Earlier in August, Eli Lilly (LLY) announced that in two late stage trials, its drug, Solanezumab, did not meet the primary endpoints of halting the progression of the debilitating disease, Alzheimer, in patients with a mild to moderate condition. However, the company did indicate that the drug in fact slowed down memory decline in patients with the condition in its initial stages. In a latest development, the company yesterday reported the results from the two studies, which focused on patients with mild Alzheimer's. The results were positive, and show that the drug may be effective for patients with early-stage Alzheimer's, but to conclude that this alone will be sufficient for an FDA approval, and to project a revival of Eli Lilly based on this would be a bit farfetched. We are of the view that the stock is overstretched at the moment, with a price of $50.78, and therefore recommend that investors looking for a dividend paying stock, backed by strong fundamentals, should wait for an ideal entry point.
Lilly will make sure it points out to the regulator how the drug fulfills an unmet need currently, since there is no drug in the market that slows the progression of the disease. However, statistical significance will not be enough to win over the regulator, and further clinical works will be deemed necessary before the drug hits the market. Eli Lilly is desperate to bring a drug into the market in order to make up for the sales drop due to exclusivity losses. Should the drug manage to gain an approval, it has a multi-billion dollar market, according to a JPMorgan analysis. America alone has 5.4 million people with Alzheimer's; the number is growing, and is expected to reach 16 million by 2050. The situation is aggravated by the fact that Alzheimer is the only one in the list of top 10 causes of death in America, which still has no cure, or even a way to prevent/slow the progression of the disease.
In the company's study named Expedition 1, patients with mild Alzheimer's experienced a 42% reduction in cognitive decline after 18 months of treatment, a statistically positive result. The second study, named Expedition 2, revealed a 20% reduction in cognitive decline, which is not statistically significant. The 34% reduction that the company flaunts was reached by pooling the results of the two studies together. Although investors responded to the news with great optimism and pushed the stock up by ~6%, not everyone is satisfied with the findings. For example, one article quotes a professor of neurology saying, "The data cannot be regarded as significant. They did not prove it works."
There seems to be nothing wrong with the company's fundamentals (Table 1). A strong balance sheet, high cash flows and low debt levels leave ample room for acquisitions and dividend payments. What is problematic is the company's depleting product pipeline and increased pressure from generics. Total revenue for the second quarter of 2012 was down 10% YoY; the fall largely attributable to the loss of exclusivity of Zyprexa last year. The drug alone has accounted for nearly 19% of revenues, or $5 billion. So negative is the outlook of the market that Lilly is perhaps one of the few big pharmaceutical companies to receive a negative long-term earnings growth rate.
5-year Average ROE
Lilly also spends a hefty portion on research and development. R&D as a percentage of sales stood at 24% for the second quarter, as compared to Pfizer's (PFE) 11%, AstraZeneca's (AZN) 18% and 14% for GlaxoSmithKline (GSK). Do these figures guarantee Lilly's success? No, but they do show that the company is moving in the right direction.
Johnson & Johnson (JNJ)
L.T Growth Rate
We have already pointed out LLY's strong financial position and foresee no problems in it being able to pay out dividends. LLY is a dividend stock bolstered by strong fundamentals. Analysts' mean price target is $45 and EPS forecast is $3.78 for 2013. Based on the average forward P/E multiple of 12x for the industry and on 2013 earnings, we estimate a price target, in line with the market expectations, of $45. At current levels, the stock seems ahead of itself, and we therefore recommend investors looking for a solid dividend yield to wait for a more realistic entry point.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.