Eli Lilly: Should Investors Be Concerned About This Lackluster Pipeline?

On October 22, Fitch Ratings revised its outlook on Eli Lilly (NYSE:LLY) from Stable to Negative, stating that the company’s patent cliff is the steepest in the industry. The revised rating highlights Lilly’s expiring patents and lackluster drug pipeline as the company prepares to report third quarter earnings on October 24.

For Eli Lilly, expirations are approaching quickly. Within the next three years, products accounting for 35 percent of annual sales, based on the twelve-month period ending June 30, 2012, will lose exclusivity.

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Lilly’s rating was lowered because “Fitch is highly concerned about the company’s ability to counter the negative effects on earnings and cash flows from a patent cliff that lasts until the loss of market protection for Cymbalta in December 2013.” The ratings service predicts that the loss of market protection for Cymbalta and Humalog, which will lose exclusivity in May 2013, could result in sales decreases of nearly 8 percent from 2012 to 2014.

The floodgates have already opened: in October 2011, Eli Lilly lost market exclusivity for its top-selling pharmaceutical, Zyprexa, a drug used to treat the symptoms of schizophrenia.

Ahead of Eli Lilly’s earnings report, analysts expectations for the quarter have risen. At the moment, the average estimate of analysts for third quarter profits is 82 cents per share, which is a 27.4 percent decline from the company’s earnings in the third quarter last year, and expectations for third quarter revenue is $5.62 billion, a decline of 8.6 percent from the same quarter a year ago.

Earnings have already shown the effects of the patent cliff; last quarter, the company reported a 10 percent decline in revenue and a 23 percent decline in net income due to the expiration of Zyprexa’s patent. The drug once generated annual sales of $5 billion. However, the expiration of its patent pushed sales down 73 percent to $379.5 million in the second quarter.

On October 12, Cowen & Co analyst Steven Scala downgraded Eli Lilly to “underperform” based on the company’s “broad, but undifferentiated” pipeline. In his opinion, Eli Lilly has $10 billion in pipeline potential in 2018, which is less than half the revenue level the company has now.

The pharmaceutical manufacturer has several drugs in development: the Alzheimer’s drug solanezumab and the once-weekly diabetes drug Dulaglutide.

According to Scala’s research note, solanezumab accounts for much of the stock’s recent run. However, analysts hold mixed opinions about the drug’s future, and Scala believes it will ultimately fail. Initial trials of the drug were halted after results missed the study’s primary endpoint, which was to improve mental cognition in patients with mild or moderate cases. The study was then reanalyzed, combining data from two studies, and the subsequent results indicated that the drug had potential to treat patients that had not yet developed symptoms. Following this news, shares in Eli Lilly reached $50 per share for the first time in four years. Currently, Washington University’s Inherited Alzheimer’s Network Trials Unit is testing solanezumab. But Scala said in his note that the existing data is not sufficient for regulatory approval.

Scala has a more positive outlook on the Dulaglutide, which was shown in recent trials to help patients control their blood sugar levels better than older treatments. He estimates that the drug could generate $500 million in sales by 2018, but that will do little to offset patent loses now. The company is planning to seek FDA approval next year.

Eli Lilly will face another round of key patent expiry in 2017, while still recovering from the first period of patent losses. Alimta, Strattera, and Cialis will all lose patent protection during that time.

While the company currently has a 14.52 trailing P/E and a dividend yield of 3.7 percent, Seeking Alpha cautioned in a recent article that “pharmaceutical companies live by their drug pipelines and potentially die once the patent life on their drugs expires.”

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