Eli Lilly (LLY) commands one of the pricier valuations among its large-cap pharmaceutical peers. It recently fetched 17.9 times the $5.40 analysts expect it to earn this year. In contrast, Merck (MRK) was at 15 times and Pfizer (PFE) was at 13 times. Lilly bolstered its case for a premium valuation with a strong second-quarter earnings report on July 24, and the stock has appreciated more than 13% this month alone. But just how long can the company sustain this torrid run?
Probably not for that long, but the company remains well positioned and has a good chance to grow its earnings at a double-digit clip over the next few years. The Indianapolis-based company’s portfolio includes drugs for immunology, cancer, cardiovascular disease, neuroscience (including depression), and diabetes.
It boasts good margin growth, reflecting solid cost controls, with a second-quarter operating margin of 29%, up from 18% in 2014. And newer drugs such as Trulicity, which treats diabetes, and Taltz (plaque psoriasis) are making their mark.
Another plus from Lilly’s latest earnings release: The company plans to sell its animal-health business, called Elanco. Damien Conover, a Morningstar analyst, estimates that the division could fetch $12 billion to $13 billion. Proceeds from the initial public offering will be used to pay down debt and return capital to shareholders, says Mark Taylor, communications director at Eli Lilly. The stock was recently yielding 2.3%.
Conover maintains that Lilly “will be one of the fastest-growing large drug companies in the industry, with an annualized revenue growth rate of 5% over the next three years.” He puts the stock’s fair value at $100; it was recently at $96.40.
Like any large drug company, Lilly does face pressure on patent expirations, including one for its erectile-dysfunction drug Cialis. There’s also a political climate that’s hostile to drug-price increases. In May, President Donald Trump released a blueprint for lower drug prices.
In Lilly’s second-quarter earnings release last week, Lilly CEO David Ricks noted that the company remains “focused on driving revenue growth through volume, not price” and that the second-quarter results “reflect this strategy.”
Alessandro Valentini, a portfolio manager at Causeway Capital Management, estimates that Lilly could add up to $9 billion of sales from its newer drugs and lose some $4 billion from patent expirations, leaving the company in good shape. Causeway holds Lilly’s stock. The drugs “they have put in place to get margins higher than the current levels have helped the top line,” says Valentini. Even with patent expirations, “you still have a pretty clear path for revenue growth in the mid-single digits over the next two years,” he adds.
Lilly earned $1.50 a share in the quarter on an adjusted basis, up from $1.11 a year earlier. Revenue totaled $6.4 billion, a 9% year-over-year gain.
The company has launched nine new products since 2014, including Trulicity, Verzenio (breast cancer), and Oluminant (rheumatoid arthritis). And one highlight of the last quarter was Trulicity. Its second-quarter revenue was nearly $780 million, up 62% from a year earlier. Sales of Taltz were $220 million, an increase of nearly 60%.
Lilly also raised its adjusted 2018 earnings guidance to $5.40 to $5.50 a share, up from $5.10 to $5.20 previously.
The company has been spending heavily on research and development—typically “more than 20% of its sales,” compared with a midteens industry average, according to Morningstar’s Conover.
For investors, the key question is whether Lilly’s superior growth is baked into the stock. The stock’s forward price/earnings ratio, though pricey compared with the group, remains about 12% below its five-year average.
The stock is bound to cool off a bit, but it should continue its upward trajectory along with solid earnings growth.
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