Is Eli Lilly Stock a Buy or Sell After Earnings and a Big 2023 Rally?

Eli Lilly LLY reported earnings on Nov 2. With Lilly stock up more than 60% in 2023, here is Morningstar’s take on its earnings and the outlook for its stock.

Key Morningstar Metrics for Eli Lilly

• Fair Value Estimate: $368.00
• Morningstar Rating: 1 star
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

What We Thought of Eli Lilly’s Earnings

Overall, Eli Lilly’s earnings were fairly in line with our expectations. Weight-loss drug Mounjaro was a little higher (partly due to better insurance coverage) and diabetes medication Trulicity was a little lower (partly due to pricing pressure). The results were strong and a good reason the stock should trade at a premium valuation.

Excluding coronavirus products and a Zyprexa product sale, total sales increased 24%, a rate that will likely continue over the next couple of years. Mounjaro posted $1.4 billion in the quarter and remains key to the firm’s growth potential. We expect the drug will gain a weight loss indication later in the year, adding to the current diabetes indication. With leading efficacy data, we think it will post peak annual sales of over $30 billion. Lilly’s decision to start a phase 2 study with high-dose Mounjaro holds the potential to increase the drug’s established efficacy. Lilly has also made strides in increasing its supply of Mounjaro, getting it off the FDA’s drug shortage list. However, we expect supply constraints may limit Mounjaro (and similar drug Trulicity) internationally in 2024.

Lilly is well-positioned for growth and is protecting its wide moat with innovative new drugs. However, even with bullish expectations for Mounjaro (over $30 billion annually) and Alzheimer’s drug donanemab (over $7 billion annually), we still think the stock looks expensive. Lilly is an example of a great company with an overvalued stock.

Fair Value Estimate for Eli Lilly Stock

With its 1-star rating, we believe Eli Lilly’s stock is significantly overvalued compared with our long-term fair value estimate.

Our fair value estimate for Lilly is $368.00. The outlook for Mounjaro is a key driver of this valuation. While Mounjaro sales have yet to fully materialize (partly due to insurance still expanding coverage), we expect it to become Lilly’s largest product over the next five years based on its leading efficacy profile in diabetes and weight loss. We believe Mounjaro holds peak annual sales potential above $25 billion. The drug entered the market in 2022 for diabetes treatment, and we anticipate a label expansion into obesity treatment in 2023.

We also expect the oral GLP-1 drug orforglipron to develop into a major drug based on the convenience of oral administration. Additionally, orforglipron’s efficacy looks positioned to match Novo Nordisk’s NVO competitive drugs Wegovy and potentially high-dose oral semaglutide, and as a non-peptide agonist, the drug doesn’t require any special delivery technology.

In aggregate, the company looks well-positioned to drive top-line growth. We project annual sales increases of close to 18% during the next five years as a result of new drug launches offsetting patent losses. We expect diabetes drugs Jardiance and Trulicity, along with cancer drug Verzenio and immunology drug Taltz, to remain important drivers for cash flows. Donanemab should also ramp quickly following expected positive efficacy data in 2023.

Another important point driving our valuation is cost controls and operating leverage from new drugs. While the outcome of operating cost controls will depend on new revenue associated with the success of recently launched drugs and the pipeline, we expect Lilly will significantly improve operating margins. We estimate a weighted cost of capital for Lilly at 7%, in line with the peer group.

Read more about Eli Lilly’s fair value estimate.

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. Lilly’s diversified product portfolio means the company’s top drugs represent only a moderate amount of total sales, with the largest drug, Trulicity, representing almost 20% of total sales, which sets up manageable cash flow declines as new products mitigate the generic competition. Also, Lilly’s operating structure 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 sets up the company as a strong partner for smaller drug companies that lack Lilly’s 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 of the needed economy of scale for insulin production. Also, Lilly’s recently launched biologic drugs create higher hurdles for biosimilars to gain market share following the eventual patent expirations.

Read more about Eli Lilly’s moat rating.

Risk and Uncertainty

We have raised Eli Lilly’s Uncertainty Rating to High from Medium 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 since several variables are affecting the sales potential for the weight loss indication, including levels of insurance coverage and pricing. Donanemab holds the potential to become another major new drug, but its outlook also has a wide range of outcomes, since the market potential could be very large but the visibility on 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 rating is appropriate. Most big biopharma firms tend to have Medium 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 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. They have 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 cannibalization of the firm’s current approved drugs.
• Competition for weight loss drug Mounjaro could significantly increase over the next three years.

This article was compiled by Tom Lauricella.