3 Risks to Consider Before Buying Eli Lilly

Eli Lilly (LLY) Stock Scoreboard Analysis - Motley Fool

Key Concepts:

• GLP-1 Market: A market for drugs that mimic the glucagon-like peptide-1 hormone, used in treating diabetes and obesity.
• Tirzepatide: The active ingredient in Eli Lilly’s Mounjaro (diabetes) and Zepbound (obesity) drugs.
• Semaglutide: A competing GLP-1 drug, notably found in Novo Nordisk’s Ozempic and Wegovy.
• Forward Earnings: A company’s expected earnings over a future period, used in valuation metrics.
• Market Cap: The total value of a company’s outstanding shares.
• Pipeline: A company’s portfolio of potential drugs under development.
• Goodwill: An intangible asset arising when one company acquires another for a premium value.

I. Business Strength & Industry Position

Eli Lilly (LLY) is currently the leading company in the GLP-1 market, despite significant competition. Keith Speights emphasizes that while no stock is “invincible,” Lilly comes “pretty close” due to its dominance. The company’s success isn’t limited to diabetes and obesity; it also holds a strong position in cancer and autoimmune disease treatments. Karl Thiel notes that 60% of Lilly’s revenue currently comes from Tirzepatide (Mounjaro and Zepbound). He highlights the historical risk associated with such concentration – previous pharmaceutical giants like Pfizer and Bristol Myers Squibb have made questionable mega-mergers when overly reliant on a single franchise. However, Thiel believes Lilly is “a really long way from that threat,” citing a patent protection for Tirzepatide lasting at least a decade. A key differentiator is Lilly’s company culture, described as distinct from many other large pharmaceutical companies, fostering internal development rather than relying heavily on acquisitions.

II. Management Evaluation

The analysts rate Lilly’s management highly, with Keith Speights giving a score of 9/10 and Karl Thiel an 8.5/10. Speights points to the dramatic increase in Lilly’s market capitalization under CEO David Ricks, who took the helm in 2017. From $82 billion in 2017, Lilly’s market cap has grown to approximately $950 billion, briefly exceeding $1 trillion. Thiel emphasizes Ricks’s leadership in making the strategic decision to test Tirzepatide head-to-head against semaglutide (Ozempic/Wegovy) rather than placebo, a crucial factor in the drug’s success. He also notes that Ricks inherited a strong internal development focus from his predecessor, John Lechleiter.

III. Financial Performance

Lilly’s financials are considered exceptionally strong. Revenue increased by approximately 64% year-over-year in Q3, and adjusted earnings per share rose by 20%. The company maintains a solid cash position, despite having approximately $43 billion in debt. However, the debt is largely attributed to investments in expanding manufacturing capacity, which Thiel views positively, equating it to a “sunshiny” way to allocate capital, potentially leading to future tax reductions. This is contrasted with debt incurred through share buybacks or acquisitions that create “goodwill” on the balance sheet.

IV. Valuation & Future Outlook

Valuation is the primary concern raised by the analysts. Karl Thiel assigns a 5-10% potential return over the next five years, citing that the stock is currently “priced for perfection” in a competitive market with potential downward pricing pressures. He questions whether the growth potential of Tirzepatide is sufficient to justify a price-to-sales ratio of 14x and a price-to-earnings ratio of nearly 40x. He acknowledges Lilly’s strong obesity pipeline and manufacturing capabilities but warns of the stock’s volatility in response to any setbacks in the obesity market. Keith Speights is more optimistic, predicting potential double-digit returns, citing the continued growth potential of Mounjaro and Zepbound, and Lilly’s robust late-stage pipeline beyond obesity and diabetes. He assigns a safety score of 7/10, acknowledging the risk of competing drugs or pipeline failures. Anand Chokkavelu notes the impressive profitability implied by the 14x sales and 40x earnings ratio.

V. Key Arguments & Perspectives

• Keith Speights: Lilly’s strong management, financial position, and pipeline justify a bullish outlook and a higher safety score.
• Karl Thiel: While acknowledging Lilly’s strengths, the high valuation and competitive pressures necessitate a more cautious approach, with a lower potential return and safety score.
• Shared Perspective: Both analysts agree that Lilly’s internal development focus and avoidance of large, potentially value-destructive mergers are key strengths.

VI. Notable Quotes

• Keith Speights: “Eli Lilly comes pretty close [to being invincible].”
• Karl Thiel: “Lilly has this culture that has avoided these big mega mergers and is focused really internally on its development.”
• Karl Thiel: “It’s that something better could come along [that’s the risk].”
• Anand Chokkavelu: “It's like the Roth IRA of how you allocate capital [referring to capital expenditures leading to future tax reductions].”

VII. Overall Score & Recommendations

The Motley Fool analysts collectively give Eli Lilly a strong overall score of 7.6/10. While acknowledging the company’s exceptional strengths, the high valuation prevents Anand Chokkavelu from personally buying shares. Keith Speights prefers Vertex Pharmaceuticals, while Karl Thiel favors Roche as alternative investment options.

VIII. Conclusion

Eli Lilly is a financially robust and well-managed pharmaceutical company with a dominant position in the rapidly growing GLP-1 market. However, its current valuation presents a risk, making it susceptible to volatility. While the long-term outlook remains positive, investors should carefully consider the potential for increased competition and downward pricing pressures before investing. The company’s strategic focus on internal development and its strong pipeline position it well for future success, but the stock’s price already reflects a significant degree of optimism.