Here’s Pharmboy’s first stock and option recommendation for the new year, or decade, in this case. He’s generally bullish on Lilly and presents two strategies - a simple buy/write strategy and a slightly more complicated strategy which includes selling puts and calls. - IlenePharmboy Takes On Lilly
Courtesy of Pharmboy
Another year has come and gone, 2010 (twenty ten or two thousand ten – which do you prefer?) is here. The market is great for some, and a baffling experience for others. One thing we do know is that we all need, at some point, health care in one form or another! This year, my write-ups may focus on longer term strategies so that we don’t have to manage our trades on a daily basis. This means a bit more depth in the analysis of companies we invest in, and perhaps some longer term picks.
So, here we go for Pharmboy’s first segment for a new decade!
Eli Lilly (NYSE:LLY) - is a global pharmaceutical company and is a member of the Fortune 500. Its global headquarters is located in Indianapolis, Indiana. The company was founded in 1876 by a pharmaceutical chemist, Eli Lilly, after whom the company was ultimately named. The company’s first innovation was changing the flavorings of medicines so that they were easier to take. The business grew and in 2008, had of $20Billion.
Among the company’s major pharmaceutical breakthroughs are: cephalosporin (antibiotic), erythromycin (antibiotic), insulin, and fluoxetine (Prozac). Among other distinctions, Lilly is the world’s largest manufacturer and distributor of medications used in a broad range of psychiatric and mental health-related conditions, including clinical depression, generalized anxiety disorder, narcotic addiction, insomnia, bipolar disorder, schizophrenia, and others. Below is a list of their brands:
Lilly has a diverse pipeline for cancer, pain and of course, glucose management. Much of its growth comes from its purchase of Imclone in 2008 for $6.5B. [click on chart to enlarge]
Lilly announced via the WSJ that it was hiring outside contractors to run tests on its drug candidates. This is not new; in 2008 Lilly announced a large deal with Covance (NYSE:CVD) to run many of those studies. Things are just getting started in the Clinical Research Organization (CRO) industry. It’s a gamble, but Lilly’s management feels the CROs can do the job cheaper than they can. The CROs usually have higher productivity with less wage pressures and have very little vested interest in the project.
S&P Reports that:
1. Lilly faces a major patent cliff starting with the loss of U.S. patent protection on Zyprexa in 2011.We believe LLY is addressing this issue by stepping-up new drug development activities and acquisitions. In 2008, Lilly acquired ImClone Systems, which gave it access to Erbitux, an anti-cancer drug that we expect to grow in the years ahead. Although expected to be dilutive in 2011, Imclone expanded LLY’s biologics base and has provided cost synergies. However, we see somewhat limited prospects for LLY’s new Effient anti-clotting agent, which has been linked with bleeding risks.2. Risks to our recommendation and target price include greater-than-expected competitive pressures, as well as failure to develop and commercialize new drugs.3. Our 12-month target price of $40 applies a below-peers multiple of 8.4X to our 2010 EPS estimate, which we believe is reasonable given the impending patent cliff. Our DCF model, which assumes decelerating cash flow growth over the next 10 years, aWACC of 7.0%, and perpetuity growth of 1%, also indicates intrinsic value of $40. The dividend recently yielded 5.5%.
In Lilly’s Phase III program for Solanezumab, a total of 2000 patients with mild to moderate AD are expected to receive either a 400 mg infusion of Solanezumab or a placebo once every four weeks. Each research volunteer will participate over about 19 months. The overall trial is anticipated to be completed in mid 2012.
So, in viewing Lilly as a potential investment, what do we do? Let’s be a little conservative and collect the dividend (ex-dividend date is February 10). The high/low stock price is roughly $40/27 and we are almost smack in the middle of that channel. The stock has some support at $35. Let’s buy the stock here, and sell the $35 Feb 2010 Puts for 60 cents or better and place an order to sell the $36 Apr 2010 Calls for 1.35 or better (Currently $1.15-1.25). This way the stock is covered with the calls and the dividend can be collected (assuming the stock does not run up above 37.30 before the February dividend date). I'd sell the same number of calls and puts in this case.
With solid support at $35, the puts sold will take some margin in an account, but you should be able to collect most if not all of the 60cents. The MACD and RSI are rising, but the 20 & 50d moving averages have crossed the wrong way (but should correct on a run up). This gives you a 33.9 entry (with dividend) if called away at 37.3, or roughly 10% gain in a few months.
Alternatively, just buy the stock here and hedge with the $35 Jan 2011Calls for $3.10. This protects your money down to $32, which is the lower end of the analysts’ stock price range. Be prepared to be called away if the option premium is less than the dividend amount. Usually, if the premium is eroded from the call, then they will call the stock from you so that they can collect the dividend.
Disclosure: Author currently has no positions in LLY.