Better Buy: Eli Lilly & Co. or AstraZeneca plc?

Eli Lilly and AstraZeneca are leaders in diabetes treatment. Both are seeing sales fall as blockbuster drugs lose patent protection, but is one of these companies a better buy than the other?

Mar 24, 2014 at 6:30PM

The market for treating diabetes is becoming getting increasingly competitive as drug developers innovate new, longer-lasting therapies to address the growing patient population. Over the coming two decades, the number of people diagnosed with diabetes is expected to climb from 366 million in 2011 to 552 million in 2030. That means there will be three new cases of diabetes diagnosed every 10 seconds.

The business of treating diabetes is already big. Among the leaders are Eli Lilly (NYSE:LLY) and AstraZeneca (NYSE:AZN). Both offer short and long-term insulin therapies generating billions in annual revenue, but both are also facing short-term headwinds tied to high-profile patent expirations. Since sales are likely to slump, is one of these companies a better buy than the other?

LLY Chart

LLY data by YCharts.

Debating earnings
Lilly lost patent exclusivity for its $5 billion a year depression treatment Cymbalta in December. That expiration means generic versions of the drug will likely shave away 70%-90% of Cymbalta's sales this year. AstraZeneca faces a similarly stiff challenge when its $3.8 billion a year Nexium goes off-patent in May.

In January, the loss of Cymbalta forced Lilly to lower its revenue guidance for 2014 from $20 billion to $19.2 billion -- $19.8 billion. Meanwhile, AstraZeneca in February predicted its sales would drop by low-to-mid single digits in 2014, and wouldn't return to 2013 levels until 2017.

The companies' sales slides will similarly drive earnings lower. Lilly expects earnings per share to come in between $2.77 and $2.85 in 2014, and AstraZeneca thinks earnings will fall from 2013 by a midteens rate this year. That has industry analysts expecting $2.81 per share for Lilly and $4.26 per share for Astra this year.

The earnings drop appears to have been more expected at Lilly, as analysts have actually improved their current year outlook from $2.78 per share over the past 90 days. Estimates at AstraZeneca, however, were $4.71 per share 90 days ago. The boost at Lilly may suggest analyst pessimism has bottomed -- at least for now.

It also suggests investors interested in owning shares in either company based on earnings will need cost savings initiatives to kick in more quickly than expected. If they do, Lilly and Astra could outpace their tepid outlooks.

Lilly hopes to shave up to $1 billion in costs by reducing its research and development spending. And AstraZeneca has announced moves geared toward eliminating $1.1 billion in annual expenses.

Debating valuation
Since revenue and earnings growth appear likely to elude both companies over the coming year, investors may want to focus more on valuation.

Unfortunately, neither company is overly cheap. Lilly's shares are trading at 14 times last year's earnings, but 18 times estimated earnings next year. AstraZeneca's shares have a current and future P/E of 31 and 15 times, respectively. Of course, those ratios could move dramatically if either company can more quickly reap the benefit of accountants' sharpened pencils.

The price-to-sales ratio for each company is also frothy. That shouldn't be surprising given the expected patent-driven hits to revenue. At Lilly, the price-to-sales ratio is 2.7 times, while it's 3.17 at AstraZeneca.

Since neither appears particularly inexpensive, investors should also consider the strength of their dividend. Lilly's forward dividend yield is 3.3% and AstraZeneca's is 5.7%. Those are both compelling given the anemic rates investors are receiving in fixed income investments. However, those rates will only remain compelling if cash flow stays strong enough to support their payouts going forward. 

Since earnings can be volatile due to one-time charges, investors should look at the cash dividend payout ratio, which looks at operating cash in relation to dividend payments. That can be a better gauge of whether these companies' businesses are delivering enough cash from operations to handle their dividend commitments. At both companies, the ratio appears fine based on the past 12 months. However, since cash flow will likely shrink this year, investors will want to watch this measure closely to see if it spikes.

LLY Cash Dividend Payout Ratio (TTM) Chart

LLY Cash Dividend Payout Ratio (TTM) data by YCharts.

Both companies also have solid cash cushions they can lean on. Lilly has more than $5 in cash per share on hand, and levered free cash flow totaled $3.06 billion over the past 12 months. AstraZeneca has $10 billion in cash, or $8 per share, and produced $7 billion in free cash flow in the past year.

Fool-worthy final thoughts
Both companies are in the middle of important restructurings. That could make each leaner and better able to translate future sales into shareholder-friendly profit. Of course, the ability to return to growth and really leverage their cost-conscious footprint will come from ushering new drugs through their pipeline to market.

At Lilly, a lot of that pipeline potential rests on dulaglutide, a GLP-1 diabetes therapy under review by the FDA. During trials, the once-weekly therapy was as effective as Novo Nordisk's blockbuster once-daily drug Victoza. That dosing advantage has analysts thinking dulaglutide may see peak sales of more than $1.5 billion per year. 

Over at AstraZeneca, investors should be watching olaparib, a drug for BRCA mutated ovarian cancer that could get EU approval this year, and brodalumab, a drug that is being co-developed with Amgen and is in phase 3 trials for psoriasis.

Since neither of these companies are growing sales or earnings, and neither appears cheap, they are likely both better buys for speculatively oriented dividend investors willing to bet that restructuring and pipelines will pan out, or long-term investors believing the diabetes market opportunity trumps any short-term headaches. 

Here are 9 dividend stocks with fewer question marks.
One of the dirty secrets that few finance professionals will openly admit is the fact that dividend stocks as a group handily outperform their non-dividend paying brethren. The reasons for this are too numerous to list here, but you can rest assured that it's true. However, knowing this is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor's portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.


Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information