Eli

Lilly and Company - Stock Valuation Report

Eric Wu


 Eli Lilly and Company
7/14/18
Wu, E

Stock Evaluation Report: Eli Lilly and Company, 7/14/18

SUMMARY
Eli Lilly and Company (LLY) is a global healthcare leader that discovers, develops, manufactures,
and markets pharmaceutical products worldwide. The company operates through two
segments, Human Pharmaceutical and Animal Health products. Eli Lilly is the 16th largest
company within the healthcare sector of the S&P 500, generating $22,781.3 million in revenue
in FY2017, an 8% increase from FY2016.1 (all
revenues noted in millions) Summary
Recommendation BUY
INVESTMENT THESIS Ticker LLY
We are placing a BUY rating on LLY with a Sector Healthcare
price target of $85.51. With the combination Industry Pharmaceuticals
of 11 new products within their pipeline Price as of 7/15/18 $89.71
poised to launch by 2023, rapidly growing Target Price $108.24
products such as Trulicity, Taltz, Basaglar, Potential Upside 20.7%
Cyramza, and Jardiance, and an aging and Dividend Yield 2.62%
increasingly unhealthy demographic, Eli Lilly Total Projected Return 23.32%
looks to weather the upcoming loss of Market Data
domestic patent exclusivity for Cialis, Forteo, Market Cap 93.26B
and Alimta Shares Outstanding 1,085,430,000
EPS (TTM) 1.97
RISKS TO THIS RECOMMENDATION P/E Ratio 19.89
• Pharmaceutical research and EV/EBITDA 14.23
development is costly and uncertain Beta 0.3
• Losing effective intellectual property Qtrly Revenue (YoY %) 9%
protection on revenue generating Performance
products will lead to rapid and severe 52 Week Price Low-High 73.69 - 89.87
revenue decline in those product lines 1 Year Return 6.77%
• Human pharmaceutical business is
subject to government price controls and
unanticipated tax liabilities
• Intense competition from lower-cost
generic and biosimilar manufacturers1

Contact Information
Fund SIM, OSU
Instructor Royce West, CFA
Name Eric Wu, PharmD
Email wu.517@osu.edu

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Table of Contents

COMPANY OVERVIEW ............................................................................................................................ 3

General Overview ..................................................................................................................................... 3
Business Segments ................................................................................................................................... 3
Animal Health Products ........................................................................................................................ 4
Human Pharmaceutical Products ......................................................................................................... 5
Market Landscape .................................................................................................................................. 10
Patent Exclusivity Loss Summary ...................................................................................................... 13
INVESTMENT THESIS ............................................................................................................................ 14
Healthcare Sector Summary ................................................................................................................... 14
Financial Analysis .................................................................................................................................... 15
Valuation Analysis and Price Target ....................................................................................................... 16
Discounted Cash Flow Model ............................................................................................................. 17
Relative Multiples Valuation Model ................................................................................................... 18
RISKS ......................................................................................................................................................... 19
CONCLUSION .......................................................................................................................................... 20
APPENDIX ................................................................................................................................................ 21
Pipeline Summary ................................................................................................................................... 21
Estimated Product Revenue ................................................................................................................... 22
Discount Cash Flow Valuation ................................................................................................................ 23
Income Statement .................................................................................................................................. 24
REFERENCES ........................................................................................................................................... 25

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 Eli Lilly and Company
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Company Overview
GENERAL OVERVIEW
Eli Lilly and Company (LLY) is a global healthcare leader headquartered in Indianapolis, Indiana
that discovers, develops, manufactures, and markets pharmaceutical products worldwide. The
company operates through two segments, Human Pharmaceutical Products and Animal Health
Products. Established in 1876, LLY employs approximately 38,000 individuals worldwide with
products marketed in 120 countries, leading them to be the 16th largest company per market
cap within the healthcare sector of the S&P 500.5
The human pharmaceutical segment consists of several divisions: Endocrinology, oncology,
cardiovascular, neuroscience, and immunology. Lilly’s animal segment operates through their
Elanco division, focusing on both animals for consumption and companion animals.1
In 2017, LLY generated $22,871.3 million in revenue, an 8% increase from the prior year. LLY
posted an earnings (loss) of $0.19 attributed to new U.S. tax laws and company restructuring.
With 11 medications poised to launch by 2023 (9 total since 2014), LLY looks to continue
increasing revenue trends.2 The stock has outperformed the industry this year thus far,
however, competitive pressures are expected to increase as patent exclusivity for certain
products such as Cialis are expiring.
BUSINESS SEGMENTS
Eli Lilly’s animal health products segment (operated through Elanco Animal
Health) is a global company that has enjoyed a decade of growth. Elanco focuses
on identifying and developing products that meet unmet veterinary, food
producer, and pet owner needs. Additionally, Elanco also utilizes discoveries from
the human health laboratories to develop products supporting the wellbeing of farm animals
and pets. Elanco sells its products primarily to wholesale distributors. Unfortunately, it has
underperformed as of late (-2.3% revenue between FY2016 and FY2017) and Lilly is reviewing
strategic alternatives including a sale, merger, initial public offering, or retention of the
business. They are hoping to make a decision about Elanco in mid-2018.2
Lilly’s human pharmaceuticals products segment drives the majority of revenues
within the company. Of $22,871.30 million revenue, $19,785.60 originated from

the human pharmaceutical products segment. This segment is further divided
into 6 divisions: Endocrinology (Humalog®, Trulicity®, Forteo®, Humulin®,
Trajenta®, Jardiance®, Basaglar®), oncology (Alimta®, Cyramza®, Erbitux®),
cardiovascular (Cialis®, Effient®), neuroscience (Cymbalta®, Strattera®, Zyprexa®), immunology
(Taltz®), and other.2

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Revenue By Segment Revenue By Region

Other
Animal Health Foreign
13% Countries
16%
Japan
11% United
States
56%
Human
Pharmaceutical Europe
87% 17%

FY2016 FY2017 Change% FY2016 FY2017 Change%
Animal Health 3,158.20 3,085.60 -2.30% USA 11,506.20 12,785.10 11.11%
Human Europe 3,768.10 3,943.20 4.65%
18,063.90 19,785.60 9.53%
Pharmaceuticals Japan 2,330.90 2,419.70% 3.81%
Total 21,222.10 22,871.30

7.78% Other 3,616.90 3,723.30

2.94%

Lilly’s Animal health business operated through Elanco comprised 13% of total company
revenue. Elanco reported $761.3 million in revenue in 2018 Q1, a 1% decrease from 2017
($769.4 million). According to Lilly’s Q1 press release, this is due to worldwide food animal
revenue decreasing by 7% driven by market access pressures. Companion animal revenue
increased by 10%, however, primarily driven by higher realized prices and the favorable impact
of foreign exchange rates.3
Lilly’s Animal Health Products include1:
Food Animal
• Rumensin®: a cattle feed additive that improves feed efficiency and growth and also controls
and prevents coccidiosis
• Coban®, Maxiban®, and Monteban®: an anticoccidial agent used in poultry
• Posilac®: a protein supplement to improve milk productivity in dairy cows
• Optaflexx® and Paylean®: leanness and performance enhancers for cattle and swine

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• Tylan®: an antibiotic used to control certain diseases in cattle, swine, and poultry
• Denagard®: an antibiotic for the control and treatment of respiratory and enteric diseases in
swine and poultry
Companion Animal
• Trifexis®: a monthly chewable tablet for dogs that kills fleas, prevents flea infestations,
prevents heartworm disease, and controls intestinal parasite infections
• Comfortis®: a chewable tablet that kills fleas and prevents flea infestations in dogs
• Interceptor® Plus: A monthly chewable tablet that prevents heartworm disease and treats and
controls adult hookworm, roundworm, whipworm, and tapeworm in dogs
• Galliprant®: an anti-inflammatory tablet that targets the key receptor associated with canine
Osteoarthritis pain
• Feline, canine, and rabies vaccines: Duramune®, Ultra Duramune®, Duramune Lyme®, Bronci-
Shield®, Fel-O-Vax®, ULTRA Fel-O-Vax®, and Fel-O-Guard®, and Rabvac®

Lilly’s Human Pharmaceutical Products experienced varied growth and loss. Comprising of 87%
of total revenue for FY2017, Lilly’s Human Pharmaceutical Products reported $4938.7 million in
2018 Q1, a 10.7% increase from 2017 Q1. According to Lilly’s Q1 Press Release, this may be due
to revenue increase of 4% due to favorable impact of foreign exchange rates, a 3% increase due
to higher realized prices, and a 2% increase due to volume. Increased revenue was partially
offset due to loss of patent exclusivity for Strattera and Effient®, as well as decreased demand
for Cialis.3 Notably, endocrinology has enjoyed strong growth (25%) and will be discussed in
further detail later. Some divisions within the human pharmaceutical products such as

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cardiovascular (-11%) and neuroscience (-20%) experienced notable loss and will also be
discussed in further detail later.

Lilly’s Human Pharmaceutical Segment Consists of1:

Endocrinology
• Humalog®, Humalog Mix 75/25, Humalog U-100, Humalog U-200, Humalog Mix 50/50: insulin
analogs for the treatment of diabetes; For 2018 Q1, Humalog revenue increased by 12%
relative to 2017 Q1. Largely due to higher realized prices due to changes in estimates to rebates
and discounts and changes in payer segment mix in conjunction with increased volume.
International revenues also enjoyed favorable impact of foreign exchange rates.3

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• Humulin®, Humulin 70/30, Humulin N, Humulin R, and Humulin U-500: human insulins for the
treatment of diabetes; The 4% increase in revenue for 2018 Q1 vs 2017 Q1 was driven by
increased demand, partially offset by lower realized prices and decreased foreign revenue3
• Trulicity®: GLP-1 agonist used for the treatment of type 2 diabetes; 2018 Q1 revenue increased
by 82% relative to 2017 Q1. This is largely due to higher demand within the GLP-1 class and
increased share of market for Trulicity. Foreign revenue was bolstered by increased volume and
favorable impact of foreign exchange rates3
• Trajenta®: DPP4 inhibitor used for the treatment of type 2 diabetes
• Jentadueto® and Jentadueto XR: a combination of Trajenta (linagliptin) and metformin for the
treatment of type 2 diabetes
• Jardiance®: SGLT2 inhibitor used for the treatment of type 2 diabetes and to reduce the risk of
cardiovascular death in adult patients with diabetes and established cardiovascular disease;
2018 Q1 revenue enjoyed a 104% increase relative to 2017 Q1. This was largely due to
increased share of the market for Jardiance and growth in the SGLT2 class3
• Glyxambi®: a combination tablet of Trajenta (linagliptin) and Jardiance (empagliflozin) for the
treatment of type 2 diabetes
• Synjardy® and Synjardy XR: a combination tablet of Jardiance (empagliflozin) and metformin
for the treatment of type 2 diabetes
• Basaglar®: a long-acting human insulin analog for the treatment of diabetes; 2018 Q1 revenue
($166 million) increased by $12.3 million relative to 2017 Q4. This is largely a result of increased
demand due to Medicare Part D formulary access and partially offset by lower realized prices
and changes in estimates of rebates and discounts.
• Forteo®: a parathyroid analog used for the treatment of osteoporosis in postmenopausal
women and men at high risk and for glucocorticoid-induced osteoporosis in men and
postmenopausal women; 2018 Q1 saw a 10% decrease in revenue compared to 2017 Q1.
Revenue in the U.S. decreased by 31%, primarily due to decreased volume and lower realized
prices; this was dampened by an increase in foreign revenue driven by favorable impact of
foreign exchange rates and increased volume3
• Evista®: a selective estrogen receptor modulator used for the prevention and treatment of
osteoporosis in postmenopausal women and for the reduction of the risk of invasive breast
cancer in postmenopausal women with osteoporosis and postmenopausal women at high risk
for invasive breast cancer
• Humatrope®: a growth hormone used for the treatment of human growth hormone deficiency
and certain pediatric growth conditions

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Neuroscience
• Cymbalta®: an SNRI used for the treatment of major depressive disorder, diabetic peripheral
neuropathic pain, generalized anxiety disorder, fibromyalgia, and chronic musculoskeletal pain
due to chronic lower back pain or chronic pain due to osteoarthritis
• Zyprexa®: an atypical antipsychotic used for the treatment of schizophrenia, acute mixed or
manic episodes associated with bipolar I disorder, and bipolar maintenance
• Strattera®: a norepinephrine reuptake inhibitor used for the treatment of attention-deficit
hyperactivity disorder
• Prozac®: an SSRI used for the treatment of major depressive disorder, obsessive-compulsive
disorder, bulimia nervosa, and panic disorder
• Amyvid®: a radioactive diagnostic agent for positron emission tomography imaging of beta-
amyloid neuritic plaques in the brain

Oncology
• Alimta®: an antimetabolite, antineoplastic agent used in combination with another agent for
advanced non-small cell lung cancer for patients with non-squamous cell histology

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• Erbitux®: an EGFR inhibiting, antineoplastic agent used as both a single agent and in
combination for the treatment of certain types of colorectal cancers and for certain types of
head and neck cancers
• Cyramza®: a VEGF inhibiting, antineoplastic agent used in metastatic gastric cancer, metastatic
NSCLC, and metastatic colorectal cancer; 2018 Q1 noted a 7% increase in revenue relative to
2017 Q1. This was largely due to increased volume and higher realized prices. Foreign revenue
was bolstered by favorable impact of foreign exchange rates and increased volume, partially
offset by lower realized prices3
• Gemzar®: an antimetabolite, antineoplastic agent used for the treatment of metastatic breast
cancer, NSCLC, and advanced or recurrent ovarian cancer (in the EU for bladder cancer)
• Portrazza®: an EGFR inhibiting, antineoplastic agent used in combination for metastatic
squamous NSCLC
• LartruvoTM: a PDGFR-alpha blocking, antineoplastic agent used in combination for the
treatment of soft tissue carcinoma; 2018 Q1 U.S. Revenue ($43 million) noted a $1.5 million
increase relative to 2017 Q4.3
• VerzenioTM: a cyclin-dependent kinase inhibiting, antineoplastic agent used as a single agent or
in combination for the treatment of advanced or metastatic breast cancer; 2018 Q1 revenue
($29.7 million) noted an increase of $8.7 million compared to 2017 Q43

Immunology
• Olumiant®: a janus associated kinase inhibitor, used for the treatment of adults with moderate
to severely active rheumatoid arthritis; 2018 Q1 revenue ($32.2 million) noted a $9.2 million
increase relative to 2017 Q4, largely due to a strong launch uptake in Germany3
• Taltz®: an anti-interleukin 17A monoclonal antibody, antipsoriatic agent used for the treatment
of moderate to severe plaque psoriasis; 2018 U.S. revenue ($111.2 million) saw a decrease of
$31.3 Million from 2017 Q4. This was largely due to lower volume due to specialty pharmacy
buying patterns, offset by higher demand, including an increase in new patient starts3

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Cardiovascular
• Cialis®: a PDE5 inhibitor used for the treatment of erectile dysfunction and benign prostatic
hyperplasia. U.S. revenue increased by 6% compared to 2017 Q1 driven by higher realized
prices, but was largely offset by decreased demand due to the entry of generic sildenafil. Cialis
revenue outside the U.S. decreased by 23% driven by loss of exclusivity in Europe.3
• Effient®: a thienopyridine, antiplatelet agent used for the reduction of thrombotic
cardiovascular events (including stent thrombosis) in patients with acute coronary syndrome
who are managed with an artery-opening procedure known as percutaneous coronary
intervention

MARKET LANDSCAPE
Eli Lilly is the 9th largest pharmaceutical company within the pharmaceutical industry. Although
the health care sector as a whole has performed well relative to the S&P 500 benchmark, it is
noted that the pharmaceuticals industry has consistently lagged behind. There are many factors
that may have contributed to this, although fears of harsh legislation limiting profits were
avoided this year, and pharmaceuticals have enjoyed a slight rebound in performance.
With a wide array of
targeted disease states,
Lilly faces an equally
wide variety of
competing
pharmaceutical
companies and generic
manufacturers (discussed later.) One mitigating factor is that many pharmaceutical companies
target specific disease states mindfully allocating their resources while limiting their exposure
to competition. Notably, in comparison to 4 of the 5 largest companies per market cap within
the pharmaceutical industry: Johnson & Johnson (JNJ), Merck and Co (MRK), Novartis AG

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(NVS) and Pfizer Inc (PFE), many overlapping disease states are targeted and several trends are
evident.
This figure shows total pharmaceutical revenue in FY2017 and growth from FY2016. Worth
mentioning, many of
these companies have
other business segments
outside of
pharmaceuticals or are
involved with generic
manufacturing (NVS),
but this figure is based
on comparable,
innovative
pharmaceutical revenue.
Despite JNJ being the
largest company within
the healthcare sector
per market cap, all 4
other companies generated higher revenues through their pharmaceutical segment. JNJ did,
however, enjoy a near 18% increase into 2017.

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This figure further compares Lilly’s divisional revenues versus competing rival companies, along
with their % change from 2016 to 2017. Notably, Lilly has enjoyed a large portion of revenue
from endocrinology, which is unsurprising considering their portfolio is heavily weighted within
the diabetes disease state.
Age-adjusted Prevalence of Obesity and Diagnosed Diabetes
Among US Adults

Obesity (BMI ≥30 kg/m2)

1994 2000 2015

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

Diabetes
1994 2000 2015

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

A look at the U.S. trends in regards to obesity and diabetes (often linked due to correlative
nature of patients) shows the dramatically increasing numbers affected by both. Between 1994
and 2015, the percentage of patients within the country diagnosed with these disease states
has nearly doubled. To put this into perspective, in 2012 the estimated total economic cost of
diagnosed diabetes was $245 billion, which was a 41% increase from previous estimated costs
in 2007 of $174 billion.11 Within diabetes treatment guidelines, GLP-1 agonists such as Trulicity
have been gaining momentum, as their favorable side effect profile and improved dosing
schedule (once weekly) have gained provider appeal. Desirable weight loss and lack of
hypoglycemia risk have led to increased usage and Trulicity’s weekly dosing differentiates this
product with remaining GLP-1 agonists.
Although they have the lowest amount of revenue generated through immunology, Taltz and
Olumiant enjoyed massive growth and will look to continue that trend as Olumiant gained FDA
approval within the U.S. in June of 2018. Losses within the cardiovascular and neuroscience
divisions are linked to losses of patent exclusivity for several products. Within the neuroscience
division, Zyprexa and Cymbalta

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revenue continue to decline since their patents expired in 2011 and 2013, respectively. The
cardiovascular division noted a strong decline due to Cialis revenue loss as Pfizer reached a
settlement that allowed Teva in 2017 to begin manufacturing a generic for their PDE5 inhibiting
competitor, Viagra. The following diagram depicts impending patent losses and 2017 revenues:

With impending domestic losses of patent exclusivity with Cialis, and foreign losses of Forteo
and Cymbalta, Lilly will have to seek out opportunities to mitigate revenue losses due to those
products. Once drugs lose patent protection, lower-priced generics quickly siphon off as much
as 90% of the brand-name sales as they offer products priced at on average 30% of the brand-
name products.12
Lilly will hope to weather the imminent losses of revenue through continued growth from their
current portfolio as well as drawing revenue from their innovative pipeline in which they hope
to have 11 new products introduced by 2023 (9 since 2014.) Their current pipeline (Appendix)
shows that Lilly hopes to introduce products from a multitude of their current divisions.

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Investment Thesis
HEALTHCARE SECTOR SUMMARY
With the aforementioned factors providing optimism despite the impending loss of patents,
several other factors may also play a significant role. As the U.S. continues to age, health care
expenses increase dramatically as well. As the CDC has explained, from 1997 to 2013, patients
aged ≥65 increased from 34.2M to 46.5M (out of 271.3M to 315.7M), a 16.84% increase
relative to total
population. Mean
annual expenses per
person with expenses
for patients aged ≥65
was $10,125
compared to $5,256
for the total
population.14,15 The
Centers for Medicare
& Medicaid Services
(CMS) has projected
national health care
spending to grow at Source: https://www.cdc.gov/chronicdisease/resources/publications/aag/healthy-aging.htm

an average rate of 5.5% per year for 2017-2026 (2008-2016 grew at 4.2%)19. These factors may
demonstrate a long-term influence for profitability, as it is estimated that the patient
population aged ≥65 looks to double by 2050. Additionally, as we enter the late to recession
phases of the business cycle, experts believe that investors will note the signs of economic
slowdown leading to heavier investments within defensive-oriented, less economically sensitive
sectors (those tied to basic needs, such as healthcare.)4
Despite optimistic factors, the pharmaceutical industry has lagged the remainder of the sector
for the last several years. This may partially be in response to uncertainty in potential legislation
that looks to reduce pharmaceutical prices for consumers which would naturally create a ripple
of decreased profits throughout
the health care sector. When
current U.S. President Donald
Trump declared via social media
platform Twitter23 in regards to
speculative Pfizer drug price
increases, PFE saw a 1.2% decrease in stock price and the pharmaceutical industry as a whole

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saw a reduction by 0.55% per Fidelity. Notably, both company and industry bounced back by
the next day. On May 11, 2018, President Trump spoke in regards to his proposal for health
care reform. He had mentions of eliminating the middlemen, limiting special interests, while
instructing Secretary Azar (Eli Lilly and Company’s President of the U.S. Division from 2012-2017
and now United States Secretary of Health and Human Services) to continue working towards
battling rising costs. Notably, President Trump stated13:

~
Despite previously stating that pharmaceutical companies were “getting away with murder,”
President Trump didn’t mention plans that allowed Medicare to directly negotiate drug prices
or permit lower-priced drug imports from other countries, which were previously met much
resistance. Instead, he mentioned increasing costs for foreign governments and patients to help
alleviate the cost burden within The U.S. S&P and NASDAQ biotech indices rose nearly 3%
following the address.17 Notably, if the current administration targets foreign drug prices, a
proposal that had potentially dire consequences for the pharmaceutical industry resulted in
what could prove to have an entirely opposite and thus positive net effect on Lilly.
FINANCIAL ANALYSIS
Eli Lilly and Company is a financially healthy company.
Total revenues
continue to grow,
with 2018 Q1 revenues enjoying an 8% increase from
2017 Q1.3 With regards to Lilly’s operating expenses as a
percentage of total revenue, Lilly has committed to
maintaining proportional R&D expenses to maintain and
develop their promising pipeline. Additionally, through a
“company-wide effort to drive productivity, streamline
how they work, and a reduced workforce” Lilly
continued to note a decreased
proportion of SG&A expenses.2
This all contributed to a
continually increasing operating margin with a company goal of 30 percent or better by 2020.2

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In comparison to these companies’ averages, Lilly

maintains similar or slightly more impressive margins.
Additionally, with a comparable current ratio (1.4) as
the other large pharmaceutical companies, Lilly
continues to maintain a healthy working capital to
ensure that it
can adequately
meet its
current
liabilities while providing an 8.16% return on equity.4
Lilly continues to consistently exceed consensus
earnings estimates for the past 4 quarters, while
demonstrating continued
earnings growth. Finally,
despite the extreme scrutiny from the press and
governmental officials in regards to drug costs weighing
pharmaceuticals, Lilly has managed in the past 5 years to
provide an annualized total shareholder average return of
15%, compared to 16% for the S&P benchmark due to the
increase in stock price and steady dividend stream.2
Of note, due to The 2017 Tax Act, an estimated income tax
provision of $1.91 billion was recorded in December of 2017,
which resulted in the -0.19 EPS, later reconciled to 4.28.1,2

VALUATION ANALYSIS AND PRICE TARGET
With these factors in mind, since 2013 (when patent exclusivity for Cymbalta was lost), Lilly has
sustained continued, consistent sales growth. Although key patent losses are expected in 2018,
it appears that Lilly is much better equipped with a
robust pipeline and current portfolio to weather the
losses. Thus, based on previous trends and typical
pharmaceutical product cycles, my revenue growth
estimate is slightly more bullish than consensus
estimates. Basing loss of Cialis revenue on losses
experienced by Pfizer when Teva began
manufacturing generic sildenafil in 2017, my
estimations for divisional revenues are (Consensus
estimate was $23,930):

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With a steady and stable cash flow, and steadily and consistently improving metrics and inputs
such as the aforementioned operating expenses, The Discounted Cash Flow (DCF) Model is an
appropriate model to use to assess Lilly’s intrinsic stock value. Additionally, DCF isn’t influenced
by short-term market conditions or non-economic factors, which is useful during this time of
volatility due to public scrutiny. I have assigned a 60% weight to the DCF based valuation. With
intense competition within the prescription drug companies, multiples based valuation
demonstrates importance as we can utilize similar, competing companies to determine an
estimated price target while seeking correlations between their operating and financial
characteristics. I have assigned a 40% weight to my valuation based on multiples.

DISCOUNTED CASH FLOW MODEL

The appendix
contains details in
regards to the DCF
modeling used. I
have taken a
discount rating of
9.50% and a
terminal growth
rate of 4%. The current S&P 500 multiple implies a 4% growth rate and 10% discount rate. With
defensive characteristics, favorable demographics, traditionally low beta, and other factors
listed above, I believe the 9.50% discount rate would be warranted. Notably, if a reasonable
9.0% were used, our
valuation would
increase from $111
to $122.2, (23.7% to
36.2%) With high
level of uncertainty
and scrutiny
regarding health
care regulations (short-term concerns with nothing certain or concrete yet) weighing stock
prices, this appears to be an opportunity to BUY Lilly as the stock appears to be undervalued.
These figures above detail how stock prices may
fluctuate with regards to adjustments to both
discount rates and terminal growth rates.
RELATIVE VALUATION MODEL
The health care sector as a whole traditionally
trades at slightly higher rates relative to the

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S&P 500. This is largely attributed to large profit

margins, continual and steady revenue growth, and
improving operating margins. However, both the
sector as a whole and Lilly as an individual stock is
currently trading just below the benchmark P/E. This
again may be attributed to uncertainty in government
legislation and
scrutiny resulting from increased drug pricing. However,
as mentioned, this may very likely be an unrealized,
short-term phenomenon that presents us a buying
opportunity. Following the S&P 500, Lilly is currently
showing higher pricing ratios compared to their median
over the last 10 years. This appears to be a reflection of
the market as a whole. Additionally, after the
large one-time paid
tax in 2017 lowering
earnings, effective
tax rates decreased
to 15.5% for 2018
Q1.3 In comparison
with similar peers
within the
pharmaceutical industry,
Lilly is notably not far off from
the average multiples these
companies present.
Weighing each ratio equally
results in a target price of
$104.09. Finally, with
steady, predictable cash
flows and remarkably
similar peers to
compare with, a
60:40 valuation nets a
final price target of
$108.24, or a 20.7%
upside to current
pricing.

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Risks
• Pharmaceutical research and development is costly and uncertain1
o For every 5,000 compounds discovered, only 1 reaches the pharmacy
o Fewer than a third of marketed drugs achieve enough commercial success to recoup
their R&D investments21
o According to a study conducted by Tufts Center for the Study for Drug Development,
cost of developing a prescription drug that gains market approval is approximately
$2.6 billion, a 145% increase over the estimate the center made in 200320
o FDA requires drugs to undergo three phases of clinical testing on humans:
Phase I: Safety and Dosage (70% move to the next phase)
Phase II: Efficacy and Side Effects (33% move to the next phase)
Phase III: Efficacy and monitoring of adverse reactions (25-30% of drugs move to the
next phase)22
• Losing effective intellectual property protection on revenue generating products will lead
to rapid and severe revenue decline in those product lines1
o Once drugs lose patent protection, lower-priced generics quickly siphon off as much
as 90% of the brand-name sales12
o Although Viagra had been losing revenue steadily since 2011, 2017 saw a 30% decline
in revenue despite the generic release occurring late in the fiscal year
o Cymbalta saw a decline in revenue of nearly 70% the year after losing patent
exclusivity
• Human pharmaceutical business is subject to government price controls and unanticipated
tax liabilities1
o As noted previously, pharmaceutical drug pricing has been highly scrutinized within
both the media and by government officials
o Uncertainty and volatility is expected to continue as efforts to limit increasing drug
prices are continually present; Despite this, President Trump directed blame on
“middle men” such as pharmacy benefit managers
• Intense competition from lower-cost generic and biosimilar manufacturers1
o When comparable generics are available, they offer products priced at on average
30% of the brand-name products.12
o In 2010, Congress approved the Biologics Price Competition and Innovation Act
(BPCIA), allowing an abbreviated approval pathway for biosimilars (a less expensive,
interchangeable product with an FDA-approved biological product such as insulin)
o In 2015, the first biosimilar product was approved for marketing in the U.S.; Notably,
Lilly has Basaglar which has demonstrated immense revenue growth from 2016 to
2017 and continues to realize that growth into 2018 Q1

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Company Overview Ÿ Investment Thesis Ÿ Risks
 Eli Lilly and Company
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Wu, E

Conclusion
BUY Eli Lilly and Company (NYSE: LLY) with a price target of $108.24 as it is currently
undervalued by approximately 21%
Since the start of 2018, Lilly has had Olumiant (baricitinib), a rheumatoid arthritis medication
used in Europe approved in the U.S. The FDA approved it at lower doses, but success in foreign
countries will yield domestic benefits. Lilly’s galcanezumab also met its primary endpoint in its
phase III study, providing encouraging potential for future migraine and cluster headache
therapy.
Combining Lilly’s promising pipeline with the optimistic factors (aging demographics,
increasingly unhealthy population, increased healthcare spending, defensive sector, inelastic
demand, etc.) underlying the pharmaceutical industry, Lilly looks poised to continue their
success for the foreseeable future as they continue to improve the well-being of their financial
health (increasing revenues, decreasing operation expenses, etc.) and as a result, patient
health.

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Conclusion
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PIPELINE SUMMARY
Phase 1 Phase 2

Phase 3 Regulatory Review

Human Segment Division

*Multiple indications2

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Appendix
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References
1. Eli Lilly and Company. (2017). Annual Report and Proxy Statement 2017. Retrieved from
https://investor.lilly.com/static-files/423887ae-38f3-463c-9d11-43088a30d68f
2. Eli Lilly and Company. (2017). 2017 Integrated Summary Report. Retrieved from
https://assets.ctfassets.net/hadumfdtzsru/2Ayd5rsLd2AyMsQ8wY8wO0/79e2398c034863923b99098
b53762406/2017_Lilly_Integrated_Summary_Report.pdf
3. Eli Lilly and Company. (2018). Q1 Earnings Release 2018. Retrieved from
https://investor.lilly.com/static-files/a644463e-77d5-41de-8d99-cd0604e580e3
4. Data from: Fidelity.com (7-14-18)
5. Data from: Finance.Yahoo (7-14-18)
6. Data from: Market Realist (7-14-18)
7. Johnson and Johnson. (2017). Proxy Statement 2017. Retrieved from
https://jnj.brightspotcdn.com/c4/59/2988b7a8407c93507f0a08708d9e/2017-0310-proxy-statement-
with-bookmarks.pdf
8. Pfizer, Inc. (2017, 2014, 2011, 2008). Financial Report 2017, 2014, 2011, 2008. Retrieved from
https://investors.pfizer.com/financials/annual-reports/default.aspx
9. Novartis AG. (2017) Annual Report 2017. Retrieved from
https://www.novartis.com/investors/novartis-annual-report/annual-report-archive
10. Merck and Co, Inc. 2017. Annual Report 2017. Retrieved from
http://investors.merck.com/financials/annual-reports-and-proxy/default.aspx
11. Economic costs of diabetes in the U.S. In 2012. Diabetes care. 2013;36:1033–1046. [PMC free
article][PubMed]
12. DeRuiter, Jack. “Drug Patent Expirations and the ‘Patent Cliff.’” U.S. Pharmacist – The Leading Journal
in Pharmacy, USPharmacist, 20 June 2012, stage.uspharmacist.com/article/drug-patent-expirations-
and-the-patent-cliff.
13. Garden, Rose. “Remarks by President Trump on Lowering Drug Prices.” The White House, The United
States Government, 11 Mar. 2018, 14:08, www.whitehouse.gov/briefings-statements/remarks-
president-trump-lowering-drug-prices/.
14. “Healthy Aging.” Centers for Disease Control and Prevention, Centers for Disease Control and
Prevention, 15 Jan. 2016, www.cdc.gov/chronicdisease/resources/publications/aag/healthy-
aging.htm.
15. “National Center for Health Statistics.” Centers for Disease Control and Prevention, Centers for
Disease Control and Prevention, 3 May 2017, www.cdc.gov/nchs/fastats/health-expenditures.htm.
16. Mukherjee, Sy. “Why Trump's Big Drug Price Speech Sent Health Care Stocks Soaring.” Fortune,
Fortune, 11 May 2018, fortune.com/2018/05/11/trump-drug-pricing-proposal-health-stocks/.
17. Mukherjee, Sy. “Why Trump's Big Drug Price Speech Sent Health Care Stocks Soaring.” Fortune,
Fortune, 11 May 2018, fortune.com/2018/05/11/trump-drug-pricing-proposal-health-stocks/.
18. Data from: Bloomberg (5-16-18)
19. “National Health Expenditure Projections 2017-2026.” National Health Expenditure Projections 2017-
2026, Centers for Medicare & Medicaid Services, 17 Apr. 2018, www.cms.gov/Research-Statistics-
Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/index.html.

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20. Mullin, Rick. “Tufts Study Finds Big Rise in Cost of Drug Development.” CEN RSS, American Chemical
Society, 20 Nov. 2014, cen.acs.org/articles/92/web/2014/11/Tufts-Study-Finds-Big-Rise.html.
21. Spiegel, Francis. “The Economics of Pharmaceutical Research and Development: An Industry
Perspective.” Advances in Pediatrics, Institute of Medicine (US) Committee on Technological
Innovation in Medicine, 1 Jan. 1991, www.ncbi.nlm.nih.gov/books/NBK234300/.
22. “The Drug Development Process - Step 3: Clinical Research.” U S Food and Drug Administration Home
Page, Center for Biologics Evaluation and Research, 13 June 2018,
www.fda.gov/ForPatients/Approvals/Drugs/ucm405622.htm.
23. Trump, Donald J. “‘Pfizer & Others..."Twitter, Twitter, 9 July 2018,
twitter.com/realdonaldtrump/status/1016368503723577344?lang=en.

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References