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Eli Lilly and Company - Stock Valuation Report Eric Wu

Eli Lilly and Company 7/14/18 Wu, E

Stock Evaluation Report: Eli Lilly and Company, 7/14/18 SUMMARY Eli Lilly and Company (LLY) is a global healthcare leader that discovers, develops, manufactures, and markets pharmaceutical products worldwide. The company operates through two segments, Human Pharmaceutical and Animal Health products. Eli Lilly is the 16th largest company within the healthcare sector of the S&P 500, generating $22,781.3 million in revenue in FY2017, an 8% increase from FY2016.1 (all revenues noted in millions) Summary Recommendation BUY INVESTMENT THESIS Ticker LLY We are placing a BUY rating on LLY with a Sector Healthcare price target of $85.51. With the combination Industry Pharmaceuticals of 11 new products within their pipeline Price as of 7/15/18 $89.71 poised to launch by 2023, rapidly growing Target Price $108.24 products such as Trulicity, Taltz, Basaglar, Potential Upside 20.7% Cyramza, and Jardiance, and an aging and Dividend Yield 2.62% increasingly unhealthy demographic, Eli Lilly Total Projected Return 23.32% looks to weather the upcoming loss of Market Data domestic patent exclusivity for Cialis, Forteo, Market Cap 93.26B and Alimta Shares Outstanding 1,085,430,000 EPS (TTM) 1.97 RISKS TO THIS RECOMMENDATION P/E Ratio 19.89 • Pharmaceutical research and EV/EBITDA 14.23 development is costly and uncertain Beta 0.3 • Losing effective intellectual property Qtrly Revenue (YoY %) 9% protection on revenue generating Performance products will lead to rapid and severe 52 Week Price Low-High 73.69 - 89.87 revenue decline in those product lines 1 Year Return 6.77% • Human pharmaceutical business is subject to government price controls and unanticipated tax liabilities • Intense competition from lower-cost generic and manufacturers1

Contact Information Fund SIM, OSU Instructor Royce West, CFA Name Eric Wu, PharmD Email [email protected]

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Eli Lilly and Company 7/14/18 Wu, E

Table of Contents

COMPANY OVERVIEW ...... 3 General Overview ...... 3 Business Segments ...... 3 Animal Health Products ...... 4 Human Pharmaceutical Products ...... 5 Market Landscape ...... 10 Patent Exclusivity Loss Summary ...... 13 INVESTMENT THESIS ...... 14 Healthcare Sector Summary ...... 14 Financial Analysis ...... 15 Valuation Analysis and Price Target ...... 16 Discounted Cash Flow Model ...... 17 Relative Multiples Valuation Model ...... 18 RISKS ...... 19 CONCLUSION ...... 20 APPENDIX ...... 21 Pipeline Summary ...... 21 Estimated Product Revenue ...... 22 Discount Cash Flow Valuation ...... 23 Income Statement ...... 24 REFERENCES ...... 25

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Eli Lilly and Company 7/14/18 Wu, E

Company Overview GENERAL OVERVIEW Eli Lilly and Company (LLY) is a global healthcare leader headquartered in , that discovers, develops, manufactures, and markets pharmaceutical products worldwide. The company operates through two segments, Human Pharmaceutical Products and Animal Health Products. Established in 1876, LLY employs approximately 38,000 individuals worldwide with products marketed in 120 countries, leading them to be the 16th largest company per market cap within the healthcare sector of the S&P 500.5 The human pharmaceutical segment consists of several divisions: Endocrinology, oncology, cardiovascular, neuroscience, and immunology. Lilly’s animal segment operates through their

Elanco division, focusing on both animals for consumption and companion animals.1 In 2017, LLY generated $22,871.3 million in revenue, an 8% increase from the prior year. LLY posted an earnings (loss) of $0.19 attributed to new U.S. tax laws and company restructuring. With 11 poised to launch by 2023 (9 total since 2014), LLY looks to continue increasing revenue trends.2 The stock has outperformed the industry this year thus far, however, competitive pressures are expected to increase as patent exclusivity for certain products such as Cialis are expiring. BUSINESS SEGMENTS Eli Lilly’s animal health products segment (operated through Animal Health) is a global company that has enjoyed a decade of growth. Elanco focuses on identifying and developing products that meet unmet veterinary, food producer, and pet owner needs. Additionally, Elanco also utilizes discoveries from the human health laboratories to develop products supporting the wellbeing of farm animals and pets. Elanco sells its products primarily to wholesale distributors. Unfortunately, it has underperformed as of late (-2.3% revenue between FY2016 and FY2017) and Lilly is reviewing strategic alternatives including a sale, merger, initial public offering, or retention of the business. They are hoping to make a decision about Elanco in mid-2018.2 Lilly’s human pharmaceuticals products segment drives the majority of revenues within the company. Of $22,871.30 million revenue, $19,785.60 originated from the human pharmaceutical products segment. This segment is further divided into 6 divisions: Endocrinology (Humalog®, Trulicity®, Forteo®, Humulin®, Trajenta®, Jardiance®, Basaglar®), oncology (Alimta®, Cyramza®, Erbitux®), cardiovascular (Cialis®, Effient®), neuroscience (Cymbalta®, Strattera®, Zyprexa®), immunology

(Taltz®), and other.2

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Revenue By Segment Revenue By Region

Other Animal Health Foreign 13% Countries 16% Japan 11% United States 56% Human Pharmaceutical Europe 87% 17%

FY2016 FY2017 Change% FY2016 FY2017 Change% Animal Health 3,158.20 3,085.60 -2.30% USA 11,506.20 12,785.10 11.11% Human Europe 3,768.10 3,943.20 4.65% 18,063.90 19,785.60 9.53% Pharmaceuticals Japan 2,330.90 2,419.70% 3.81% Total 21,222.10 22,871.30 7.78% Other 3,616.90 3,723.30 2.94%

Lilly’s Animal health business operated through Elanco comprised 13% of total company revenue. Elanco reported $761.3 million in revenue in 2018 Q1, a 1% decrease from 2017 ($769.4 million). According to Lilly’s Q1 press release, this is due to worldwide food animal revenue decreasing by 7% driven by market access pressures. Companion animal revenue increased by 10%, however, primarily driven by higher realized prices and the favorable impact

of foreign exchange rates.3

Lilly’s Animal Health Products include1:

Food Animal • Rumensin®: a cattle feed additive that improves feed efficiency and growth and also controls and prevents coccidiosis • Coban®, Maxiban®, and Monteban®: an anticoccidial agent used in poultry • Posilac®: a protein supplement to improve milk productivity in dairy cows • Optaflexx® and Paylean®: leanness and performance enhancers for cattle and swine

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• Tylan®: an used to control certain diseases in cattle, swine, and poultry • Denagard®: an antibiotic for the control and treatment of respiratory and enteric diseases in swine and poultry Companion Animal • Trifexis®: a monthly chewable tablet for dogs that kills fleas, prevents flea infestations, prevents heartworm disease, and controls intestinal parasite infections • Comfortis®: a chewable tablet that kills fleas and prevents flea infestations in dogs • Interceptor® Plus: A monthly chewable tablet that prevents heartworm disease and treats and controls adult hookworm, roundworm, whipworm, and tapeworm in dogs • Galliprant®: an anti-inflammatory tablet that targets the key receptor associated with canine pain • Feline, canine, and rabies : Duramune®, Ultra Duramune®, Duramune Lyme®, Bronci- Shield®, Fel-O-Vax®, ULTRA Fel-O-Vax®, and Fel-O-Guard®, and Rabvac®

Lilly’s Human Pharmaceutical Products experienced varied growth and loss. Comprising of 87% of total revenue for FY2017, Lilly’s Human Pharmaceutical Products reported $4938.7 million in 2018 Q1, a 10.7% increase from 2017 Q1. According to Lilly’s Q1 Press Release, this may be due to revenue increase of 4% due to favorable impact of foreign exchange rates, a 3% increase due to higher realized prices, and a 2% increase due to volume. Increased revenue was partially offset due to loss of patent exclusivity for Strattera and Effient®, as well as decreased demand

for Cialis.3 Notably, endocrinology has enjoyed strong growth (25%) and will be discussed in further detail later. Some divisions within the human pharmaceutical products such as

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cardiovascular (-11%) and neuroscience (-20%) experienced notable loss and will also be discussed in further detail later.

Lilly’s Human Pharmaceutical Segment Consists of1: Endocrinology • Humalog®, Humalog Mix 75/25, Humalog U-100, Humalog U-200, Humalog Mix 50/50: analogs for the treatment of diabetes; For 2018 Q1, Humalog revenue increased by 12% relative to 2017 Q1. Largely due to higher realized prices due to changes in estimates to rebates and discounts and changes in payer segment mix in conjunction with increased volume.

International revenues also enjoyed favorable impact of foreign exchange rates.3

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• Humulin®, Humulin 70/30, Humulin N, Humulin R, and Humulin U-500: human for the treatment of diabetes; The 4% increase in revenue for 2018 Q1 vs 2017 Q1 was driven by

increased demand, partially offset by lower realized prices and decreased foreign revenue3 • Trulicity®: GLP-1 agonist used for the treatment of type 2 diabetes; 2018 Q1 revenue increased by 82% relative to 2017 Q1. This is largely due to higher demand within the GLP-1 class and increased share of market for Trulicity. Foreign revenue was bolstered by increased volume and

favorable impact of foreign exchange rates3 • Trajenta®: DPP4 inhibitor used for the treatment of type 2 diabetes • Jentadueto® and Jentadueto XR: a combination of Trajenta () and for the treatment of type 2 diabetes • Jardiance®: SGLT2 inhibitor used for the treatment of type 2 diabetes and to reduce the risk of cardiovascular death in adult patients with diabetes and established cardiovascular disease; 2018 Q1 revenue enjoyed a 104% increase relative to 2017 Q1. This was largely due to

increased share of the market for Jardiance and growth in the SGLT2 class3 • Glyxambi®: a combination tablet of Trajenta (linagliptin) and Jardiance () for the treatment of type 2 diabetes • Synjardy® and Synjardy XR: a combination tablet of Jardiance (empagliflozin) and metformin for the treatment of type 2 diabetes • Basaglar®: a long-acting human for the treatment of diabetes; 2018 Q1 revenue ($166 million) increased by $12.3 million relative to 2017 Q4. This is largely a result of increased demand due to Medicare Part D formulary access and partially offset by lower realized prices and changes in estimates of rebates and discounts. • Forteo®: a parathyroid analog used for the treatment of osteoporosis in postmenopausal women and men at high risk and for glucocorticoid-induced osteoporosis in men and postmenopausal women; 2018 Q1 saw a 10% decrease in revenue compared to 2017 Q1. Revenue in the U.S. decreased by 31%, primarily due to decreased volume and lower realized prices; this was dampened by an increase in foreign revenue driven by favorable impact of

foreign exchange rates and increased volume3 • Evista®: a selective estrogen receptor modulator used for the prevention and treatment of osteoporosis in postmenopausal women and for the reduction of the risk of invasive breast cancer in postmenopausal women with osteoporosis and postmenopausal women at high risk for invasive breast cancer • Humatrope®: a used for the treatment of human growth hormone deficiency and certain pediatric growth conditions

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Neuroscience • Cymbalta®: an SNRI used for the treatment of major depressive disorder, diabetic peripheral neuropathic pain, generalized anxiety disorder, , and chronic musculoskeletal pain due to chronic lower back pain or due to osteoarthritis • Zyprexa®: an atypical used for the treatment of , acute mixed or manic episodes associated with bipolar I disorder, and bipolar maintenance • Strattera®: a norepinephrine reuptake inhibitor used for the treatment of attention-deficit hyperactivity disorder • Prozac®: an SSRI used for the treatment of major depressive disorder, obsessive-compulsive disorder, bulimia nervosa, and panic disorder • Amyvid®: a radioactive diagnostic agent for positron emission tomography imaging of beta- amyloid neuritic plaques in the brain

Oncology • Alimta®: an antimetabolite, antineoplastic agent used in combination with another agent for advanced non-small cell for patients with non-squamous cell histology

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• Erbitux®: an EGFR inhibiting, antineoplastic agent used as both a single agent and in combination for the treatment of certain types of colorectal cancers and for certain types of head and neck cancers • Cyramza®: a VEGF inhibiting, antineoplastic agent used in metastatic gastric cancer, metastatic NSCLC, and metastatic colorectal cancer; 2018 Q1 noted a 7% increase in revenue relative to 2017 Q1. This was largely due to increased volume and higher realized prices. Foreign revenue was bolstered by favorable impact of foreign exchange rates and increased volume, partially

offset by lower realized prices3 • Gemzar®: an antimetabolite, antineoplastic agent used for the treatment of metastatic breast cancer, NSCLC, and advanced or recurrent ovarian cancer (in the EU for bladder cancer) • Portrazza®: an EGFR inhibiting, antineoplastic agent used in combination for metastatic squamous NSCLC • LartruvoTM: a PDGFR-alpha blocking, antineoplastic agent used in combination for the treatment of soft tissue carcinoma; 2018 Q1 U.S. Revenue ($43 million) noted a $1.5 million

increase relative to 2017 Q4.3 • VerzenioTM: a cyclin-dependent kinase inhibiting, antineoplastic agent used as a single agent or in combination for the treatment of advanced or metastatic breast cancer; 2018 Q1 revenue

($29.7 million) noted an increase of $8.7 million compared to 2017 Q43

Immunology • Olumiant®: a janus associated kinase inhibitor, used for the treatment of adults with moderate to severely active rheumatoid arthritis; 2018 Q1 revenue ($32.2 million) noted a $9.2 million

increase relative to 2017 Q4, largely due to a strong launch uptake in Germany3 • Taltz®: an anti-interleukin 17A monoclonal antibody, antipsoriatic agent used for the treatment of moderate to severe plaque ; 2018 U.S. revenue ($111.2 million) saw a decrease of $31.3 Million from 2017 Q4. This was largely due to lower volume due to specialty pharmacy

buying patterns, offset by higher demand, including an increase in new patient starts3

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Cardiovascular • Cialis®: a PDE5 inhibitor used for the treatment of and benign prostatic hyperplasia. U.S. revenue increased by 6% compared to 2017 Q1 driven by higher realized prices, but was largely offset by decreased demand due to the entry of generic . Cialis

revenue outside the U.S. decreased by 23% driven by loss of exclusivity in Europe.3 • Effient®: a thienopyridine, antiplatelet agent used for the reduction of thrombotic cardiovascular events (including stent thrombosis) in patients with acute coronary syndrome who are managed with an artery-opening procedure known as percutaneous coronary intervention

MARKET LANDSCAPE Eli Lilly is the 9th largest pharmaceutical company within the . Although the health care sector as a whole has performed well relative to the S&P 500 benchmark, it is noted that the pharmaceuticals industry has consistently lagged behind. There are many factors that may have contributed to this, although fears of harsh legislation limiting profits were avoided this year, and pharmaceuticals have enjoyed a slight rebound in performance. With a wide array of targeted disease states, Lilly faces an equally wide variety of competing pharmaceutical companies and generic manufacturers (discussed later.) One mitigating factor is that many pharmaceutical companies target specific disease states mindfully allocating their resources while limiting their exposure to competition. Notably, in comparison to 4 of the 5 largest companies per market cap within the pharmaceutical industry: Johnson & Johnson (JNJ), Merck and Co (MRK), AG

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(NVS) and Inc (PFE), many overlapping disease states are targeted and several trends are evident. This figure shows total pharmaceutical revenue in FY2017 and growth from FY2016. Worth mentioning, many of these companies have other business segments outside of pharmaceuticals or are involved with generic manufacturing (NVS), but this figure is based on comparable, innovative pharmaceutical revenue. Despite JNJ being the largest company within the healthcare sector per market cap, all 4 other companies generated higher revenues through their pharmaceutical segment. JNJ did, however, enjoy a near 18% increase into 2017.

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This figure further compares Lilly’s divisional revenues versus competing rival companies, along with their % change from 2016 to 2017. Notably, Lilly has enjoyed a large portion of revenue from endocrinology, which is unsurprising considering their portfolio is heavily weighted within the diabetes disease state. Age-adjusted Prevalence of Obesity and Diagnosed Diabetes Among US Adults

Obesity (BMI ≥30 kg/m2) 1994 2000 2015

No Data <14.0% 14.0%–17.9% 18.0%–21.9% 22.0%–25.9% > 26.0%

Diabetes 1994 2000 2015

No Data <4.5% 4.5%–5.9% 6.0%–7.4% 7.5%–8.9% >9.0%

CDC’s Division of Diabetes Translation. United States Surveillance System available at http://www.cdc.gov/diabetes/data

A look at the U.S. trends in regards to obesity and diabetes (often linked due to correlative nature of patients) shows the dramatically increasing numbers affected by both. Between 1994 and 2015, the percentage of patients within the country diagnosed with these disease states has nearly doubled. To put this into perspective, in 2012 the estimated total economic cost of diagnosed diabetes was $245 billion, which was a 41% increase from previous estimated costs in 2007 of $174 billion.11 Within diabetes treatment guidelines, GLP-1 agonists such as Trulicity have been gaining momentum, as their favorable side effect profile and improved dosing schedule (once weekly) have gained provider appeal. Desirable weight loss and lack of hypoglycemia risk have led to increased usage and Trulicity’s weekly dosing differentiates this product with remaining GLP-1 agonists. Although they have the lowest amount of revenue generated through immunology, Taltz and Olumiant enjoyed massive growth and will look to continue that trend as Olumiant gained FDA approval within the U.S. in June of 2018. Losses within the cardiovascular and neuroscience divisions are linked to losses of patent exclusivity for several products. Within the neuroscience division, Zyprexa and Cymbalta

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revenue continue to decline since their patents expired in 2011 and 2013, respectively. The cardiovascular division noted a strong decline due to Cialis revenue loss as Pfizer reached a settlement that allowed Teva in 2017 to begin manufacturing a generic for their PDE5 inhibiting competitor, Viagra. The following diagram depicts impending patent losses and 2017 revenues:

With impending domestic losses of patent exclusivity with Cialis, and foreign losses of Forteo and Cymbalta, Lilly will have to seek out opportunities to mitigate revenue losses due to those products. Once drugs lose patent protection, lower-priced generics quickly siphon off as much as 90% of the brand-name sales as they offer products priced at on average 30% of the brand- name products.12 Lilly will hope to weather the imminent losses of revenue through continued growth from their current portfolio as well as drawing revenue from their innovative pipeline in which they hope to have 11 new products introduced by 2023 (9 since 2014.) Their current pipeline (Appendix) shows that Lilly hopes to introduce products from a multitude of their current divisions.

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Investment Thesis HEALTHCARE SECTOR SUMMARY With the aforementioned factors providing optimism despite the impending loss of patents, several other factors may also play a significant role. As the U.S. continues to age, health care expenses increase dramatically as well. As the CDC has explained, from 1997 to 2013, patients aged ≥65 increased from 34.2M to 46.5M (out of 271.3M to 315.7M), a 16.84% increase relative to total population. Mean annual expenses per person with expenses for patients aged ≥65 was $10,125 compared to $5,256 for the total population.14,15 The Centers for Medicare & Medicaid Services (CMS) has projected national health care spending to grow at Source: https://www.cdc.gov/chronicdisease/resources/publications/aag/healthy-aging.htm an average rate of 5.5% per year for 2017-2026 (2008-2016 grew at 4.2%)19. These factors may demonstrate a long-term influence for profitability, as it is estimated that the patient population aged ≥65 looks to double by 2050. Additionally, as we enter the late to recession phases of the business cycle, experts believe that investors will note the signs of economic slowdown leading to heavier investments within defensive-oriented, less economically sensitive sectors (those tied to basic needs, such as healthcare.)4 Despite optimistic factors, the pharmaceutical industry has lagged the remainder of the sector for the last several years. This may partially be in response to uncertainty in potential legislation that looks to reduce pharmaceutical prices for consumers which would naturally create a ripple of decreased profits throughout the health care sector. When current U.S. President Donald Trump declared via social media

platform Twitter23 in regards to speculative Pfizer drug price increases, PFE saw a 1.2% decrease in stock price and the pharmaceutical industry as a whole

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saw a reduction by 0.55% per Fidelity. Notably, both company and industry bounced back by the next day. On May 11, 2018, President Trump spoke in regards to his proposal for health care reform. He had mentions of eliminating the middlemen, limiting special interests, while instructing Secretary Azar (Eli Lilly and Company’s President of the U.S. Division from 2012-2017 and now United States Secretary of Health and Human Services) to continue working towards battling rising costs. Notably, President Trump stated13: }

~ Despite previously stating that pharmaceutical companies were “getting away with murder,” President Trump didn’t mention plans that allowed Medicare to directly negotiate drug prices or permit lower-priced drug imports from other countries, which were previously met much resistance. Instead, he mentioned increasing costs for foreign governments and patients to help alleviate the cost burden within The U.S. S&P and NASDAQ biotech indices rose nearly 3% following the address.17 Notably, if the current administration targets foreign drug prices, a proposal that had potentially dire consequences for the pharmaceutical industry resulted in what could prove to have an entirely opposite and thus positive net effect on Lilly. FINANCIAL ANALYSIS Eli Lilly and Company is a financially healthy company. Total revenues continue to grow, with 2018 Q1 revenues enjoying an 8% increase from

2017 Q1.3 With regards to Lilly’s operating expenses as a percentage of total revenue, Lilly has committed to maintaining proportional R&D expenses to maintain and develop their promising pipeline. Additionally, through a “company-wide effort to drive productivity, streamline how they work, and a reduced workforce” Lilly continued to note a decreased

proportion of SG&A expenses.2 This all contributed to a continually increasing operating margin with a company goal of 30 percent or better by 2020.2

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In comparison to these companies’ averages, Lilly maintains similar or slightly more impressive margins. Additionally, with a comparable current ratio (1.4) as the other large pharmaceutical companies, Lilly continues to maintain a healthy working capital to ensure that it can adequately meet its current liabilities while providing an 8.16% return on equity.4 Lilly continues to consistently exceed consensus earnings estimates for the past 4 quarters, while demonstrating continued earnings growth. Finally, despite the extreme scrutiny from the press and governmental officials in regards to drug costs weighing pharmaceuticals, Lilly has managed in the past 5 years to provide an annualized total shareholder average return of 15%, compared to 16% for the S&P benchmark due to the

increase in stock price and steady dividend stream.2 Of note, due to The 2017 Tax Act, an estimated income tax provision of $1.91 billion was recorded in December of 2017, which resulted in the -0.19 EPS, later reconciled to 4.28.1,2

VALUATION ANALYSIS AND PRICE TARGET With these factors in mind, since 2013 (when patent exclusivity for Cymbalta was lost), Lilly has sustained continued, consistent sales growth. Although key patent losses are expected in 2018, it appears that Lilly is much better equipped with a robust pipeline and current portfolio to weather the losses. Thus, based on previous trends and typical pharmaceutical product cycles, my revenue growth estimate is slightly more bullish than consensus estimates. Basing loss of Cialis revenue on losses experienced by Pfizer when Teva began manufacturing generic sildenafil in 2017, my estimations for divisional revenues are (Consensus estimate was $23,930):

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With a steady and stable cash flow, and steadily and consistently improving metrics and inputs such as the aforementioned operating expenses, The Discounted Cash Flow (DCF) Model is an appropriate model to use to assess Lilly’s intrinsic stock value. Additionally, DCF isn’t influenced by short-term market conditions or non-economic factors, which is useful during this time of volatility due to public scrutiny. I have assigned a 60% weight to the DCF based valuation. With intense competition within the prescription drug companies, multiples based valuation demonstrates importance as we can utilize similar, competing companies to determine an estimated price target while seeking correlations between their operating and financial characteristics. I have assigned a 40% weight to my valuation based on multiples.

DISCOUNTED CASH FLOW MODEL The appendix contains details in regards to the DCF modeling used. I have taken a discount rating of 9.50% and a terminal growth rate of 4%. The current S&P 500 multiple implies a 4% growth rate and 10% discount rate. With defensive characteristics, favorable demographics, traditionally low beta, and other factors listed above, I believe the 9.50% discount rate would be warranted. Notably, if a reasonable 9.0% were used, our valuation would increase from $111 to $122.2, (23.7% to 36.2%) With high level of uncertainty and scrutiny regarding health care regulations (short-term concerns with nothing certain or concrete yet) weighing stock prices, this appears to be an opportunity to BUY Lilly as the stock appears to be undervalued. These figures above detail how stock prices may fluctuate with regards to adjustments to both discount rates and terminal growth rates. RELATIVE VALUATION MODEL The health care sector as a whole traditionally trades at slightly higher rates relative to the

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S&P 500. This is largely attributed to large profit margins, continual and steady revenue growth, and improving operating margins. However, both the sector as a whole and Lilly as an individual stock is currently trading just below the benchmark P/E. This again may be attributed to uncertainty in government legislation and scrutiny resulting from increased drug pricing. However, as mentioned, this may very likely be an unrealized, short-term phenomenon that presents us a buying opportunity. Following the S&P 500, Lilly is currently showing higher pricing ratios compared to their median over the last 10 years. This appears to be a reflection of the market as a whole. Additionally, after the large one-time paid tax in 2017 lowering earnings, effective tax rates decreased to 15.5% for 2018

Q1.3 In comparison with similar peers within the pharmaceutical industry, Lilly is notably not far off from the average multiples these companies present. Weighing each ratio equally results in a target price of $104.09. Finally, with steady, predictable cash flows and remarkably similar peers to compare with, a 60:40 valuation nets a final price target of $108.24, or a 20.7% upside to current pricing.

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Risks

• Pharmaceutical research and development is costly and uncertain1 o For every 5,000 compounds discovered, only 1 reaches the pharmacy o Fewer than a third of marketed drugs achieve enough commercial success to recoup their R&D investments21 o According to a study conducted by Tufts Center for the Study for Drug Development, cost of developing a prescription drug that gains market approval is approximately

$2.6 billion, a 145% increase over the estimate the center made in 200320 o FDA requires drugs to undergo three phases of clinical testing on humans: Phase I: Safety and Dosage (70% move to the next phase) Phase II: Efficacy and Side Effects (33% move to the next phase) Phase III: Efficacy and monitoring of adverse reactions (25-30% of drugs move to the

next phase)22 • Losing effective intellectual property protection on revenue generating products will lead

to rapid and severe revenue decline in those product lines1 o Once drugs lose patent protection, lower-priced generics quickly siphon off as much as 90% of the brand-name sales12 o Although Viagra had been losing revenue steadily since 2011, 2017 saw a 30% decline in revenue despite the generic release occurring late in the fiscal year o Cymbalta saw a decline in revenue of nearly 70% the year after losing patent exclusivity • Human pharmaceutical business is subject to government price controls and unanticipated

tax liabilities1 o As noted previously, pharmaceutical drug pricing has been highly scrutinized within both the media and by government officials o Uncertainty and volatility is expected to continue as efforts to limit increasing drug prices are continually present; Despite this, President Trump directed blame on “middle men” such as pharmacy benefit managers

• Intense competition from lower-cost generic and biosimilar manufacturers1 o When comparable generics are available, they offer products priced at on average 30% of the brand-name products.12 o In 2010, Congress approved the Biologics Price Competition and Innovation Act (BPCIA), allowing an abbreviated approval pathway for (a less expensive, interchangeable product with an FDA-approved biological product such as insulin) o In 2015, the first biosimilar product was approved for marketing in the U.S.; Notably, Lilly has Basaglar which has demonstrated immense revenue growth from 2016 to 2017 and continues to realize that growth into 2018 Q1

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Conclusion BUY Eli Lilly and Company (NYSE: LLY) with a price target of $108.24 as it is currently undervalued by approximately 21% Since the start of 2018, Lilly has had Olumiant (), a rheumatoid arthritis used in Europe approved in the U.S. The FDA approved it at lower doses, but success in foreign countries will yield domestic benefits. Lilly’s also met its primary endpoint in its phase III study, providing encouraging potential for future migraine and cluster headache therapy. Combining Lilly’s promising pipeline with the optimistic factors (aging demographics, increasingly unhealthy population, increased healthcare spending, defensive sector, inelastic demand, etc.) underlying the pharmaceutical industry, Lilly looks poised to continue their success for the foreseeable future as they continue to improve the well-being of their financial health (increasing revenues, decreasing operation expenses, etc.) and as a result, patient health.

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PIPELINE SUMMARY

Phase 1 Phase 2

Phase 3 Regulatory Review

Human Segment Division

*Multiple indications2

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References 1. Eli Lilly and Company. (2017). Annual Report and Proxy Statement 2017. Retrieved from https://investor.lilly.com/static-files/423887ae-38f3-463c-9d11-43088a30d68f 2. Eli Lilly and Company. (2017). 2017 Integrated Summary Report. Retrieved from https://assets.ctfassets.net/hadumfdtzsru/2Ayd5rsLd2AyMsQ8wY8wO0/79e2398c034863923b99098 b53762406/2017_Lilly_Integrated_Summary_Report.pdf 3. Eli Lilly and Company. (2018). Q1 Earnings Release 2018. Retrieved from https://investor.lilly.com/static-files/a644463e-77d5-41de-8d99-cd0604e580e3 4. Data from: Fidelity.com (7-14-18) 5. Data from: Finance.Yahoo (7-14-18) 6. Data from: Market Realist (7-14-18) 7. Johnson and Johnson. (2017). Proxy Statement 2017. Retrieved from https://jnj.brightspotcdn.com/c4/59/2988b7a8407c93507f0a08708d9e/2017-0310-proxy-statement- with-bookmarks.pdf 8. Pfizer, Inc. (2017, 2014, 2011, 2008). Financial Report 2017, 2014, 2011, 2008. Retrieved from https://investors.pfizer.com/financials/annual-reports/default.aspx 9. Novartis AG. (2017) Annual Report 2017. Retrieved from https://www.novartis.com/investors/novartis-annual-report/annual-report-archive 10. Merck and Co, Inc. 2017. Annual Report 2017. Retrieved from http://investors.merck.com/financials/annual-reports-and-proxy/default.aspx 11. Economic costs of diabetes in the U.S. In 2012. Diabetes care. 2013;36:1033–1046. [PMC free article][PubMed] 12. DeRuiter, Jack. “Drug Patent Expirations and the ‘Patent Cliff.’” U.S. – The Leading Journal in Pharmacy, USPharmacist, 20 June 2012, stage.uspharmacist.com/article/drug-patent-expirations- and-the-patent-cliff. 13. Garden, Rose. “Remarks by President Trump on Lowering Drug Prices.” The White House, The United States Government, 11 Mar. 2018, 14:08, www.whitehouse.gov/briefings-statements/remarks- president-trump-lowering-drug-prices/. 14. “Healthy Aging.” Centers for Disease Control and Prevention, Centers for Disease Control and Prevention, 15 Jan. 2016, www.cdc.gov/chronicdisease/resources/publications/aag/healthy- aging.htm. 15. “National Center for Health Statistics.” Centers for Disease Control and Prevention, Centers for Disease Control and Prevention, 3 May 2017, www.cdc.gov/nchs/fastats/health-expenditures.htm. 16. Mukherjee, Sy. “Why Trump's Big Drug Price Speech Sent Health Care Stocks Soaring.” Fortune, Fortune, 11 May 2018, fortune.com/2018/05/11/trump-drug-pricing-proposal-health-stocks/. 17. Mukherjee, Sy. “Why Trump's Big Drug Price Speech Sent Health Care Stocks Soaring.” Fortune, Fortune, 11 May 2018, fortune.com/2018/05/11/trump-drug-pricing-proposal-health-stocks/. 18. Data from: Bloomberg (5-16-18) 19. “National Health Expenditure Projections 2017-2026.” National Health Expenditure Projections 2017- 2026, Centers for Medicare & Medicaid Services, 17 Apr. 2018, www.cms.gov/Research-Statistics- Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/index.html.

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20. Mullin, Rick. “Tufts Study Finds Big Rise in .” CEN RSS, American Chemical Society, 20 Nov. 2014, cen.acs.org/articles/92/web/2014/11/Tufts-Study-Finds-Big-Rise.html. 21. Spiegel, Francis. “The Economics of Pharmaceutical Research and Development: An Industry Perspective.” Advances in Pediatrics, Institute of Medicine (US) Committee on Technological Innovation in Medicine, 1 Jan. 1991, www.ncbi.nlm.nih.gov/books/NBK234300/. 22. “The Drug Development Process - Step 3: Clinical Research.” U S Food and Drug Administration Home Page, Center for Biologics Evaluation and Research, 13 June 2018, www.fda.gov/ForPatients/Approvals/Drugs/ucm405622.htm. 23. Trump, Donald J. “‘Pfizer & Others..."Twitter, Twitter, 9 July 2018, twitter.com/realdonaldtrump/status/1016368503723577344?lang=en.

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