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Morningstar | Lilly's 1Q Hurt by Generic Competition and Slowing Trulicity Growth, but Still Well Positioned

Eli Lilly reported first-quarter results slightly below our expectations, but we don't expect any major changes to our fair value estimate based on the minor underperformance. We see the stock as largely fairly valued with the potential of the company's leading drugs well reflected in the stock price. The strength of currently marketed drugs as well as the pipeline confirms our wide moat rating.

In the quarter, total sales increased 5% operationally, with strong growth from diabetes drugs Trulicity, Basaglar, and Jardiance along with gains from immunology drug Taltz and cancer drug Verzenio offsetting generic competition to erectile dysfunction drug Cialis. We expect growth will accelerate in 2020 as the company laps generic competition on Cialis and recently launched drugs continue to grow. While we expect growth for Trulicity to continue, we expect a deceleration of the robust historical growth due to increasing competition from Novo Nordisk and pricing pressure from payers that seemed to play a minor role in the slower growth of the drug in the quarter (up 30% year over year but down from the close to 60% annual growth seen in 2018). Although Taltz and Verzenio entered markets later than competitors, we expect the drugs to gain more share based on excellent clinical data.

As Lilly's recently launched drugs continue to grow, the company is well positioned to expand margins as the growth from specialty drugs carries stronger margins. We expect operating margins to expand by close to 500 basis points over the next three years despite still funding a strong pipeline, with research and development expenditures averaging more than 22% of sales over the next three years.

In the pipeline, we remain bullish on neurology drug lasmiditan, immunology drug mirikizumab, and diabetes drug tirzepatide, all of which hold annual sales potential of over $1 billion. However, recent long-term data on pain drug tanezumab highlighted a recurring concern around joint safety, and we expect to slightly reduce our probability of approval while Lilly and partner Pfizer discuss potential next steps with the regulatory agencies for this drug. For a complete review of Lilly's pipeline and currently marketed portfolio, please see "Annual Drug Pipeline Report: Moats Remain Secure as Innovation Counters Pricing and Generic Headwinds, but M&A Accelerating."