Does Lilly Make the Grade for 2013?

An annual return of 18% isn't bad at all. That's what you would have gained if you bought shares of Eli Lilly (NYSE: LLY  ) at the beginning of 2012 and held them all year long. Is Lilly poised for a repeat performance in 2013?

I have graded several aspects of the company's business in articles over the past few days. Let's pull them all together and look at one other important criterion to see if Lilly is a keeper.

Current product lineup
Lilly scored only a "D" for its current product lineup. As discussed in the first article of this series, considerable risk exists for the company's revenue stream as more drugs go off-patent in the coming years. Cymbalta and Humalog both lose patent exclusivity in 2013.

Some new competitors are emerging to challenge several of Lilly's products. One example is VIVUS  (NASDAQ: VVUS  ) , which received approval from the Food and Drug Administration for Stendra in 2012. Stendra could gain in the erectile dysfunction drug market at the expense of Lilly's Cialis. 

The company's current lineup is not without its strengths. It has a good balance of products without too much dependence on one product. Some products are experiencing strong growth. However, the risk of revenue losses outweighs these positives and results in a poor overall grade for Lilly's current products on the market.

Pipeline
While Lilly boasts 12 late-stage drugs in its pipeline with another 49 drugs in early and mid-stage trials, we gave the pipeline a grade of "C". That middle-of-the-road score reflects the mix of solid and weak prospects in Lilly's development program.

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One of the best potential drug candidates for Lilly is dulaglutide. Clinical studies in 2012 found that the diabetes drug achieved better results than did currently marketed drugs from Bristol-Myers Squibb (NYSE: BMY  ) and Merck (NYSE: MRK  ) .

On the other hand, tabalumab is a good example of the challenges facing Lilly's pipeline. Two phase 3 studies for use of the drug in treating rheumatoid arthritis are under way, but another late-stage study was canceled after researchers found no significant improvement in patients taking tabalumab. 

Financials
Like the theme song from The Jeffersons TV show, we're moving on up. Lilly's financials scored a solid "B"

Yes, there are some real areas of concern. Revenue and earnings are both on a downward slide. With more drugs going off-patent, those problems could get even worse.

For now, though, Lilly's financials compare well against other pharmaceutical companies. For example, Lilly, AstraZeneca (NYSE: AZN  ) and Bristol-Myers Squibb all have similar market caps. The other two companies have higher debt-to-equity levels and lower free cash flow than Lilly. On the key metric of return on invested capital, Lilly fares much better than Bristol over the past year and narrowly trails AstraZeneca.

Management
One important area that we have not yet addressed is management. If the key for getting a good grade is industry experience, Lilly's CEO, Dr. John Leichletter, deserves an "A." He joined Lilly in 1979, starting off as a senior organic chemist. Leichletter has held management positions in pharmaceutical product development and regulatory affairs and served as COO from 2005 to 2008.

Results trump experience, though. What are Leichletter's results since taking over as CEO in April 2008? Shares are down 4%. To put it mildly, that's awful. However, this time frame includes the overall market meltdown of late 2008, which can't be blamed on Leichletter. On the other hand, competitors like AstraZeneca and Bristol are up 47% and 18%, respectively, during the same period.

It's true that including dividends helps. However, Lilly still lags far behind its similar-sized peers in total return. In fact, the company's total return falls below every other pharmaceutical company with which it compares itself for management performance.  

Should Lilly's management receive an "F"? Perhaps, but the company's stock performance does look much better if we focus on the last year. My grade for management, therefore, is a "D." 

Making the grade
It's time to tally the scores. Lilly receives two "D" grades -- one for current products and one for management. The company receives one "B" for financials and a "C" for its pipeline. If we assign equal weighting to each category, that gives Lilly an overall grade of "C-." 

Does Lilly make the grade for individual investors in 2013? My view is that there are too many potential winners in the market to put money on a "C-" performer. That's especially the case when Lilly's financials are in danger of worsening as more drugs go off-patent. The next year will show whether this grade is fair, too harsh or perhaps even too lenient.

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