After Earnings and a Big Rally, Is Eli Lilly Stock a Buy, a Sell, or Fairly Valued?

Eli Lilly LLY released its second-quarter earnings report on Aug. 8, 2023, before the market open. Here’s Morningstar’s take on Eli Lilly’s earnings and stock.

Key Morningstar Metrics for Eli Lilly

• Fair Value Estimate: $368.00
• Morningstar Rating: 2 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

What We Thought of Eli Lilly’s Q2 Earnings

We believe Lilly’s strong growth in the quarter reflects several recent innovative product launches that reinforce its wide moat. However, though the company projected above-consensus peak sales for its diabetes and weight-loss drug Mounjaro (tirzepatide, its most important recent launch), we still view Lilly’s stock as overvalued, with the market showing signs of over-optimism.

In the quarter, total sales increased 22% operationally (excluding COVID-19 products and Baqsimi rights), driven by new product launches and a lack of major patent losses. We expect this growth rate will accelerate as more new drugs launch and Mounjaro gains the new indication in weight loss that’s likely later in the year. We project peak annual sales of Mounjaro of over $30 billion based on its leading efficacy in treating weight loss and diabetes. Importantly, Lilly’s older GLP-1, Trulicity, appears to be maintaining market share, with sales down 5% largely due to a mix shift against a backdrop of strong demand.

Lilly’s pipeline continues to show remarkable strength. We are bullish on the oral GLP-1 orforglipron (phase 3 data likely in 2025), the Alzheimer’s drug donanemab (launch likely in early 2024), and the cardiometabolic drug retatrutide (phase 3 study starts in 2023).

Fair Value Estimate for Eli Lilly

With its 2-star rating, we believe Eli Lilly’s stock is overvalued compared with our long-term fair value estimate.

We increased our fair value estimate to $368 from $289 per share, largely based on increased projections for Mounjaro and orforglipron. While Mounjaro sales have yet to fully materialize (partly due to insurance still expanding coverage), we expect the drug to become Lilly’s largest product over the next five years based on a leading efficacy profile in diabetes and weight loss. We expect Mounjaro holds a peak annual sales potential above $25 billion. The drug entered the market in 2022 for diabetes treatment, and we expect a label expansion into obesity treatment in 2023.

Additionally, we expect orforglipron to develop into a major drug based on the convenience of oral administration. Its efficacy looks positioned to match that of Novo Nordisk’s Wegovy, and as a non-peptide agonist, it doesn’t require any special delivery technology.

Read more about Eli Lilly’s fair value estimate.

Eli Lilly Historical Price/Fair Value Ratios

Ratios over 1.00 indicate when the stock is overvalued, while ratios below 1.00 mean the stock is undervalued.

Economic Moat Rating

Patents, economies of scale, and a powerful distribution network support Eli Lilly’s wide moat.

Lilly’s patent-protected drugs carry strong pricing power, which enables the firm to generate returns on invested capital in excess of its cost of capital. Further, the patents give the company time to develop the next generation of drugs before generic competition arises.

The firm’s diversified product portfolio means its top drugs represent only a moderate amount of total sales, with the largest drug, Trulicity, representing almost 20%, which sets up manageable cash flow declines as new products mitigate the generic competition. The company’s operating structure also allows for cost-cutting after patent losses to reduce the margin pressure from lost high-margin drug sales.

Overall, Lilly’s established product line creates the enormous cash flows needed to fund the average $800 million in development costs per new drug. In addition, the company’s powerful distribution network makes it a strong partner for smaller drug companies that lack its resources. Lilly’s entrenched insulin franchise creates an added layer of competitive advantage, as interchangeable insulin competition seems many years away due to the complexity of gaining generic approval for insulin and the high cost to build the needed economy of scale for insulin production.

Read more about Eli Lilly’s moat rating.

Risk and Uncertainty

We have increased Eli Lilly’s Uncertainty Rating from Medium to High, based on an increasingly variable outcome for several key drug launches.

Mounjaro is likely to develop into a major new drug, but its cone of uncertainty is high, as several variables affect the sales potential for the weight loss indication, including people’s level of insurance coverage and pricing. Donanemab could become major, but its outlook also has a wide range of outcomes; the market potential could be very large, but the visibility for market uptake is less clear.

With donanemab and Mounjaro representing close to half of Lilly’s projected sales by the end of the next 10 years, we believe a High Uncertainty Rating is appropriate. Most big biopharma firms tend to have Medium Uncertainty Ratings. Beyond product-specific uncertainties, Lilly faces tough competition from generics manufacturers and brand-name drugmakers. The company encounters considerable regulatory and legal risks, including product approvals, patent challenges, and liability lawsuits.

Read more about Eli Lilly’s risk and uncertainty.

LLY Bulls Say

• Lilly is developing a new Alzheimer’s drug, donanemab, that could become a major blockbuster, especially because the FDA appears to have a lower threshold for approval for this disease.
• Lilly’s cancer drug Verzenio reported strong data in early-stage breast cancer, opening up the potential for it to be the first CDK4/6 drug to launch in this multi-billion-dollar market.
• Lilly is creating the next generation of diabetes and weight loss drugs with major market potential, given the high prevalence of these diseases.

LLY Bears Say

• The risks to success for donanemab remain high both in clinical development and insurance coverage.
• Several of Lilly’s next-generation diabetes drugs could lead to the cannibalization of its current approved drugs.
• Competition for the weight loss drug Mounjaro could significantly increase over the next three years.

This article was compiled by Monit Khandwala.