Don’t Gild The Lilly, Just Hold It

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Mr Market beams as investors run from pillar-to-post trying to find the best bet for an investment. And even as some stocks go bonkers at the exchange, Pharma investors repeatedly convince themselves to be patient.

As we all wait for Eli Lilly (NYSE: LLY) to come out with its Q4 results, a question looms above us: Will Eli Lilly bear down on one’s portfolio?

That is indeed a question haunting investors. In the eternal bear-and-bull tussle, Eli Lilly has found itself a favorite amongst bears owing to consistent quarterly setbacks. So should you dismiss it right away? I suggest that you wait and observe.

An overview of the Pharma Industry

The US pharmaceutical industry boasts of a powerful global presence besides being a key economic driver in North America. This massive exposure to global economics makes the pharma industry fairly volatile. At the same time costs in this industry are mind-boggling. The amount of money going into research to develop new drugs to cope with generic competition is huge.  This makes most companies operating in this industry appropriate for long-term investments.

Sadly, Eli is not an investment that you could look to for the long-term--Eli is more like a hold-for-a-while stock. Patent expiration of its super-seller drugs like Zyprex and the impending loss of Cymbalta have left Eli in an insecure place. Furthermore, new drugs like Threshold Pharmaceuticals Gemzar are expected to threaten its existing market share.

Thus, out of desperation Eli’s looking to cut costs and expand the drug pipeline. But lay-offs are not enough to keep margins up forever, nor does the FDA approve all drugs proposed. So times could get tougher for Eli.

Also, the stomach cancer drug ramucirumab has proven to be less of a performer than most of us had expected.  The six Phase III studies conducted on this drug now look like a poor (and expensive) management decision.

Patent woes

But Eli is not the only one having to cope with patent losses.  Competitor Bristol-Myers Squibb (NYSE: BMY) saw dropping sales due to patent expiration of Plavix and Avapro/Avalide last quarter. Rival Pfizer (NYSE: PFE) has been through the same with the loss of Lipitor’s patent in 2011. Each of these companies has handled patent losses their own way. Pfizer resorted to cutting its research budget, selling off units and share buy-backs, while Bristol-Myers is currently focusing on churning out blockbuster drugs to capture lost market, besides having toned down advertising costs.

The week ahead will see Bristol-Myers and Pfizer introduce the anti-clotting drug Eliquis in the U.S., which will have to compete with Xarelto, from the stable of Johnson & Johnson. Eliquis could be a drug that both Pfizer and Bristol-Myers are looking upon as a potential blockbuster drug. Investors have their fingers crossed for this one.

The struggle continues, but there’s hope

So, competition from other drug makers just keeps getting more intense.  This generic tussle could result in lower revenue figures for the pharmaceutical industry this year. I’m not saying it will happen, but growing costs, currency impact, and a stubbornly slow economic growth besides patent losses could bear down on revenue figures.

However, the good news is that the pharma industry could well reap the goodies in the medium future. The key for grossing more revenue is demand for medication from the baby boom population of the 1940’s, which is now aging. So, demand is going to grow steadily well into another decade or two. To make the most of this general recovery, Eli must put its patent loss behind and focus on innovation.

What do metrics say?

If you check the Beta levels, you will see that Eli Lilly is one of the more volatile stocks around, with high risk and at the same time a small possibility of reward. 

<table> <tbody> <tr> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>P/E (TTM)</strong></p> </td> <td> <p><strong>Dividend Yield (%)</strong></p> </td> <td> <p><strong>ROE</strong></p> </td> <td> <p><strong>Beta</strong></p> </td> </tr> <tr> <td> <p><strong>Pfizer</strong></p> </td> <td> <p>20.88</p> </td> <td> <p>3.28%</p> </td> <td> <p>11.58</p> </td> <td> <p>00.80</p> </td> </tr> <tr> <td> <p><strong>Bristol- Myers Squibb</strong></p> </td> <td> <p>31.62</p> </td> <td> <p>3.91%</p> </td> <td> <p>12.04%</p> </td> <td> <p>00.69</p> </td> </tr> <tr> <td> <p><strong>Merck</strong></p> </td> <td> <p>19.65</p> </td> <td> <p>4.00%</p> </td> <td> <p>11.75%</p> </td> <td> <p>00.79</p> </td> </tr> <tr> <td> <p><strong>Johnson & Johnson</strong></p> </td> <td> <p>19.07</p> </td> <td> <p>3.34%</p> </td> <td> <p>13.98%</p> </td> <td> <p>00.43</p> </td> </tr> <tr> <td> <p><strong>Eli Lilly</strong></p> </td> <td> <p>14.44</p> </td> <td> <p>3.69%</p> </td> <td> <p>27.92%</p> </td> <td> <p>00.86</p> </td> </tr> <tr> <td> <p><strong>S&P 500</strong></p> </td> <td> <p>17.70</p> </td> <td> <p>2.10%</p> </td> <td> <p>-</p> </td> <td> <p>-</p> </td> </tr> </tbody> </table>

Though, the P/E (ttm) is low, I suggest that you don’t read too much into that. Dividend yield is only average, but the ROE seems healthy. But revenues are upsetting.

Should the financials worry you?

  • Debt-to-Equity: Looking at a debt-to-equity ratio of 0.34, which is relatively small, it seems evident that Eli has kept debt levels in control. Positive.
  • Operating margin: One of the major concerns of the health industry is its proclivity to spend way too much on drug development and that demands a look at Eli’s Operating margin (ttm), which looks healthy at  21.96%. Positive.
  • Free cash flow per share: Now cash is another major criterion investors should consider before investing because it dictates dividend figures. Eli’s free cash flow per share at $3.02 ensures that the company has a cash cushion. So, that makes Eli look good enough to handle future losses, if any, as well as finance restructurings. Positive.
  • Price/Sales: The Price/Sales ratio is quite high at 2.62, and that is a reason for concern. Negative.
  • EPS: EPS should technically not be in the red, but looking at the past figures, negative EPS has been a common sight with Eli. Negative.

Be Foolish

Though Eli Lilly is trying to remain profitable despite the odds, I doubt share buy-backs and cost cuts can reclaim much of its past glory. It looks like a stock that hints “hold, but not for too long.” Several factors like information transparency are going to open up more medicine options for the customers, and that will influence existing customer loyalty. The Q4 results are expected to be disappointing, and that would further hurt investor sentiment.

thebose has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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