We continue to be impressed with the recent developments at Eli Lilly as the company is poised to radically ramp sales growth potential in the event the commercialization of new products and its late-stage pipeline come to fruition.
By Alexander J. Poulos
Key Takeaways
The share price of Eli Lilly has performed wonderfully of late as the company reported a beat-and-raise quarter thanks in large part to sales growth in newer products.
Lilly scored a key patent win for its oncology mainstay Alimta, thus ensuring a steady revenue stream.
With a patent win protecting Alimta, Lilly is in good shape to weather the revenue hit from a generic version of Cialis entering the market.
We suspect Lilly will be able to post revenue growth over the next five years, thus powering the share price higher unlike many others in Big Pharma facing imminent patent cliffs.
We are putting our fair value estimate of Eli Lilly under review, and we expect to raise it materially. However, we don’t expect shares to come out undervalued.
Sales Growth Acceleration
Eli Lilly (LLY) reported a beat-and-raise quarter July 23 as its innovative suite of new products continues to exceed initial expectations. In the first half of 2018, Lilly posted sales of $12.05 billion, an increase of 9% versus the comparable period in 2017 thanks in large part to a ramp in sales of Trulicity, its innovative GLP-1 treatment for diabetes. Trulicity augments Lilly’s traditional strength in Diabetes as we view the product as a natural line extension of its long-standing diabetes franchise.
Sales growth of 9% is exceedingly rare in the world of big pharma as the industry remains plagued by patent losses of key products, which hamper revenue growth. Such was the case for Eli Lilly in 2014 as the patent for its then key product Cymbalta lost patent exclusivity in December of 2013. Comparable year-over-year sales figures were destined to fall as the loss of its top-selling product would be nearly impossible to replace in such a short period.
We applaud the move by the management team at the time to double down its focus on its core Diabetes franchise, which directly led to new innovative products such as Jardiance and Trulicity, which currently account for 14.5% ($1.756 billion) of Lilly’s current year-to-date sales. We wanted to highlight the importance of patience when investing in the innovative pharma/biotech sector as the pace of innovation may vary. For example, in the case of Eli Lilly, many skeptics have been impressed by the new product line-up more-than-offsetting the loss of Cymbalta as the pace of innovation at Eli Lilly continues.
Guidance Update
At the time of the second-quarter report, Lilly’s management increased the midpoint of its 2018 revenue target range $300 million thanks in large part to the unexpected strength of its newly-marketed products. Lilly now expects to post annual sales of $24-24.5 billion versus a previous range of $23.7-24.2 billion. The increase in expected sales performance for the year is helping profitability, too, as the company is now expecting non-GAAP gross margins of ~76%, an increase of one percentage point versus prior guidance. The increased top-line and improved levels of profitability translated into a raise in the earnings guidance range, by $0.30, now to $5.40-$5.50 per share on a non-GAAP basis. We continue to be highly impressed with the potential of Lilly as it begins to realize the full extent of its new product portfolio.
Cialis
As is the norm of big pharma, the product line-up is constantly bedeviled with patent expirations. Lilly is not exempt from this trend with its key erectile dysfunction franchise Cialis coming under intense generic competition later this year. The Cialis franchise is already posting sales deceleration as the generic version of Viagra has cut into sales with Cialis posting revenue of $1.034 billion for the first six months of 2018 versus $1.161 billion in the comparable period in 2017. As is our analytical approach, we’ll break down the product suite of Eli Lilly into key therapeutic franchises with a focus on the trends affecting the top three franchises.
Diabetes Franchise
At its core, Lilly remains committed to its Diabetes franchise—initially established in 1923 with the development of Iletin. The company remains at the forefront of the treatment paradigm for diabetes with a wide product suite encompassing modern analog insulins such as Humalog, recombinant human insulins such as Humulin, GLP-1 agonist Trulicity, a biosimilar to Lantus sold under the trade name Basaglar, and the oral treatment Jardiance. Lilly boasts a deep line-up encompassing the entire diabetes treatment paradigm which is unmatched in the industry, in our view. The closest competitor is Novo Nordisk (NVO), but the Danish pharma powerhouse lacks a worthy alternative to Jardiance and Basalglar. Sales of the uber-important Diabetes franchise totaled $4.358 billion (36% of Lilly’s overall sales) as the continued strength of Trulicty and franchise mainstay Humalog continue to anchor sales.
Inflammatory Disease
The Inflammatory Disease franchise is a newly-formed division spearheaded by Taltz for the treatment of psoriatic arthritis and plaque psoriasis. Taltz is a monoclonal antibody that targets Interleukin-17A to help mollify the symptoms of psoriatic arthritis and plaque psoriasis. The inflammatory disease category remains the single largest area of specialty drug spending (which is the fastest growing area of the overall pharmaceutical drug budget based on dollar volume). We are pleased to see Lilly gain a toehold in this arena, first with Taltz followed by the innovative Jak-1 treatment Olumiant. Taltz sales for the first half of 2018 totaled $366 million versus $236 million in the comparable period in 2017. We believe the ultimate commercial potential of Taltz is well north of a billion dollar annual run-rate, thus handing Lilly another blockbuster to pair with its strength in Diabetes.
We initially had high hopes for Olumiant, as the first entrant from the innovative Jak-1 class seemed poised to exhibit first-mover advantage as it would enter the market well in advance of the competition. A lengthy delay from the FDA coupled with approval for the less-effective lower-dose regiment has, in our view, severely impeded the once-lofty potential of this treatment. Sales of Olumiant totaled $77 million for the first half of 2018. We think the franchise might even be permanently impaired given the threat of blood clots coupled with sub-optimal potency (based on the superb results posted by the group receiving the higher dose in clinical studies). We doubt clinicians are in a rush to embrace Olumiant in light of the plethora of the more well-established choices available.
Oncology
Oncology remains an area of intense R&D spend in the pharma/biotech sector with Lilly adding to the trend with its new product suite that includes recently-approved Lartruvo and Verzenio. Lilly’s key asset in Oncology remains Alimta in combination with Cisplatin for the treatment of Non-Squamous Non-small cell lung cancer. Lilly was able to prevail in a hotly-contested patent fight, thus ensuring Alimta sales well into 2022, a key win for Lilly as it takes a potential patent cliff off the table. Alimta sales totaled $1.055 billion underscoring the importance of the favorable patent ruling.
Regarding sales, Alimta and Cialis are Lilly’s third and fourth most valuable asset–a patent cliff while not insurmountable would have torpedoed expected revenue gains over the next four quarters. Sales of Cymraza continue to ramp higher as Lilly aims to expand the prescribing label of the product. Cymraza sales totaled $402.4 million in the first half of 2018,a jump of 13% versus the comparable period in 2017. Lilly’s newest assets in Oncology remain in their respective lifecycle infancy as the salesforce begins to educate prescribers about the virtues of the products.
Concluding Thoughts
While we remain impressed with the virtues of Eli Lilly, we just can’t get comfortable with the equity’s share at this juncture. Lilly scores a 2.3 on our proprietary Dividend Cushion ratio, and the company retains balance-sheet flexibility to afford an annual dividend hike, which appeals to an income-seeking investor that may wish to gain exposure to the pharmaceutical sector. We’re placing shares under review with expectations of a fair value estimate increase, but we don’t expect them to come out as undervalued at this time.
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Independent healthcare and biotech contributor Alexander J. Poulos does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.