Friday, December 07, 2007

The Business of Diabetes: Lilly Presents An Otimistic 2008 Forecast; Wall Street Less Certain

Yesterday at an investor conference, Eli Lilly and Company (the maker of the insulin analog Humalog, antidepressant Cymbalta, erectile dysfunction treatment Cialis and co-marketer of the type 2 diabetes drug Byetta) executives projected 2008 earnings per share between $3.85 and $4 on sales growth in the mid-to-high single digits.

According to analysts surveyed by Thomson Financial as well as Reuters' estimates, that forecast translates to growth of 8% to 14% over the expected 2007 full-year earnings, which exceeds analysts' 2008 profit forecast of $3.81 a share.

Recently, the company has tried its best to put a positive spin on the results for its anti blood clotting drug prasugrel, which, assuming it receives FDA approval, will compete with the blockbuster Plavix, which is jointly marketed by Bristol-Myers Squibb and Sanofi Aventis. But news that the company was halting a trial due to patient safety concerns raised questions about whether this drug would be a sure-fire blockbuster in the making, or whether the company was simply engaging in damage control.

As I wrote fairly recently, CEO Sidney Taurel wrote a scathing letter published in The Wall Street Journal about integrity in the media, but the irony was that his letter sounded, at beast hippocritical, more like a CEO who wanted to protect the value of his stock options than a company truly concerned about patient well-bring. With the company's latest forecast, the real question is whether anyone on Wall Street believes it.

"Clearly the 2008 forecast is much better than expected," said Lehman Brothers analyst Tony Butler.

A fair number of prominent Wall Street analysts have questioned whether the company will have enough new products to make up for the expected plunge in sales of several drugs that will lose their American patent protection in coming years. These drugs include the chemotherapy agent Gemzar in 2010, Zyprexa in 2011 and Cymbalta in 2013.

Citigroup Smith Barney noted "Lilly is including a timely approval of prasugrel in its assumptions, which could prove to be optimistic given the mixed TRITON study results. That said, even excluding a prasugrel launch, the guidance was above our expectations." This opinion was shared by many, including the few who remain bullish on the stock.

S&P said "we think long-term prospects hinge heavily on prasugrel, which has shown mixed clinical data (good efficacy, but with bleeding risks), to offset a patent cliff in 2010-2013."

That time period is a huge concern to analysts. Morgan Stanley analyst Jami Rubin echoed that outlook, saying "The issue is not 2008; the issue is 2011 and beyond."

Overall, Wall Street is presently evenly split when it comes to its outlook for Lilly. Zacks data shows that Lilly has earned 4 "strong buy," 11 "hold," and 3 "strong sell" ratings. This configuration leaves the shares vulnerable to both upgrades and downgrades.

Smith Barney, which is recommending its clients "hold" the stock, rated Lilly as Medium Risk, largely because of challenges to its in-line product portfolio (specifically Zyprexa, the insulin franchise, and Evista). They note that there are a number of downside risks to their target price.

Lilly was quite bullish on the outlook for its diabetes business, but a closer look suggests that outlook is not due to excellent fundamentals in the business, but due to some good luck. For one thing, the diabetes market is growing rapidly on a worldwide basis, so almost everyone will show some growth, even if they do nothing. But Lilly's diabetes drug outlook is heavily dependent on foreign sales, and it may be relatively easy to accomplish revenue growth in spite of severe weakness in its product line thanks to expected continued weakness in the U.S. dollar.

Drugs sold in other countries are paid for in the local currency while Lilly's costs are indexed to the dollar, so they benefit by converting those Canadian Dollars, Japanese Yen or Euros into U.S. Dollars. But the fundamentals look less solid.

In the U.S., Lilly's insulin business is likely to continue struggling. As The Wall Street Journal's Health Blog recently reported, the rivalry between Novo and Lilly means that while many drug sales reps are getting pink slips, both companies have instead been beefing their salesforces for diabetes products, although as The Wall Street Journal reported, Lilly has been using contract sales representatives rather than its own employees to sell its diabetes drugs. However, the other side to the currency exchange equation is that rival Novo Nordisk can hire more American salespeople while having a much smaller impact on its bottom line because their earnings are expressed in Danish Krones. It will be tougher for Lilly to absorb those costs, so it was not at all surprising that Lilly president John Lechleiter said that the company had no plans at the moment to hire even more diabetes reps, saying "We're not in this to see who can add more salespeople."

But Lilly also faces trouble from another European rival, France's Sanofi Aventis. Their rapid-acting insulin analog, Apidra (which is a relative newcomer), is very likely to take some share from both Humalog and Novolog because those are the two best sellers, and Apidra's market share is likely to continue growing, admittedly from a small base.

Finally, although the brand-name drug industry was able to postpone a vote on a bill in 2007 impacting biopharmaceuticals, it seems almost certain that in 2008, Congress will pass legislation enabling generic biopharmaceuticals (see here for my article on that subject, including links to many follow-ups). Even Novo Nordisk's U.S. President, Martin Soeters, told Reuters that his company fully expects generics to emerge by 2008 or 2009 at the latest. That means Lilly's venerable yet highly profitable Humulin business could face serious risks from generics in the not-too-distant future, and Humulin still accounts for about 25% of the company's diabetes business revenues.

The real question is whether Lilly's drug pipeline is all that much stronger than its rivals. In the words of The Wall Street Journal, at the moment "Big Pharma Faces Grim Prognosis". The rise of generics wouldn't matter quite as much if the drug companies research labs were creating a stream of new hits, but they aren't. Wall Street analysts examine the drug pipeline's thoroughly when making their forecasts, as do money managers such as pension funds and mutual fund companies who own the stocks.

On Friday morning, following the Lilly investor presentation, Lilly shares were little changed despite the company's rosy 2008 forecast. It seems that so far, investors remain unconvinced.

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