Big Alzheimer Flop Creates Buying Opportunity for Eli Lilly
- By Ong Kai Kiat
Eli Lilly (LLY) made the news for the wrong reasons on Nov. 23 after announcing that its experimental treatment for Alzheimer's drug, Solanezumab, had failed. If it had been successful, Eli Lilly would have the distinction of researching the first effective disease modifying drug in the world.
Big reward and big flop
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The intrinsic value of LLY
Given the global aging population, the treatment for this neurodegenerative disease for memory loss and cognitive impairment is a high risk and high reward market. According to The World Alzheimer Report 2016, there are 47 million patients with dementia which will rise to 131 million by 2050. The cost of dementia is currently estimated to be $818 billion.
Source: New York Times
Alzheimer is the more advanced form of dementia and Eli Lilly's medicine didn't even work for those who have the milder state of dementia. Therefore the results were largely disappointing. This resulted in a gap down from the prior day's closing price of $75.99 to the opening price of $64.34 on Nov. 23.
Look beyond the big failure
Following such a sharp drop, Eli Lilly had stagnated between $64 to $69 in the following days. Although the market responded decisively to the disappointing results, we should not forget that Eli Lilly has a stable flow of drugs in the pipeline. In its October 2016 earning calls, management reported that Lartruvo had been approved for the U.S., and Europe is on the verge of approving this drug for soft tissue sarcoma.
While the cure for Alzheimer had been lost, the oral inhibitor for Alzheimer, which Eli Lilly is jointly developing with AstraZeneca (AZN), is still on track. In fact, Eli Lilly had just paid $30 million to co-develop this drug with AstraZeneca on Dec. 9. They are also acquiring Boehringer Ingelheim to create vaccines.
On the cost side, Eli Lilly had also managed to cut its operating cost to be on track for a 2% to 2.5% reduction for the year. Despite facing patent challenges from generic drug makers, Eli Lilly had managed to increase its revenue by 6% from $14.6 billion for the first 9 months of 2015 to $15.5 billion in the same period of 2016. Its gross margin had expanded by 3% and its net income by 2%.
Conclusion
This pharmaceutical company has been around since 1876 and chances are high that it will survive for the next 50 years. It is priced at 31 times earnings based on its current price which is lower than 37 times for rival Merck (MRK) and slightly higher than its partner AstraZeneca's 30 times earnings.
Beyond these numbers, the key test for any pharmaceutical company is still their ability to create the next blockbuster drug. For instance, Cialis alone generated $554 million in sales worldwide for Eli Lilly in 2004. For the general population, the best option is to go periodic health review to stay in the pink of health.
Failing which, they will have to fill the coffers of pharmaceutical companies. Given the recent discounted valuation of Eli Lilly, this is a good company to consider.
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This article first appeared on GuruFocus.
Warning! GuruFocus has detected 3 Warning Signs with LLY. Click here to check it out.
The intrinsic value of LLY
