Eli Lilly (LLY): Dividend Growth Is About To Change by Simply Safe Dividends

Eli Lilly (LLY) is a blue chip stock that has paid a consistent dividend since the early 1970s.

The company’s total dividends paid have increased from 4.55 cents per share in 1972 to a projected $2.04 per share in fiscal year 2016.

However, the company’s dividend growth rate has materially slowed, and the dividend payout ratio is now over 80%.

Should investors be concerned that Eli Lilly could be poised for years of flat dividends or possibly even a cut to the dividend?

Let’s take a look at the business.

Eli Lilly and Co

Business Analysis

Eli Lilly is a global pharmaceutical company with an operating history that dates back to the late 1800s. In 2015, they generated sales of nearly $20 billion, which is down from the recent peak of $24.3 billion in 2011.

In general, the pharmaceutical industry can be a pretty good space to invest in for dividend investors seeking a stable dividend income over time.

Dividend investors do not have to worry about economic cycles or cyclical end markets leading to an unanticipated dividend cut when investing in this recession-resistant industry.

Besides analyzing all the usual important financial ratios, dividend investors instead need to pay attention to the quality of the product portfolio and pipeline of new products along with any significant legal issues the company could have outstanding.

Eli Lilly operates the business through two business segments – human pharmaceutical products (84% of sales) and animal health products (16%).

The Human Pharmaceutical Products business produces therapeutics targeting areas including endocrine, neuroscience, oncology, and cardiovascular. Their key drugs targeting these markets are Humalog (diabetes), Alimta (cancer), Forteo (osteoporosis), Cialis (cardiovascular), and Cymbalta (depression). They have 6 different billion-dollar revenue drugs, and their top ten drugs add up to nearly 70% of sales.

The Animal Health Products business produces drugs for companion animals as well as farm animals. In January 2015, they completed the acquisition of Novartis Animal Health for $5.3 billion dollars to improve their competitive position within the market, particularly within companion animal and swine markets.

Like many other large pharmaceutical companies, Eli Lilly recently transitioned through a difficult time with a patent expiration in many key drugs. They lost patent protection on Zyprexa (2010 revenue of $5 billion), Cymbalta (2012 revenue of $5 billion), and Humalog (2012 revenue $2.4 billion).

Eli Lilly, LLY, Dividend Safety Analysis

Source: Simply Safe Dividends

However, they are not completely out of the woods yet. Over the next few years they face patent expiration in key markets for large products including Alimta (13% of sales), Cialis (11%), Forteo (7%), Cymbalta (4%), Zyprexa (4%), Strattera (3%), and Effient (2%).

Thankfully, Eli Lilly invests around 20% of sales in research and development, above peers who average in the mid-teens (see our analysis on Johnson & Johnson).

These investments have resulted in a rather robust pipeline of new products in their late stage pipeline and even a few recent introductions to the market.

The major therapeutics investors need to keep an eye on are Jardiance (Type 2 diabetes), Baricitinib (Rheumatoid arthritis), Taltz (Psoriasis), and Solanezumab (Alzheimer’s).

The revenue potential from these products is expected to be quite significant. Jardiance has already been launched and is expected to be a multibillion-dollar product. While Baricitinib and Taltz  aren’t expected to have the same sales potential as Jardiance, they are both expected to be billion-dollar plus selling drugs.

The real question mark in Eli Lilly’s late stage pipeline is Solanezumab, which is used to treat Alzheimer’s.

The benefits to patients and sales potential from this therapeutic could be substantial, but to date no pharmaceutical company has been approved for a treatment that has proven to slow Alzheimer’s effects. In other words, Solanezumab remains a long shot.

When the entire pipeline and recent launches are considered, Eli Lilly is positioned to have the potential to launch 20 new products in 10 years (2014 through 2023). This gives the management team confidence in their projections for at least 5% annual revenue growth through the rest of the decade despite key drugs coming off patent protection.

Furthermore, shareholders should benefit from improved margins at the company. The management team has committed to an OPEX-to-revenue ratio of 50% or less in 2018. This would represent an improvement from a GAAP OPEX-to-revenue ratio of nearly 58% in 2015.

Clearly if management is able to execute on this margin improvement from increased efficiency in R&D and marketing, selling, and administrative costs, it would be a great achievement and would allow for significant dividend increases.

Dividend Safety Analysis: Eli Lilly

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Eli Lilly’s dividend and fundamental data charts can all be seen by clicking here.

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. A score of 50 is average, 75 or higher is considered excellent, and 25 or lower is considered weak.

Investors can learn more about our Dividend Safety Scores and view their track record here.

Eli Lilly’s Dividend Safety Score is 59, which indicates that the dividend is somewhat safer than the average stock in the market and unlikely to be cut.

If Eli Lilly is able to execute on their strategy and the recent drug launches meet expectations, the company’s dividend safety will continue to rise.

The company expects 2016 non-GAAP EPS of $3.50-$3.60 with the major difference between GAAP and non-GAAP being amortization of intangible assets from recent acquisitions. As dividend investors, we feel comfortable with this adjustment as this is a non-cash charge.

If the company maintains the $0.51 per share quarterly dividend for the fourth quarter of 2016 like we expect, then the company’s payout ratio would be around 57% for 2016.

This is much healthier than the 88% payout ratio the company reported in 2014 and 2015 and puts the company closer to its historical payout ratio in the 45-65% range over the past decade.

Eli Lilly, LLY, Dividend Safety Analysis

Source: Simply Safe Dividends

Let’s take a closer look at some of the other important drivers of the Dividend Safety Score.

As of the end of the second quarter 2016, Eli Lilly had $9.3 billion dollars of debt of which $646 million is due within a year. This debt is offset by cash of $3.2 billion dollars, making total net debt $6.1 billion.

This is a very comfortable amount of debt for the company as illustrated by a net debt to EBIT ratio of just 1.6x.

Furthermore, the company’s EBIT/Interest expense ratio is very healthy at over 20x. Dividend investors can feel comfortable that the company isn’t over leveraged. Eli Lilly also maintains healthy investment grade credit ratings with the major agencies.

Eli Lilly, LLY, Dividend Safety Analysis

Source: Simply Safe Dividends

The company has also been a

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