Seeking the Tao of Eli Lilly

Questions continue to linger about the drugmaker, but there are several reasons to be hopeful.
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As

Eli Lilly

(LLY) - Get Report

prepares to deliver its first-quarter financial report on Thursday, Wall Street has once again shifted into its "Double W" mode --

wondering

about the company's future drugs and

worrying

about its existing ones.

The worrying has been going on for some time, especially about Zyprexa for schizophrenia, Strattera for attention-deficit hyperactivity disorder and, more recently, Cymbalta for depression.

However, the wondering has intensified as a couple of experimental drugs come closer to regulatory decisions. The drugs are Prasugrel, an anticoagulant, and Arxxant, a treatment for diabetic retinopathy, a condition in which diabetes causes vision damage.

John Boris, an analyst with Bear Stearns, describes having a yin and yang investment thesis on Lilly. The yang side of the equation features declining sales for Zyprexa and Strattera, while the yin side examines the R&D prospects.

Noting that Lilly has some new products with "high growth potential" and won't be plagued by major patent expirations for several years, Boris rates the Indianapolis-based drugmaker as "peer-perform."

He's voting with the majority. According to Thomson First Call, 14 analysts are neutral on the stock, 11 have buy ratings and two have sell ratings.

The first quarter should offer some hints about trends for existing drugs, most notably Zyprexa, whose sales fell 5% in 2005 to $4.2 billion, and Strattera, whose sales fell 17% to $552 million last year. Launched in late 2004, Cymbalta enjoyed a powerful start with $680 million in sales last year, but Boris and some other analysts detect signs of flattening prescription growth.

Boris expects Lilly to produce first-quarter earnings per share of 75 cents, matching consensus estimate. For the first quarter of 2005, Lilly earned 68 cents a share.

Even though Lilly

won a lawsuit 12 months ago protecting the U.S. Zyprexa patent, the schizophrenia drug still dominates Wall Street's view of the company.

"We find it difficult to recommend the stock until we see stronger evidence of stabilizing global trends" for Zyprexa, says Boris in a recent report to clients. The case is now under appeal. The drug accounted for 29% of corporate revenue last year, and, Boris says, more than half of Lilly's profit.

Several competing schizophrenia drugs with fewer side effects "are making meaningful inroads" in the U.S., says Boris, who doesn't own shares. His firm has a noninvestment banking relationship. "It appears that this risk is spilling over into international markets. Any near-term pressure on Zyprexa could cause meaningful declines in the stock."

Investors are "paying top dollar for decelerating growth," David Moskowitz of Friedman Billings Ramsey said in late March while cutting his rating to underperform from market-perform.

Citing the sagging sales of Zyprexa and Strattera, he adds that Cymbalta "is struggling to meaningfully get over 5% market share" for antidepressants. Moskowitz, who doesn't own shares, says profit and sales growth should decline next year. His firm says it seeks to do business with companies mentioned in research reports.

A more favorable view comes from Steve Scala of S.G. Cowen. The concerns about Zyprexa and Cymbalta aren't new, he pointed out in an April 3 research report. Lilly should produce solid first-quarter results, says Scala, adding that long-term growth prospects are among the best of the Big Pharma companies.

"We continue to believe that Lilly is one of the most compelling" big U.S. drug stocks, says Scala, who says its shares should outperform the

S&P 500

over the next 12 months. He doesn't own shares. His firm says it does and attempts to do business with companies covered in its reports.

Scala says Zyprexa should produce a 5% first-quarter sales gain thanks to price increases imposed in June 2005 and February 2006, as well as to the new Medicare drug plan whose rules favor many central-nervous-system drugs.

He says first-quarter sales should benefit from price increases enacted in January and February for a host of other drugs, including Cymbalta and Strattera. Although Cymbalta's market share of new prescriptions is flat, "our physician experts remain positive on the outlook," he says.

Among the experimental drugs, Scala says the anticoagulant Prasugrel has "wildcard upside potential," but investors must wait until a 13,000-patient clinical trial is completed next year. The test compares Prasugrel to Plavix. Both reduce the risk of clots by preventing blood platelets from sticking together. Plavix is sold by

Bristol-Myers Squibb

(BMY) - Get Report

and

Sanofi-Aventis

(SNY) - Get Report

.

Scala says Lilly is expected to seek regulatory approval during the second half of next year for Prasugrel as treatment for acute coronary syndromes, a group of symptoms and injuries caused by a lack of oxygen to the heart.

But David Risinger of Merrill Lynch is skittish about Prasugrel because of the clinical trial guidelines. "It needs to demonstrate superiority to Plavix with an immaterial increase in bleeding risk," he says in a March 28 research report, in which he downgraded Lilly's stock to neutral from buy.

He says late-stage clinical-trial data for Arxxant weren't particularly exciting, adding that the FDA "may not approve the product in a timely fashion this year." Lilly's application to the FDA includes the results from only one late-stage clinical trial. The agency usually requires two successful trials for approval, says Risinger, who doesn't own shares. His firm has an investment-banking relationship.

Although the agency might approve Arxxant without additional testing, Risinger says it's more likely that the FDA will ask for another study. The agency might act on the drug late in the summer.