Eli Lilly (LLY) reported third-quarter results slightly below both our and consensus expectations, but we don’t expect any changes to our $97 fair value estimate and continue to view the stock as undervalued. We believe the market is underappreciating the company’s strong pipeline and recently launched drugs, which support a higher valuation and the company’s wide moat.
In the quarter, total sales increased 5% as new product launches helped offset mature drug declines. While insulin Humalog and cancer drug Alimta both fell by close to 9% due to competitive pressures, the company’s recently launched drugs added close to 10% to the top line. Within the new products and pipeline drugs, we remain most bullish on new immunology drugs (Taltz and baricitinib) as we expect the drugs will take significant market share from anti-TNF drugs, based on better efficacy and cleaner side effect profiles. Also, the potential label expansion for diabetes drug Jardiance to include a cardiovascular benefit should occur in the fourth quarter and help drive sales to our peak sales estimate of close to $5 billion. The wildcard in the pipeline is Alzheimer’s drug solanezumab, which should report top line Phase III data in late 2016, offering potentially more than 15% upside in the stock price if successful.
Several drugs will join the heavy generic headwinds still impacting neuroscience drug Zyprexa. Alimta (patent losses in 2017-22), erectile dysfunction drug Cialis (2017), and cardiovascular drug Effient (2017-19) should all fade quickly following generic launches. If Alimta sees generic pressure in 2017, Lilly could struggle to keep its long-term guidance for operating cost reductions (more than 500-basis-point operating margin improvement by 2018) and sales growth (5% through 2020). Beyond a strong pipeline, the insulin franchise and animal health sales should drive steady sales, helping to diversify Lilly’s operations and reduce the volatility in cash flows from patent losses.
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Damien Conover, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.