Is Lilly’s Dividend Safe?

Is Lilly’s dividend safe?

1. Patent expiration– Cymbalta lost patent protection in December.• Cymbalta sales totaled $5 billion in 2013.

– Evista lost patent protection in March.• Evista generated $1 billion in sales during 2013.

2. Shrinking margin– Operating margin has slumped nearly 4% since 2011.

2 big and important question marks hang over Lilly’s dividend:

Patent expiration

• Once branded drugs lose patent protection, brand sales typically fall by between 80% and 90% over time. Cymbalta and Evista’s sales are likely to continue lower throughout this year.

•Cymbalta sales fell 64% a year ago to $478 million in Q1.•Evista sales fell 38% from last year to $150 million in Q1.•2014 EPS guidance exiting 2013 was for $2.77 to $2.85; down from $4.15 in 2013.

– EPS Guidance was reduced to $2.72-$2.78 exiting Q1

•2014 revenue guidance exiting 2013 was for $19.2 billion to $19.8 billion, down from $23.1 billion in 2013.

– Revenue guidance was adjusted to $19.4 billion to $20 billion exiting Q1.

First, let’s consider Lilly’s patent calendar.

Shrinking marginLilly’s operating margin has fallen from 25% to 21% since 2011 and the loss of patent protection on Cymbalta and Evista forced the company’s gross margin down 5.4% year-over-year in the first quarter. The company expects full year gross margin of 73%, down from 74% estimates exiting 2013. Lilly is restructuring to offset margin erosion with hopes of realizing $1 billion in annual savings. If so, a leaner company could help re-ignite profit once top line growth returns.

Reasons for dividend optimism

– The company currently doesn’t boast any fast-growing new compounds.• Forteo posted the best year-over-year growth in Q1, rising 7% to $300 million.

– Lilly needs a blockbuster win from its R&D pipeline.• Dulaglutide is a GLP-1 diabetes therapy under FDA review for approval.

– In trials once-weekly dulaglutide was as effective as Novo’s once-daily blockbuster drug Victoza.

– If approved dulaglutide will also compete against AstraZeneca’s Bydureon and Byetta.• Empagliflozin is a SGLT-2 diabetes therapy recently denied by the FDA for approval.

– The denial was based on manufacturing concerns at partner Boehringer’s European plant, not empagliflozin’s efficacy or safety.

– Concerns have since been resolved, allowing for a resubmission for approval. If approved, it will compete against Johnson’s Invokana and Astra’s Farxiga.

• Cyramza won FDA approval in post-chemotherapy gastric cancer in April.– 1 million new cases diagnosed annually; 3rd leading cause of cancer death.– Potential as a lung cancer treatment.

Lilly is developing new products that could offset patent risk.

Cash dividend payoutLilly’s cash dividend payout ratio, which measures how much of a company’s operating cash minus capital expenses and preferred dividends is being spent to pay common dividends, is 47%. That’s lower than Novo-Nordisk, which competes against Lilly with products including the insulin Novolog, and AstraZeneca, which markets various diabetes drugs including the DPP-4 drug Onglyza. Theoretically, Lilly’s lower ratio puts it in a better position to eventually boost its dividends, but only once sales stabilize.

Current yieldLilly’s dividend yield is 3.3%, which trails AstraZeneca’s 3.79% rate, but is higher than Novo’s 1.33% yield. While that yield is intriguing, patent risks and pipeline uncertainty suggest dividend investors approach Lilly cautiously.

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