3 Dark Clouds in Lilly's Q3 Silver Lining

Don't let it get away!

Keep track of the stocks that matter to you.

Help yourself with the Fool's FREE and easy new watchlist service today.

Make no mistake about it: Eli Lilly (NYSE: LLY  ) reported solid third-quarter results.

Earnings of $1.20 billion, or $1.11 per share, handily beat analysts' expectations of $1.04 per share. Sales were up by 6% year over year to $5.78 billion, also exceeding analysts' projections -- although only narrowly.  Lilly even raised its full-year earnings guidance from a range of $4.05-$4.15 per share to a range of $4.10-$4.15 per share.

All is bright and sunny, right? Not necessarily. A detailed look at Lilly's earnings reveals some potential problems ahead. Here are three dark clouds in the big drugmaker's third-quarter silver lining.

1. Cost-cutting only works for a while
Slashing costs helped Lilly's bottom line considerably. The company reported marketing, selling, and administrative costs of $1.652 billion, down 6% year over year. This reduced spending amounted to more than $0.09 per share -- more than the amount by which Lilly beat Wall Street's earnings estimate.

Lilly, however, did increase research and development spending by $34.6 million compared to the third quarter of 2012. This higher R&D spending added another $0.03 per share in costs.

The cost-cutting moves made by Lilly appear to have been smart and have paid off. The problem, though, is that costs can only be cut to a point before they're more harmful than helpful. Don't count on continued cost reductions to keep delivering earnings beats in the future. 

2. Price increases can only help to a limited extent
Lilly's year-over-year revenue gains of 6% look solid. There's no question that bringing in another $329 million during the quarter as compared to the prior year is a good thing. But let's take a look at why revenue was higher.

The company reported 3% higher sales volume in the last quarter versus the same period in 2012. However, those gains were largely offset by a 2% decrease due to unfavorable currency fluctuations. How did Lilly manage to still increase total revenue? It bumped up prices of its drugs by 5%.

Price increases are a fact of life in the pharmaceutical industry, and Lilly will no doubt continue raising prices in the future on many of its drugs. However, there is a limit on how much the company can make such moves before risking a customer backlash. Lilly probably can't depend on future price increases to deliver well-received earnings results down the road, especially with the diminishing returns from further cost cuts.

3. The top-selling drug is already slipping
While Lilly's total sales volume was up 3%, that wasn't the case for its top-selling drug, Cymbalta. The drug continued to rock along with sales of $1.376 billion during the third quarter. That number is up 11% year over year, but the volume for Cymbalta was actually down. The higher sales figure came from price increases.

Lilly attributed the lower volume to a reduction in inventory levels in the wholesale and retail channels. However, the decline foreshadows the stark reality facing the company: Lilly's biggest current blockbuster loses patent exclusivity in a little more than a month. 

Unfortunately, the damage won't be limited to Cymbalta. Key patents for Zyprexa and Humalog have already expired. Evista goes off-patent in early 2014. That's four out of the top 10 drugs for Lilly that have either lost or soon will lose patent protection.

Bright spots
Despite these real challenges, Lilly certainly has several bright spots. One of the brightest is type 2 diabetes drug dulaglutide, which is awaiting regulatory review in both the U.S. and Europe. The drug bested Merck's (NYSE: MRK  ) Januvia and Bristol-Myers Squibb's (NYSE: BMY  ) Byetta in controlling blood glucose levels in late-stage clinical studies.

If dulaglutide performs along the lines of Byetta, it will only be a so-so win for Lilly. Byetta has generated $295 million in sales for Bristol so far this year. However, if Lilly's drug is even close to the same league as Januvia commercially, that's a different story altogether. Merck is on track to rack up $4 billion or more in sales for Januvia this year.

Lilly also claims several other drugs in its pipeline that could emerge as big winners. Cancer drugs ramucirumab and necitumumab stand out among the pack.

The most significant problem for Lilly, though, is that these bright spots might not shine quickly enough to make up for the impending revenue loss from drugs going off-patent. 2013 is looking sunny, but the weather forecast for Lilly looks potentially stormy over the next year or two.

Looking for an umbrella?
Dividend stocks can be like umbrellas on a rainy day. Over the long term, the compounding effect of the quarterly payouts, as well as their growth, adds up faster than most investors imagine. With this in mind, our analysts sat down to identify the absolute best of the best when it comes to rock-solid dividend stocks, drawing up a list in this free report of nine that fit the bill. To discover the identities of these companies before the rest of the market catches on, you can download this valuable free report by simply clicking here now.


Read/Post Comments (0) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2695267, ~/Articles/ArticleHandler.aspx, 9/30/2016 10:32:05 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 18,265.40 121.95 0.67%
S&P 500 2,160.37 9.24 0.43%
NASD 5,287.49 18.34 0.35%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/30/2016 10:16 AM
LLY $80.35 Up +0.61 +0.76%
Eli Lilly and Co. CAPS Rating: ***
BMY $54.11 Up +0.24 +0.45%
Bristol-Myers Squi… CAPS Rating: ****
MRK $62.50 Up +0.59 +0.94%
Merck and Co. CAPS Rating: ****