the same level.
It's also worth mentioning that, in contrast to Eli Lilly, each of the above comparable companies grew their earnings in their most recent quarter compared to the same period in 2011 - by a double digit percentage, in fact. Dividend yields at these three peers are also high, though GlaxoSmithKline's is the highest at 4.5% and this still falls short of Eli Lilly by a very small margin.
Overall, we see the case for Eli Lilly as a value stock and understand why hedge funds are buying in, but if Wall Street analysts prove right about growth rates at other pharmaceutical companies, any of these majors could be a good buy.