Shares of Eli Lilly (LLY 2.51%) fell 20% in July, according to data from S&P Global Market Intelligence. The pharmaceutical stock tumbled after one of the company's competitors announced promising clinical trial news on an obesity drug. Lilly has two obesity products that are powering sales right now, and it could lose market share ahead of schedule if any of its rivals push smoothly through development.
Unwelcome news from a key competitor
On July 17, Roche (RHHBY 2.84%) announced favorable clinical results for a once-daily pill for weight loss and type 2 diabetes. The Swiss pharmaceutical company's candidate achieved clinically significant weight loss with a month of treatment in a phase 1 trial. Phase I trial results are still far from commercialization, but the announcement is an unquestionably positive step. It also marks Roche's second pipeline candidate for these sorts of indications.
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The dosage method is noteworthy for Eli Lilly. The company is one of the promising early movers in the weight loss drug space with its Zepbound and Mounjaro products. Those two drugs are already blockbusters for the company, and it's looking to add more to the portfolio. It has several weight loss treatments and more convenient dosing methods in various stages of development.
Early mover status has unquestionably benefited Lilly, but the good times might be coming to an end. Obesity is a major problem globally, and it keeps getting worse every year. Where most people and healthcare professionals see a global health crisis, drugmakers see a lucrative opportunity. Demand for effective obesity treatments is nearly guaranteed to be strong for the foreseeable future.
Unfortunately for the suppliers of those treatments, the allure of robust demand is quickly attracting competition. Lilly and Novo Nordisk (NVO 2.58%) are dominant in most markets right now, but that won't be the case much longer. Roche's latest announcement is one example, but the list includes a crowd of pharma giants and startup biotechs. Pfizer (PFE 2.57%), Amgen (AMGN 3.52%), and Viking Therapeutics (VKTX 3.12%) all have promising products that could hit the market in the next couple of years. These treatments will compete on quality and price, reducing the incumbent's share of the market.
It's a matter of "when" rather than "if," and the Roche announcement was a stern reminder. Investors may have to temper expectations for the cash flows generated by two of Lilly's most important products. Immediately following the report, shares of Lilly and Novo Nordisk moved lower in tandem, while Roche did the opposite.
Eli Lilly is still priced for growth
Despite sliding, Lilly's valuation still indicates bullish sentiment. Its forward P/E ratio is over 55, which can only be supported by significant growth from the current scale. The stock isn't a compelling income play, either. The 0.6% dividend yield is fairly low compared to other established healthcare stocks. Its 70% payout ratio suggests an opportunity to comfortably increase distributions from here, but the dividend yield once again only makes sense if corporate earnings expand significantly.
LLY PE Ratio (Forward) data by YCharts
Lilly needs big results from its innovative new treatments in order to justify its valuation. That performance is entirely possible, but an influx of competition makes things uncertain. As long as the drugmaker has a bullish valuation, the stock will be prone to volatility whenever a direct competitor announces good news on its own weight loss treatments.
