Have you ever seen a picture that can shows two different things? Perhaps the most famous example of this is the picture first gaining fame in the late 19th century that shows an old lady and a young lady, depending on how you look at it.
The financial picture for pharmaceutical company Eli Lilly (NYSE: LLY ) reminds me of these types of two-in-one drawings. Let's take a look at both sides of Lilly's financial picture.
For those of us who tend to see the beauty in things, we can certainly find things to like about Lilly's financials. The chart below shows a couple of examples.
Book value, also known as shareholder equity, measures a company's financial worth by subtracting total liabilities from total assets. Generally speaking, the faster the book value of the company grows the better. In Lilly's case, book value has more than doubled over the past four years. That's good.
During the same time period, the company's total net debt decreased significantly -- from more than $5 billion to around $200 million. Total net debt includes three important items from the balance sheet in its calculation: short term debt plus long term debt, less cash and cash equivalents. Lilly's great reduction in total net debt resulted from increasing cash and decreasing debt.
Lilly's financial results reveal some less beautiful figures, too. That's especially the case over the past year.
While revenue increased overall during the past four years, the effects of hitting the patent cliff began showing up in 2012. The trajectory for trailing-12-month revenue is now headed downward. When total revenue declines, other financial numbers can begin to turn ugly very quickly.
Although revenue improved through late 2011, earnings began slipping early in the same year. Investors look for earnings growth -- not earnings stagnation and decline.
Of course, we shouldn't just look at the financial picture of one company in isolation. We should compare multiple companies to see which appears to be the best investment. How does Lilly fare in a pharmaceutical financial beauty contest?
|Company||Debt/Equity||EV/EBITDA||Levered Free Cash Flow (TTM)||ROIC||ROIC (5-Year Average)|
AstraZeneca (NYSE: AZN )
|Bristol-Myers Squibb (NYSE: BMY )||52.94||9.21||$4.52B||10.7%||17.8%|
|Merck (NYSE: MRK )||33.67||7.03||$11.69B||7.8%||10.4%|
|Pfizer (NYSE: PFE )||47.36||7.44||$16.25B||5.9%||6.5%|
Lilly stacks up well against rivals with its low debt-to-equity ratio, coming in second to Merck. This isn't surprising, since we already saw how the company dramatically lowered its total net debt.
On the valuation metric of enterprise value/EBITDA, Lilly doesn't look as attractive as most of the other companies. Only Bristol-Myers Squibb has a higher multiple.
Cash flow is what really counts for many investors. Lilly edges out its similar-sized competitors, AstraZeneca and Bristol. As we would expect, though, the much-larger companies, Merck and Pfizer, show higher free cash flow totals.
If I could only pick one measurement for comparison, that measurement would probably be return on invested capital, or ROIC. The table above shows ROIC for the past 12 months and an average over the last five years. Lilly trounces its bigger rivals during both periods. The company trails AstraZeneca a little over the past 12 months, but still boasts a respectable ROIC. However, Lilly underperformed its similar-sized competitors considerably over the past five years.
Making the grade
This is the third article in a series about whether or not Lilly makes the grade for investors. We previously examined Lilly's current product lineup and its drug pipeline, assigning grades for both.
What grade does Lilly merit for its financials? I think Lilly deserves a solid "B." Declining revenue and earnings aren't good at all. However, Lilly still looks good financially from an overall perspective. Its low debt level, solid cash flow and good ROIC help the company to match up pretty well against other pharmaceutical firms.
Granted, if revenue and earnings deteriorate significantly in the future (which could happen), Lilly's financial picture would likely follow suit. However, report cards are for a snapshot in time and are not a prediction for the future. Stay tuned for our final article in this series where we determine if Lilly ultimately makes the grade for investors in 2013.