Will This Big Pharma Continue to Trade Up?

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The third quarter financial reports of Eli Lilly (NYSE: LLY) didn’t show much growth. Shares of the company promptly reacted to this news as they have tumbled down in the past couple of weeks. Will the company’s revenues continue to dwindle for the rest of 2012? Let’s examine the recent developments in Eli Lilly and figure if the company could turn it around in the months to follow. 

During last month, shares of Eli Lilly rose by 2.6%. A close examination of the company’s stock reveals the stock jumped by nearly 13.5% between the end of September and October 18, and then the stock tumbled down by 9.6% between October 18 and October 31. The recent fall may have been stem by the publication of the recent third quarter financial reports.        

The chart below presents the normalized returns of Eli Lilly and S&P500 during the year (prices of normalized to the beginning of January). As seen, the company’s stock has outperformed the S&P500 index in recent weeks.

<img src="/media/images/user_12845/eli-lilly-snp500-nov_large.jpg" />

According to the recent third quarter financial report of Eli Lilly, the company’s revenues declined while its operating income rose compared to the same quarter in 2011: the total revenues declined by 2.8% compared to the second quarter of 2012 and by 11.5% compared to the third quarter 2012. Conversely, the company’s operating income jumped by 58% compared to Q2 2012 and by nearly 18.2% compared to third quarter of 2011. In terms of operating profitability the company has done much better than other big pharma companies. As seen in the chart below, the operating profitability of Pfizer (NYSE: PFE) and Johnson & Johnson (NYSE: JNJ) was around 21% during the third quarter of 2012 while Eli Lilly’s was 34%.

<img src="/media/images/user_12845/eli-lilly-profit-margin-jnj-and-pfe_large.jpg" />
This rise in profitability is a bit misleading. The sharp rise in operating earnings is mostly due to a special income from Bristol-Myers Squibb for the purchase of Amylin Pharmaceuticals. Amylin Pharmaceuticals paid Eli Lilly $1.259 billion with respect to a revenue sharing obligation. Eli Lilly recognized in the third quarter a $787.8 million.

When controlling for this special income/expenses the operating earnings of the company substantially declines and the operating profitability reaches 20.5%, which is lower than the operating profitability in the third quarter of 2011 and close to the operating profitability of the other above-mentioned companies.

<img src="/media/images/user_12845/eli-lilly-profit-margin-without-special-expenses-2011-2012_large.jpg" />

This correction also means the operating earnings declined in the third quarter of 2012 by nearly 6% compared to the second quarter of 2012 and by 33% in the third quarter of 2011.

The sharp fall in earnings and revenues is mostly due to the expiry of the Zyprexa patent – the revenues declined by nearly 68% in the third quarter of 2012 compared to the parallel quarter of 2011.

The silver lining from this financial report: revenues from Cymbalt increased during the quarter by nearly 16%. Most of the rise was in the U.S due to an increase in prices and demand.

These reports may pull back the company’s stock price in the weeks to follow. Moreover, it’s hard to see a way in which the company’s revenues will rally in the months to follow especially as the company’s revenues are likely to further dwindle during the rest of the year over the expiry of the Zyprexa patent. After all, Eli Lilly, much like many other big pharma companies, relies on developing new drugs and treatments. Therefore, unlike other industries, the company’s growth in sales will comes in leaps and not slowly over time.  

At least the company is offering a relatively high dividend yield compared to other big pharma companies: Eli Lilly is offering a quarterly dividend of $0.49 per share which represents a divided yield of 4.02%. In comparison, Pfizer is offering a quarterly dividend of $0.22 per share which represents a divided yield of 3.56%; Johnson & Johnson is paying a dividend of $0.61 per share per quarter which comes to a divided yield of 3.43%

Final Thoughts

The growth of Eli Lilly’s revenues heavily relies on the company’s development of new treatments. The company continues to expand its research and development expenses (during the third quarter of 2012 the company’s R&D rose by 5% in the third quarter compared to Q3 2011). E.g. the company recently announced positive results over phase three of Dulaglutide in Type 2 Diabetes. Such progress for this company could eventually lead to sharp leaps in the future. This means once the company will be able to develop another new treatment, its stock and its future revenues and earnings will hike. If you believe in this company then it will take time until the company will be able to present another sharp leap.        

Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.


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