Eli Lilly & Co. (NYSE:LLY) is a Goliath in diabetes treatment, and thanks to new drugs that can help patients control their disease better, the company's diabetes sales are soaring.

In this clip from The Motley Fool's Industry Focus: Healthcare, host Kristine Harjes and Motley Fool contributor Todd Campbell discuss the impact its diabetes drugs had on its second-quarter 2018 results, plus the company's decision to exit the animal health business.

A full transcript follows the video.

This video was recorded on July 25, 2018.

Kristine Harjes: Eli Lilly is, first and foremost, a diabetes-focused company, and they are massive. They also make drugs for cancer and some other diseases and, as will become important later in our discussion, they have a pretty sizable animal health division. Lilly reported earnings yesterday, and shares got a 5% lift.

Todd Campbell: Eli Lilly launched the very first commercial insulin for diabetes patients. They did that back in 1923. So, it's probably not surprising to find out that today, they remain the second-largest producer of diabetes drugs. They actually get about 44% of their revenue from diabetes treatments. I think, to set the stage, it might be helpful for our listeners to get a quick reminder of what exactly diabetes is. Is that cool with you, Kristine?

Harjes: Go for it.

Campbell: Great. In normal, healthy patients, when the liver produces the simple sugar glucose, or we ingest glucose from eating carbohydrates, beta cells in our pancreas create insulin. That insulin converts glucose into glycogen that gets stored in the liver or in the muscles, and can be used for energy later on. In type 1 patients, the pancreas doesn't produce insulin. In type 2 patients, we've built up a resistance to the insulin we do produce. That's a problem because as blood sugar gets high in the bloodstream, it can wreak all sorts of havoc in the body. You can have nerve damage, it can damage your kidneys, and you can also end up with cardiovascular disease.

There are about 30 million people in the U.S. alone with diabetes, and there are about 90 million people in the U.S. in prediabetes or elevated blood sugar levels. As a result, this is a massive market, it's a mega blockbuster market. As you mentioned, Eli Lilly, big company. With 44% of their revenue coming from diabetes, that works out to a little bit better than $10 billion per year just in diabetes drugs.

Harjes: Because diabetes is such a complex disease, there are a couple of different drug types that a a company might produce in the diabetes space. For example, Eli Lilly produces a rapid-acting insulin called Humalog. They also have a long-acting insulin called Basaglar, which is actually a biosimilar to the brand name long-acting insulin, Lantus, which is a Sanofi drug. That one was huge, it had $7 billion in peak sales before it lost patent protection. Now, the biosimilar Basaglar is coming after that. It's taking off like a rocket, by the way. This last quarter, their sales grew 133% year over year, and that's after 2017, when their sales surged 402%. So, this drug is really growing at bonkers levels.

But that's not where they stop. They don't just stop with insulin. They also have drugs that work to help manage the disease by either boosting insulin production, which is the case with GLP-1 drugs. They also have Jardiance, which is an SGLT2 inhibitor. What that does is increase glucose excretion from the urine. These are all different approaches to managing and treating this disease. If you take it all together, as you mentioned, Todd, this is a gigantic business unit for Eli Lilly, and it's growing. Their volume growth in the last quarter was up 31% year over year.

Campbell: Right, and that was due to the launch of those next-generation diabetes treatments, the SGLT2 inhibitors, and Basaglar, which is a massive opportunity. As an aside, one of the reasons that you and I talk a lot on the show about biosimilars and the potential opportunities for biosimilars over time, as a reminder, biosimilars are inexact copies of brand name biologic drugs that are made in living organisms, but they work as effectively. So, the FDA allows them to be prescribed instead of that brand name drug once it loses patent protection.

If you look at Eli Lilly's total sales in the second quarter, pretty good growth for a company this big. Up 9% year over year to $6.4 billion. You mentioned the diabetes volume growth. That's important. We talk a lot, and you hear a lot in the media, about price increases driving growth for a lot of these companies. They had 9% year over year volume growth across the entire company in the second quarter. Diabetes revenue growth is, obviously, incredibly important.

It'll be really interesting to see where we go from here in diabetes for Eli Lilly, because Sanofi fired and shot back across Eli Lilly's bow by launching its own biosimilar to the rapid-acting insulin Humalog earlier this year. Humalog sales were $2.9 billion in 2017. It's Lilly's biggest diabetes drug. I'm very interested to see whether or not Admelog can chip away at sales as quickly as Basaglar has chipped away at Sanofi's Lantus.

Harjes: Right now, it doesn't seem like that'll be the case. Sanofi's biosimilar is there, it launched earlier this year, but Humalog sales actually grew 13% year over year within the quarter. For now, at least, it's hanging on just fine.

One of the interesting parts of Eli Lilly's earnings was an announcement regarding its animal health division, which makes medicines for both companion animals, meaning pets, and also livestock and animals that would be not quite as companion-y. This is not a huge shock. They signposted back in October that they were thinking about options for this animal health business. Now, they're saying that they're going to IPO a minority stake in it, which will be something less than a 20% stake, in this company, and it'll be available for people to buy into. What do you think of this, Todd?

Campbell: This is a really interesting move. Investors might want to pay attention. Remember, Pfizer spun out their animal health business, which is, how do you say it?

Harjes: Zoetis.

Campbell: The ticker symbol is ZTS. They spun that out a few years ago, and it's been a wonderful investment. So, you might want to keep an eye on what happens with Elanco going forward. The reason that Lilly's spinning it out is that it's growing relatively small year over year. That's dragging down the overall performance. I think what you have a lot of these big pharmaceutical companies looking at is saying, maybe it makes sense to get rid of some of these slow growers, focus more on these next generation solutions like biologics. I think that's why you're seeing them unlock value by spinning out Elanco. As you mentioned, later this year, less than 20% equity will be available in that through an IPO. They plan to get rid of the rest of their shares, depending on market conditions, throughout the course of 2019.

Harjes: I don't know about you, Todd, but I'm assuming that right out of the gate, this company is probably going to get a pretty favorable valuation mostly because of how successful Zoetis has been. Zoetis carries a substantially higher price to earnings multiple that Pfizer itself does. It has a market cap at this point of $40 billion. When you think about Elanco, which is the Eli Lilly division, that's a company that does about 13% of Eli Lilly's total revenue. It's pretty substantial company, bringing in about $3 billion a year. The animal health market generally is expected to grow about 5% annually for, as far as we can tell, the foreseeable future. It has a lot less generic competition than human pharmaceuticals. It also has a shorter product development cycle, because it's animals as opposed to humans, so you don't have as high of fences set by the FDA to get drugs to market.

The IPO is expected at the end of this year. I'll definitely be interested to see both how the market reacts initially, and also what Eli Lilly's plans for that other over 80% of the company is. They've indicated that they don't intend to hold on to that forever.

Campbell: Right. Of course, that could create some drag, as those shares come to market, on the performance in the first year. Maybe that provides an opportunity for investors to start building up their exposure to it.

What's interesting is, Eli Lilly is doing some prep work and has been doing some prep work. They've been exiting some products within that business to try to and goose sales for once they IPO it. If you look at their pro forma after exiting those businesses, their pro forma growth for Elanco was about 8% year over year to $792 million in the second quarter.

The devil will be in the details. People are going to want to watch closely for when the S-1, which is the document that's filed with the SEC for an IPO, is filed. Read through it. It's going to be pretty insightful.

Kristine Harjes has no position in any of the stocks mentioned. Todd Campbell owns shares of Pfizer. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.