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EliLillyandCompany-StockValuationReport

EricWu

EliLillyandCompany

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StockEvaluationReport:EliLillyandCompany,7/14/18

SUMMARY

EliLillyandCompany(LLY)isaglobalhealthcareleaderthatdiscovers,develops,manufactures,

andmarketspharmaceuticalproductsworldwide.Thecompanyoperatesthroughtwo

segments,HumanPharmaceuticalandAnimalHealthproducts.EliLillyisthe16thlargest

companywithinthehealthcaresectoroftheS&P500,generating$22,781.3millioninrevenue

inFY2017,an8%increasefromFY2016.1(all

revenuesnotedinmillions)

INVESTMENTTHESIS

WeareplacingaBUYratingonLLYwitha

pricetargetof$85.51.Withthecombination

of11newproductswithintheirpipeline

poisedtolaunchby2023,rapidlygrowing

productssuchasTrulicity,Taltz,Basaglar,

Cyramza,andJardiance,andanagingand

increasinglyunhealthydemographic,EliLilly

lookstoweathertheupcominglossof

domesticpatentexclusivityforCialis,Forteo,

andAlimta

RISKSTOTHISRECOMMENDATION

• Pharmaceuticalresearchand

developmentiscostlyanduncertain

• Losingeffectiveintellectualproperty

protectiononrevenuegenerating

productswillleadtorapidandsevere

revenuedeclineinthoseproductlines

• Humanpharmaceuticalbusinessis

subjecttogovernmentpricecontrolsand

unanticipatedtaxliabilities

• Intensecompetitionfromlower-cost

genericandbiosimilarmanufacturers1

ContactInformation

Fund SIM,OSUInstructor RoyceWest,CFA

Name EricWu,PharmDEmail [email protected]

Summary

Recommendation BUY

Ticker LLY

Sector Healthcare

Industry Pharmaceuticals

Priceasof7/15/18 $89.71

TargetPrice $108.24

PotentialUpside 20.7%

DividendYield 2.62%

TotalProjectedReturn 23.32%

MarketData

MarketCap 93.26B

SharesOutstanding 1,085,430,000

EPS(TTM) 1.97

P/ERatio 19.89

EV/EBITDA 14.23

Beta 0.3

QtrlyRevenue(YoY%) 9%

Performance

52WeekPriceLow-High 73.69-89.87

1YearReturn 6.77%

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TableofContents

COMPANYOVERVIEW............................................................................................................................3

GeneralOverview.....................................................................................................................................3

BusinessSegments...................................................................................................................................3

AnimalHealthProducts........................................................................................................................4

HumanPharmaceuticalProducts.........................................................................................................5

MarketLandscape..................................................................................................................................10

PatentExclusivityLossSummary......................................................................................................13

INVESTMENTTHESIS............................................................................................................................14

HealthcareSectorSummary...................................................................................................................14

FinancialAnalysis....................................................................................................................................15

ValuationAnalysisandPriceTarget.......................................................................................................16

DiscountedCashFlowModel.............................................................................................................17

RelativeMultiplesValuationModel...................................................................................................18

RISKS.........................................................................................................................................................19

CONCLUSION..........................................................................................................................................20

APPENDIX................................................................................................................................................21

PipelineSummary...................................................................................................................................21

EstimatedProductRevenue...................................................................................................................22

DiscountCashFlowValuation................................................................................................................23

IncomeStatement..................................................................................................................................24

REFERENCES...........................................................................................................................................25

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CompanyOverview�InvestmentThesis�Risks

CompanyOverview

GENERALOVERVIEW

EliLillyandCompany(LLY)isaglobalhealthcareleaderheadquarteredinIndianapolis,Indiana

thatdiscovers,develops,manufactures,andmarketspharmaceuticalproductsworldwide.The

companyoperatesthroughtwosegments,HumanPharmaceuticalProductsandAnimalHealth

Products.Establishedin1876,LLYemploysapproximately38,000individualsworldwidewith

productsmarketedin120countries,leadingthemtobethe16thlargestcompanypermarket

capwithinthehealthcaresectoroftheS&P500.5

Thehumanpharmaceuticalsegmentconsistsofseveraldivisions:Endocrinology,oncology,

cardiovascular,neuroscience,andimmunology.Lilly’sanimalsegmentoperatesthroughtheir

Elancodivision,focusingonbothanimalsforconsumptionandcompanionanimals.1

In2017,LLYgenerated$22,871.3millioninrevenue,an8%increasefromtheprioryear.LLY

postedanearnings(loss)of$0.19attributedtonewU.S.taxlawsandcompanyrestructuring.

With11medicationspoisedtolaunchby2023(9totalsince2014),LLYlookstocontinue

increasingrevenuetrends.2Thestockhasoutperformedtheindustrythisyearthusfar,

however,competitivepressuresareexpectedtoincreaseaspatentexclusivityforcertain

productssuchasCialisareexpiring.

BUSINESSSEGMENTS

EliLilly’sanimalhealthproductssegment(operatedthroughElancoAnimal

Health)isaglobalcompanythathasenjoyedadecadeofgrowth.Elancofocuses

onidentifyinganddevelopingproductsthatmeetunmetveterinary,food

producer,andpetownerneeds.Additionally,Elancoalsoutilizesdiscoveriesfrom

thehumanhealthlaboratoriestodevelopproductssupportingthewellbeingoffarmanimals

andpets.Elancosellsitsproductsprimarilytowholesaledistributors.Unfortunately,ithas

underperformedasoflate(-2.3%revenuebetweenFY2016andFY2017)andLillyisreviewingstrategicalternativesincludingasale,merger,initialpublicoffering,orretentionofthe

business.TheyarehopingtomakeadecisionaboutElancoinmid-2018.2

Lilly’shumanpharmaceuticalsproductssegmentdrivesthemajorityofrevenues

withinthecompany.Of$22,871.30millionrevenue,$19,785.60originatedfrom

thehumanpharmaceuticalproductssegment.Thissegmentisfurtherdivided

into6divisions:Endocrinology(Humalog®,Trulicity®,Forteo®,Humulin®,

Trajenta®,Jardiance®,Basaglar®),oncology(Alimta®,Cyramza®,Erbitux®),

cardiovascular(Cialis®,Effient®),neuroscience(Cymbalta®,Strattera®,Zyprexa®),immunology

(Taltz®),andother.2

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FY2016 FY2017 Change%

AnimalHealth 3,158.20 3,085.60 -2.30%

Human

Pharmaceuticals18,063.90 19,785.60 9.53%

Total 21,222.10 22,871.30 7.78%

FY2016 FY2017 Change%

USA 11,506.20 12,785.10 11.11%

Europe 3,768.10 3,943.20 4.65%

Japan 2,330.90 2,419.70% 3.81%

Other 3,616.90 3,723.30 2.94%

Lilly’sAnimalhealthbusinessoperatedthroughElancocomprised13%oftotalcompany

revenue.Elancoreported$761.3millioninrevenuein2018Q1,a1%decreasefrom2017

($769.4million).AccordingtoLilly’sQ1pressrelease,thisisduetoworldwidefoodanimal

revenuedecreasingby7%drivenbymarketaccesspressures.Companionanimalrevenue

increasedby10%,however,primarilydrivenbyhigherrealizedpricesandthefavorableimpact

offoreignexchangerates.3

Lilly’sAnimalHealthProductsinclude1:

FoodAnimal

• Rumensin®:acattlefeedadditivethatimprovesfeedefficiencyandgrowthandalsocontrols

andpreventscoccidiosis

• Coban®,Maxiban®,andMonteban®:ananticoccidialagentusedinpoultry• Posilac®:aproteinsupplementtoimprovemilkproductivityindairycows

• Optaflexx®andPaylean®:leannessandperformanceenhancersforcattleandswine

Human

Pharmaceutical

87%

AnimalHealth

13%

RevenueBySegment

United

States

56%

Europe

17%

Japan

11%

Other

Foreign

Countries

16%

RevenueByRegion

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• Tylan®:anantibioticusedtocontrolcertaindiseasesincattle,swine,andpoultry• Denagard®:anantibioticforthecontrolandtreatmentofrespiratoryandentericdiseasesin

swineandpoultry

CompanionAnimal

• Trifexis®:amonthlychewabletabletfordogsthatkillsfleas,preventsfleainfestations,

preventsheartwormdisease,andcontrolsintestinalparasiteinfections

• Comfortis®:achewabletabletthatkillsfleasandpreventsfleainfestationsindogs• Interceptor®Plus:Amonthlychewabletabletthatpreventsheartwormdiseaseandtreatsand

controlsadulthookworm,roundworm,whipworm,andtapewormindogs

• Galliprant®:ananti-inflammatorytabletthattargetsthekeyreceptorassociatedwithcanine

Osteoarthritispain

• Feline,canine,andrabiesvaccines:Duramune®,UltraDuramune®,DuramuneLyme®,Bronci-Shield®,Fel-O-Vax®,ULTRAFel-O-Vax®,andFel-O-Guard®,andRabvac®

Lilly’sHumanPharmaceuticalProductsexperiencedvariedgrowthandloss.Comprisingof87%oftotalrevenueforFY2017,Lilly’sHumanPharmaceuticalProductsreported$4938.7millionin2018Q1,a10.7%increasefrom2017Q1.AccordingtoLilly’sQ1PressRelease,thismaybedue

torevenueincreaseof4%duetofavorableimpactofforeignexchangerates,a3%increasedue

tohigherrealizedprices,anda2%increaseduetovolume.Increasedrevenuewaspartially

offsetduetolossofpatentexclusivityforStratteraandEffient®,aswellasdecreaseddemand

forCialis.3Notably,endocrinologyhasenjoyedstronggrowth(25%)andwillbediscussedin

furtherdetaillater.Somedivisionswithinthehumanpharmaceuticalproductssuchas

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cardiovascular(-11%)andneuroscience(-20%)experiencednotablelossandwillalsobe

discussedinfurtherdetaillater.

Lilly’sHumanPharmaceuticalSegmentConsistsof1:

Endocrinology

• Humalog®,HumalogMix75/25,HumalogU-100,HumalogU-200,HumalogMix50/50:insulinanalogsforthetreatmentofdiabetes;For2018Q1,Humalogrevenueincreasedby12%

relativeto2017Q1.Largelyduetohigherrealizedpricesduetochangesinestimatestorebates

anddiscountsandchangesinpayersegmentmixinconjunctionwithincreasedvolume.

Internationalrevenuesalsoenjoyedfavorableimpactofforeignexchangerates.3

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• Humulin®,Humulin70/30,HumulinN,HumulinR,andHumulinU-500:humaninsulinsforthe

treatmentofdiabetes;The4%increaseinrevenuefor2018Q1vs2017Q1wasdrivenby

increaseddemand,partiallyoffsetbylowerrealizedpricesanddecreasedforeignrevenue3

• Trulicity®:GLP-1agonistusedforthetreatmentoftype2diabetes;2018Q1revenueincreased

by82%relativeto2017Q1.ThisislargelyduetohigherdemandwithintheGLP-1classand

increasedshareofmarketforTrulicity.Foreignrevenuewasbolsteredbyincreasedvolumeand

favorableimpactofforeignexchangerates3

• Trajenta®:DPP4inhibitorusedforthetreatmentoftype2diabetes

• Jentadueto®andJentaduetoXR:acombinationofTrajenta(linagliptin)andmetforminforthe

treatmentoftype2diabetes

• Jardiance®:SGLT2inhibitorusedforthetreatmentoftype2diabetesandtoreducetheriskof

cardiovasculardeathinadultpatientswithdiabetesandestablishedcardiovasculardisease;

2018Q1revenueenjoyeda104%increaserelativeto2017Q1.Thiswaslargelydueto

increasedshareofthemarketforJardianceandgrowthintheSGLT2class3

• Glyxambi®:acombinationtabletofTrajenta(linagliptin)andJardiance(empagliflozin)forthe

treatmentoftype2diabetes

• Synjardy®andSynjardyXR:acombinationtabletofJardiance(empagliflozin)andmetformin

forthetreatmentoftype2diabetes

• Basaglar®:along-actinghumaninsulinanalogforthetreatmentofdiabetes;2018Q1revenue

($166million)increasedby$12.3millionrelativeto2017Q4.Thisislargelyaresultofincreased

demandduetoMedicarePartDformularyaccessandpartiallyoffsetbylowerrealizedprices

andchangesinestimatesofrebatesanddiscounts.

• Forteo®:aparathyroidanalogusedforthetreatmentofosteoporosisinpostmenopausal

womenandmenathighriskandforglucocorticoid-inducedosteoporosisinmenand

postmenopausalwomen;2018Q1sawa10%decreaseinrevenuecomparedto2017Q1.

RevenueintheU.S.decreasedby31%,primarilyduetodecreasedvolumeandlowerrealized

prices;thiswasdampenedbyanincreaseinforeignrevenuedrivenbyfavorableimpactof

foreignexchangeratesandincreasedvolume3

• Evista®:aselectiveestrogenreceptormodulatorusedforthepreventionandtreatmentof

osteoporosisinpostmenopausalwomenandforthereductionoftheriskofinvasivebreast

cancerinpostmenopausalwomenwithosteoporosisandpostmenopausalwomenathighrisk

forinvasivebreastcancer

• Humatrope®:agrowthhormoneusedforthetreatmentofhumangrowthhormonedeficiency

andcertainpediatricgrowthconditions

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Neuroscience

• Cymbalta®:anSNRIusedforthetreatmentofmajordepressivedisorder,diabeticperipheral

neuropathicpain,generalizedanxietydisorder,fibromyalgia,andchronicmusculoskeletalpain

duetochroniclowerbackpainorchronicpainduetoosteoarthritis

• Zyprexa®:anatypicalantipsychoticusedforthetreatmentofschizophrenia,acutemixedor

manicepisodesassociatedwithbipolarIdisorder,andbipolarmaintenance

• Strattera®:anorepinephrinereuptakeinhibitorusedforthetreatmentofattention-deficit

hyperactivitydisorder

• Prozac®:anSSRIusedforthetreatmentofmajordepressivedisorder,obsessive-compulsive

disorder,bulimianervosa,andpanicdisorder

• Amyvid®:aradioactivediagnosticagentforpositronemissiontomographyimagingofbeta-

amyloidneuriticplaquesinthebrain

Oncology

• Alimta®:anantimetabolite,antineoplasticagentusedincombinationwithanotheragentfor

advancednon-smallcelllungcancerforpatientswithnon-squamouscellhistology

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• Erbitux®:anEGFRinhibiting,antineoplasticagentusedasbothasingleagentandincombinationforthetreatmentofcertaintypesofcolorectalcancersandforcertaintypesof

headandneckcancers

• Cyramza®:aVEGFinhibiting,antineoplasticagentusedinmetastaticgastriccancer,metastatic

NSCLC,andmetastaticcolorectalcancer;2018Q1noteda7%increaseinrevenuerelativeto

2017Q1.Thiswaslargelyduetoincreasedvolumeandhigherrealizedprices.Foreignrevenue

wasbolsteredbyfavorableimpactofforeignexchangeratesandincreasedvolume,partially

offsetbylowerrealizedprices3

• Gemzar®:anantimetabolite,antineoplasticagentusedforthetreatmentofmetastaticbreast

cancer,NSCLC,andadvancedorrecurrentovariancancer(intheEUforbladdercancer)

• Portrazza®:anEGFRinhibiting,antineoplasticagentusedincombinationformetastatic

squamousNSCLC

• LartruvoTM:aPDGFR-alphablocking,antineoplasticagentusedincombinationforthe

treatmentofsofttissuecarcinoma;2018Q1U.S.Revenue($43million)noteda$1.5million

increaserelativeto2017Q4.3

• VerzenioTM:acyclin-dependentkinaseinhibiting,antineoplasticagentusedasasingleagentorincombinationforthetreatmentofadvancedormetastaticbreastcancer;2018Q1revenue

($29.7million)notedanincreaseof$8.7millioncomparedto2017Q43

Immunology

• Olumiant®:ajanusassociatedkinaseinhibitor,usedforthetreatmentofadultswithmoderate

toseverelyactiverheumatoidarthritis;2018Q1revenue($32.2million)noteda$9.2million

increaserelativeto2017Q4,largelyduetoastronglaunchuptakeinGermany3

• Taltz®:ananti-interleukin17Amonoclonalantibody,antipsoriaticagentusedforthetreatment

ofmoderatetosevereplaquepsoriasis;2018U.S.revenue($111.2million)sawadecreaseof

$31.3Millionfrom2017Q4.Thiswaslargelyduetolowervolumeduetospecialtypharmacy

buyingpatterns,offsetbyhigherdemand,includinganincreaseinnewpatientstarts3

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Cardiovascular

• Cialis®:aPDE5inhibitorusedforthetreatmentoferectiledysfunctionandbenignprostatic

hyperplasia.U.S.revenueincreasedby6%comparedto2017Q1drivenbyhigherrealized

prices,butwaslargelyoffsetbydecreaseddemandduetotheentryofgenericsildenafil.Cialis

revenueoutsidetheU.S.decreasedby23%drivenbylossofexclusivityinEurope.3

• Effient®:athienopyridine,antiplateletagentusedforthereductionofthrombotic

cardiovascularevents(includingstentthrombosis)inpatientswithacutecoronarysyndrome

whoaremanagedwithanartery-openingprocedureknownaspercutaneouscoronary

intervention

MARKETLANDSCAPE

EliLillyisthe9thlargestpharmaceuticalcompanywithinthepharmaceuticalindustry.Although

thehealthcaresectorasawholehasperformedwellrelativetotheS&P500benchmark,itis

notedthatthepharmaceuticalsindustryhasconsistentlylaggedbehind.Therearemanyfactors

thatmayhavecontributedtothis,althoughfearsofharshlegislationlimitingprofitswere

avoidedthisyear,andpharmaceuticalshaveenjoyedaslightreboundinperformance.

Withawidearrayof

targeteddiseasestates,

Lillyfacesanequally

widevarietyof

competing

pharmaceutical

companiesandgeneric

manufacturers(discussedlater.)Onemitigatingfactoristhatmanypharmaceuticalcompanies

targetspecificdiseasestatesmindfullyallocatingtheirresourceswhilelimitingtheirexposure

tocompetition.Notably,incomparisonto4ofthe5largestcompaniespermarketcapwithin

thepharmaceuticalindustry:Johnson&Johnson(JNJ),MerckandCo(MRK),NovartisAG

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(NVS)andPfizerInc(PFE),manyoverlappingdiseasestatesaretargetedandseveraltrendsare

evident.

ThisfigureshowstotalpharmaceuticalrevenueinFY2017andgrowthfromFY2016.Worth

mentioning,manyof

thesecompanieshave

otherbusinesssegments

outsideof

pharmaceuticalsorare

involvedwithgeneric

manufacturing(NVS),

butthisfigureisbased

oncomparable,

innovative

pharmaceuticalrevenue.

DespiteJNJbeingthe

largestcompanywithin

thehealthcaresector

permarketcap,all4

othercompaniesgeneratedhigherrevenuesthroughtheirpharmaceuticalsegment.JNJdid,

however,enjoyanear18%increaseinto2017.

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ThisfigurefurthercomparesLilly’sdivisionalrevenuesversuscompetingrivalcompanies,along

withtheir%changefrom2016to2017.Notably,Lillyhasenjoyedalargeportionofrevenue

fromendocrinology,whichisunsurprisingconsideringtheirportfolioisheavilyweightedwithin

thediabetesdiseasestate.

AlookattheU.S.trendsinregardstoobesityanddiabetes(oftenlinkedduetocorrelative

natureofpatients)showsthedramaticallyincreasingnumbersaffectedbyboth.Between1994

and2015,thepercentageofpatientswithinthecountrydiagnosedwiththesediseasestates

hasnearlydoubled.Toputthisintoperspective,in2012theestimatedtotaleconomiccostof

diagnoseddiabeteswas$245billion,whichwasa41%increasefrompreviousestimatedcosts

in2007of$174billion.11Withindiabetestreatmentguidelines,GLP-1agonistssuchasTrulicity

havebeengainingmomentum,astheirfavorablesideeffectprofileandimproveddosing

schedule(onceweekly)havegainedproviderappeal.Desirableweightlossandlackof

hypoglycemiariskhaveledtoincreasedusageandTrulicity’sweeklydosingdifferentiatesthis

productwithremainingGLP-1agonists.

Althoughtheyhavethelowestamountofrevenuegeneratedthroughimmunology,Taltzand

OlumiantenjoyedmassivegrowthandwilllooktocontinuethattrendasOlumiantgainedFDA

approvalwithintheU.S.inJuneof2018.Losseswithinthecardiovascularandneuroscience

divisionsarelinkedtolossesofpatentexclusivityforseveralproducts.Withintheneuroscience

division,ZyprexaandCymbalta

Age-adjusted Prevalence of Obesity and Diagnosed Diabetes Among US Adults

Obesity (BMI ≥30 kg/m2)

Diabetes

1994

1994

2000

2000

No Data <14.0% 14.0%–17.9% 18.0%–21.9% 22.0%–25.9% > 26.0%

No Data <4.5% 4.5%–5.9% 6.0%–7.4% 7.5%–8.9% >9.0%

CDC’s Division of Diabetes Translation. United States Surveillance System available at http://www.cdc.gov/diabetes/data

2015

2015

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revenuecontinuetodeclinesincetheirpatentsexpiredin2011and2013,respectively.The

cardiovasculardivisionnotedastrongdeclineduetoCialisrevenuelossasPfizerreacheda

settlementthatallowedTevain2017tobeginmanufacturingagenericfortheirPDE5inhibiting

competitor,Viagra.Thefollowingdiagramdepictsimpendingpatentlossesand2017revenues:

WithimpendingdomesticlossesofpatentexclusivitywithCialis,andforeignlossesofForteo

andCymbalta,Lillywillhavetoseekoutopportunitiestomitigaterevenuelossesduetothose

products.Oncedrugslosepatentprotection,lower-pricedgenericsquicklysiphonoffasmuch

as90%ofthebrand-namesalesastheyofferproductspricedatonaverage30%ofthebrand-nameproducts.12

Lillywillhopetoweathertheimminentlossesofrevenuethroughcontinuedgrowthfromtheir

currentportfolioaswellasdrawingrevenuefromtheirinnovativepipelineinwhichtheyhope

tohave11newproductsintroducedby2023(9since2014.)Theircurrentpipeline(Appendix)showsthatLillyhopestointroduceproductsfromamultitudeoftheircurrentdivisions.

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InvestmentThesis

HEALTHCARESECTORSUMMARY

Withtheaforementionedfactorsprovidingoptimismdespitetheimpendinglossofpatents,

severalotherfactorsmayalsoplayasignificantrole.AstheU.S.continuestoage,healthcare

expensesincreasedramaticallyaswell.AstheCDChasexplained,from1997to2013,patientsaged≥65increasedfrom34.2Mto46.5M(outof271.3Mto315.7M),a16.84%increase

relativetototal

population.Mean

annualexpensesper

personwithexpenses

forpatientsaged≥65

was$10,125

comparedto$5,256

forthetotal

population.14,15TheCentersforMedicare&MedicaidServices(CMS)hasprojectednationalhealthcarespendingtogrowatanaveragerateof5.5%peryearfor2017-2026(2008-2016grewat4.2%)19.Thesefactorsmay

demonstratealong-terminfluenceforprofitability,asitisestimatedthatthepatient

populationaged≥65lookstodoubleby2050.Additionally,asweenterthelatetorecession

phasesofthebusinesscycle,expertsbelievethatinvestorswillnotethesignsofeconomic

slowdownleadingtoheavierinvestmentswithindefensive-oriented,lesseconomicallysensitive

sectors(thosetiedtobasicneeds,suchashealthcare.)4

Despiteoptimisticfactors,thepharmaceuticalindustryhaslaggedtheremainderofthesector

forthelastseveralyears.Thismaypartiallybeinresponsetouncertaintyinpotentiallegislation

thatlookstoreducepharmaceuticalpricesforconsumerswhichwouldnaturallycreatearipple

ofdecreasedprofitsthroughout

thehealthcaresector.When

currentU.S.PresidentDonald

Trumpdeclaredviasocialmedia

platformTwitter23inregardsto

speculativePfizerdrugprice

increases,PFEsawa1.2%decreaseinstockpriceandthepharmaceuticalindustryasawhole

Source:https://www.cdc.gov/chronicdisease/resources/publications/aag/healthy-aging.htm

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sawareductionby0.55%perFidelity.Notably,bothcompanyandindustrybouncedbackby

thenextday.OnMay11,2018,PresidentTrumpspokeinregardstohisproposalforhealth

carereform.Hehadmentionsofeliminatingthemiddlemen,limitingspecialinterests,while

instructingSecretaryAzar(EliLillyandCompany’sPresidentoftheU.S.Divisionfrom2012-2017

andnowUnitedStatesSecretaryofHealthandHumanServices)tocontinueworkingtowards

battlingrisingcosts.Notably,PresidentTrumpstated13:

Despitepreviouslystatingthatpharmaceuticalcompanieswere“gettingawaywithmurder,”

PresidentTrumpdidn’tmentionplansthatallowedMedicaretodirectlynegotiatedrugprices

orpermitlower-priceddrugimportsfromothercountries,whichwerepreviouslymetmuch

resistance.Instead,hementionedincreasingcostsforforeigngovernmentsandpatientstohelp

alleviatethecostburdenwithinTheU.S.S&PandNASDAQbiotechindicesrosenearly3%

followingtheaddress.17Notably,ifthecurrentadministrationtargetsforeigndrugprices,a

proposalthathadpotentiallydireconsequencesforthepharmaceuticalindustryresultedin

whatcouldprovetohaveanentirelyoppositeandthuspositiveneteffectonLilly.

FINANCIALANALYSIS

EliLillyandCompanyisafinanciallyhealthycompany.

Totalrevenues

continuetogrow,

with2018Q1revenuesenjoyingan8%increasefrom2017Q1.3WithregardstoLilly’soperatingexpensesasa

percentageoftotalrevenue,Lillyhascommittedto

maintainingproportionalR&Dexpensestomaintainand

developtheirpromisingpipeline.Additionally,througha

“company-wideefforttodriveproductivity,streamline

howtheywork,andareducedworkforce”Lilly

continuedtonoteadecreased

proportionofSG&Aexpenses.2

Thisallcontributedtoa

continuallyincreasingoperatingmarginwithacompanygoalof30percentorbetterby2020.2

}

~

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Incomparisontothesecompanies’averages,Lilly

maintainssimilarorslightlymoreimpressivemargins.

Additionally,withacomparablecurrentratio(1.4)astheotherlargepharmaceuticalcompanies,Lilly

continuestomaintainahealthyworkingcapitalto

ensurethatit

canadequately

meetits

current

liabilitieswhileprovidingan8.16%returnonequity.4

Lillycontinuestoconsistentlyexceedconsensusearningsestimatesforthepast4quarters,while

demonstratingcontinued

earningsgrowth.Finally,

despitetheextremescrutinyfromthepressand

governmentalofficialsinregardstodrugcostsweighing

pharmaceuticals,Lillyhasmanagedinthepast5yearsto

provideanannualizedtotalshareholderaveragereturnof15%,comparedto16%fortheS&Pbenchmarkduetothe

increaseinstockpriceandsteadydividendstream.2

Ofnote,duetoThe2017TaxAct,anestimatedincometax

provisionof$1.91billionwasrecordedinDecemberof2017,

whichresultedinthe-0.19EPS,laterreconciledto4.28.1,2

VALUATIONANALYSISANDPRICETARGET

Withthesefactorsinmind,since2013(whenpatentexclusivityforCymbaltawaslost),Lillyhas

sustainedcontinued,consistentsalesgrowth.Althoughkeypatentlossesareexpectedin2018,

itappearsthatLillyismuchbetterequippedwitha

robustpipelineandcurrentportfoliotoweatherthe

losses.Thus,basedonprevioustrendsandtypical

pharmaceuticalproductcycles,myrevenuegrowth

estimateisslightlymorebullishthanconsensus

estimates.BasinglossofCialisrevenueonlosses

experiencedbyPfizerwhenTevabegan

manufacturinggenericsildenafilin2017,my

estimationsfordivisionalrevenuesare(Consensus

estimatewas$23,930):

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Withasteadyandstablecashflow,andsteadilyandconsistentlyimprovingmetricsandinputs

suchastheaforementionedoperatingexpenses,TheDiscountedCashFlow(DCF)Modelisan

appropriatemodeltousetoassessLilly’sintrinsicstockvalue.Additionally,DCFisn’tinfluenced

byshort-termmarketconditionsornon-economicfactors,whichisusefulduringthistimeof

volatilityduetopublicscrutiny.Ihaveassigneda60%weighttotheDCFbasedvaluation.With

intensecompetitionwithintheprescriptiondrugcompanies,multiplesbasedvaluation

demonstratesimportanceaswecanutilizesimilar,competingcompaniestodeterminean

estimatedpricetargetwhileseekingcorrelationsbetweentheiroperatingandfinancial

characteristics.Ihaveassigneda40%weighttomyvaluationbasedonmultiples.

DISCOUNTEDCASHFLOWMODEL

Theappendix

containsdetailsin

regardstotheDCF

modelingused.I

havetakena

discountratingof9.50%andaterminalgrowthrateof4%.ThecurrentS&P500multipleimpliesa4%growthrateand10%discountrate.With

defensivecharacteristics,favorabledemographics,traditionallylowbeta,andotherfactors

listedabove,Ibelievethe9.50%discountratewouldbewarranted.Notably,ifareasonable

9.0%wereused,our

valuationwould

increasefrom$111to$122.2,(23.7%to36.2%)Withhigh

levelofuncertainty

andscrutiny

regardinghealth

careregulations(short-termconcernswithnothingcertainorconcreteyet)weighingstock

prices,thisappearstobeanopportunitytoBUYLillyasthestockappearstobeundervalued.

Thesefiguresabovedetailhowstockpricesmay

fluctuatewithregardstoadjustmentstoboth

discountratesandterminalgrowthrates.

RELATIVEVALUATIONMODEL

Thehealthcaresectorasawholetraditionally

tradesatslightlyhigherratesrelativetothe

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S&P500.Thisislargelyattributedtolargeprofit

margins,continualandsteadyrevenuegrowth,and

improvingoperatingmargins.However,boththe

sectorasawholeandLillyasanindividualstockis

currentlytradingjustbelowthebenchmarkP/E.This

againmaybeattributedtouncertaintyingovernment

legislationand

scrutinyresultingfromincreaseddrugpricing.However,

asmentioned,thismayverylikelybeanunrealized,

short-termphenomenonthatpresentsusabuying

opportunity.FollowingtheS&P500,Lillyiscurrently

showinghigherpricingratioscomparedtotheirmedian

overthelast10years.Thisappearstobeareflectionof

themarketasawhole.Additionally,afterthe

largeone-timepaid

taxin2017lowering

earnings,effectivetaxratesdecreasedto15.5%for2018Q1.3Incomparison

withsimilarpeers

withinthe

pharmaceuticalindustry,

Lillyisnotablynotfarofffrom

theaveragemultiplesthese

companiespresent.

Weighingeachratioequally

resultsinatargetpriceof

$104.09.Finally,withsteady,predictablecash

flowsandremarkably

similarpeersto

comparewith,a

60:40valuationnetsa

finalpricetargetof

$108.24,ora20.7%upsidetocurrent

pricing.

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Risks

• Pharmaceuticalresearchanddevelopmentiscostlyanduncertain1

o Forevery5,000compoundsdiscovered,only1reachesthepharmacy

o Fewerthanathirdofmarketeddrugsachieveenoughcommercialsuccesstorecoup

theirR&Dinvestments21

o AccordingtoastudyconductedbyTuftsCenterfortheStudyforDrugDevelopment,

costofdevelopingaprescriptiondrugthatgainsmarketapprovalisapproximately

$2.6billion,a145%increaseovertheestimatethecentermadein200320

o FDArequiresdrugstoundergothreephasesofclinicaltestingonhumans:

PhaseI:SafetyandDosage(70%movetothenextphase)

PhaseII:EfficacyandSideEffects(33%movetothenextphase)

PhaseIII:Efficacyandmonitoringofadversereactions(25-30%ofdrugsmovetothe

nextphase)22

• Losingeffectiveintellectualpropertyprotectiononrevenuegeneratingproductswillleadtorapidandsevererevenuedeclineinthoseproductlines1

o Oncedrugslosepatentprotection,lower-pricedgenericsquicklysiphonoffasmuch

as90%ofthebrand-namesales12

o AlthoughViagrahadbeenlosingrevenuesteadilysince2011,2017sawa30%declineinrevenuedespitethegenericreleaseoccurringlateinthefiscalyear

o Cymbaltasawadeclineinrevenueofnearly70%theyearafterlosingpatentexclusivity

• Humanpharmaceuticalbusinessissubjecttogovernmentpricecontrolsandunanticipatedtaxliabilities1

o Asnotedpreviously,pharmaceuticaldrugpricinghasbeenhighlyscrutinizedwithin

boththemediaandbygovernmentofficialso Uncertaintyandvolatilityisexpectedtocontinueaseffortstolimitincreasingdrug

pricesarecontinuallypresent;Despitethis,PresidentTrumpdirectedblameon

“middlemen”suchaspharmacybenefitmanagers• Intensecompetitionfromlower-costgenericandbiosimilarmanufacturers1

o Whencomparablegenericsareavailable,theyofferproductspricedatonaverage

30%ofthebrand-nameproducts.12o In2010,CongressapprovedtheBiologicsPriceCompetitionandInnovationAct

(BPCIA),allowinganabbreviatedapprovalpathwayforbiosimilars(alessexpensive,

interchangeableproductwithanFDA-approvedbiologicalproductsuchasinsulin)o In2015,thefirstbiosimilarproductwasapprovedformarketingintheU.S.;Notably,

LillyhasBasaglarwhichhasdemonstratedimmenserevenuegrowthfrom2016to

2017andcontinuestorealizethatgrowthinto2018Q1

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Conclusion

Conclusion

BUYEliLillyandCompany(NYSE:LLY)withapricetargetof$108.24asitiscurrentlyundervaluedbyapproximately21%

Sincethestartof2018,LillyhashadOlumiant(baricitinib),arheumatoidarthritismedication

usedinEuropeapprovedintheU.S.TheFDAapproveditatlowerdoses,butsuccessinforeign

countrieswillyielddomesticbenefits.Lilly’sgalcanezumabalsometitsprimaryendpointinits

phaseIIIstudy,providingencouragingpotentialforfuturemigraineandclusterheadache

therapy.

CombiningLilly’spromisingpipelinewiththeoptimisticfactors(agingdemographics,

increasinglyunhealthypopulation,increasedhealthcarespending,defensivesector,inelastic

demand,etc.)underlyingthepharmaceuticalindustry,Lillylookspoisedtocontinuetheir

successfortheforeseeablefutureastheycontinuetoimprovethewell-beingoftheirfinancial

health(increasingrevenues,decreasingoperationexpenses,etc.)andasaresult,patienthealth.

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Appendix

PIPELINESUMMARY

Phase1

Phase2

Phase3

RegulatoryReview

HumanSegmentDivision

*Multipleindications2

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Appendix

EliLillyandCompany7/14/18Wu,E

23|P a g e Appendix


24|P a g e Appendix


25|P a g e References

References

1. EliLillyandCompany.(2017).AnnualReportandProxyStatement2017.Retrievedfrom

https://investor.lilly.com/static-files/423887ae-38f3-463c-9d11-43088a30d68f2. EliLillyandCompany.(2017).2017IntegratedSummaryReport.Retrievedfrom

https://assets.ctfassets.net/hadumfdtzsru/2Ayd5rsLd2AyMsQ8wY8wO0/79e2398c034863923b99098

b53762406/2017_Lilly_Integrated_Summary_Report.pdf3. EliLillyandCompany.(2018).Q1EarningsRelease2018.Retrievedfrom

https://investor.lilly.com/static-files/a644463e-77d5-41de-8d99-cd0604e580e3

4. Datafrom:Fidelity.com(7-14-18)5. Datafrom:Finance.Yahoo(7-14-18)

6. Datafrom:MarketRealist(7-14-18)7. JohnsonandJohnson.(2017).ProxyStatement2017.Retrievedfrom

https://jnj.brightspotcdn.com/c4/59/2988b7a8407c93507f0a08708d9e/2017-0310-proxy-statement-

with-bookmarks.pdf8. Pfizer,Inc.(2017,2014,2011,2008).FinancialReport2017,2014,2011,2008.Retrievedfrom

https://investors.pfizer.com/financials/annual-reports/default.aspx

9. NovartisAG.(2017)AnnualReport2017.Retrievedfromhttps://www.novartis.com/investors/novartis-annual-report/annual-report-archive

10. MerckandCo,Inc.2017.AnnualReport2017.Retrievedfromhttp://investors.merck.com/financials/annual-reports-and-proxy/default.aspx

11. EconomiccostsofdiabetesintheU.S.In2012.Diabetescare.2013;36:1033–1046.[PMCfree

article][PubMed]12. DeRuiter,Jack.“DrugPatentExpirationsandthe‘PatentCliff.’”U.S.Pharmacist–TheLeadingJournal

inPharmacy,USPharmacist,20June2012,stage.uspharmacist.com/article/drug-patent-expirations-

and-the-patent-cliff.13. Garden,Rose.“RemarksbyPresidentTrumponLoweringDrugPrices.”TheWhiteHouse,TheUnited

StatesGovernment,11Mar.2018,14:08,www.whitehouse.gov/briefings-statements/remarks-president-trump-lowering-drug-prices/.

14. “HealthyAging.”CentersforDiseaseControlandPrevention,CentersforDiseaseControlandPrevention,15Jan.2016,www.cdc.gov/chronicdisease/resources/publications/aag/healthy-aging.htm.

15. “NationalCenterforHealthStatistics.”CentersforDiseaseControlandPrevention,CentersforDiseaseControlandPrevention,3May2017,www.cdc.gov/nchs/fastats/health-expenditures.htm.

16. Mukherjee,Sy.“WhyTrump'sBigDrugPriceSpeechSentHealthCareStocksSoaring.”Fortune,

Fortune,11May2018,fortune.com/2018/05/11/trump-drug-pricing-proposal-health-stocks/.17. Mukherjee,Sy.“WhyTrump'sBigDrugPriceSpeechSentHealthCareStocksSoaring.”Fortune,

Fortune,11May2018,fortune.com/2018/05/11/trump-drug-pricing-proposal-health-stocks/.

18. Datafrom:Bloomberg(5-16-18)19. “NationalHealthExpenditureProjections2017-2026.”NationalHealthExpenditureProjections2017-

2026,CentersforMedicare&MedicaidServices,17Apr.2018,www.cms.gov/Research-Statistics-

Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/index.html.


26|P a g e References

20. Mullin,Rick.“TuftsStudyFindsBigRiseinCostofDrugDevelopment.”CENRSS,AmericanChemical

Society,20Nov.2014,cen.acs.org/articles/92/web/2014/11/Tufts-Study-Finds-Big-Rise.html.21. Spiegel,Francis.“TheEconomicsofPharmaceuticalResearchandDevelopment:AnIndustry

Perspective.”AdvancesinPediatrics,InstituteofMedicine(US)CommitteeonTechnological

InnovationinMedicine,1Jan.1991,www.ncbi.nlm.nih.gov/books/NBK234300/.22. “TheDrugDevelopmentProcess-Step3:ClinicalResearch.”USFoodandDrugAdministrationHome

Page,CenterforBiologicsEvaluationandResearch,13June2018,www.fda.gov/ForPatients/Approvals/Drugs/ucm405622.htm.

23. Trump,DonaldJ.“‘Pfizer&Others..."Twitter,Twitter,9July2018,

twitter.com/realdonaldtrump/status/1016368503723577344?lang=en.

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