Are Eli Lilly's Lowered Expectations a Reason to Sell?

Eli Lilly (NYSE: LLY) stock tanked after the company reported third-quarter results on Wednesday, Oct. 30. The report it issued before the opening bell was more than a little problematic. In addition to top-line figures that missed Wall Street expectations, management lowered its earnings outlook.

If there's one thing the stock market hates, it's unpredictability. Eli Lilly shares were down by more than 10% when the market opened on Wednesday and investors wonder if it could slide even further.

Why Lilly missed Wall Street expectations

Lilly reported $11.44 billion in third-quarter sales, which was significantly less than the $12.11 billion expected at the average of Wall Street analysts.

It seems analysts miscalculated the impact that last year's sale of Zyprexa rights outside the U.S. could have. As reported, ex-U.S. sales fell 12% to $3.6 billion. Excluding Zyprexa, though, ex-U.S. sales were up by 33% year over year.

On the bottom line, earnings that came in at $1.18 per share were far below the Wall Street consensus expectation of $1.47. It seems that analysts failed to predict $2.8 billion worth of in-process research and development (IPRD) expenses related to the recent acquisition of Morphic Holding.

Why Lilly lowered its expectations for the rest of 2024

The expectations Lilly missed weren't nearly as significant as the still unrealized expectation it lowered. A few months ago, management told investors to expect earnings to land between $16.10 and $16.60 per share this year. The stock was hammered because the company lowered that guidance range to between $13.02 and $13.52 per share when reporting third-quarter results yesterday.

In 2022, drug companies changed how they account for payments to fund the research and development of companies they invest in. Instead of creating an intangible asset that could lose value if things don't work out, they're subtracting IPRD expenses from earnings upfront.

Thanks to the new IPRD reporting convention, pharmaceutical companies can no longer forecast upcoming expenses in a way that doesn't require subsequent guidance revisions when acquisitions are made. In this example, the acquisition of Morphic in August led to a $3.08-per-share IPRD charge. The charge didn't occur until eight days after Lilly reported the second-quarter results in which it had issued the earnings guidance range it later walked back.

In addition to IPRD charges, investors were disturbed in the latest report by stagnant sales of tirzepatide, which Lilly markets as Mounjaro for diabetes and Zepbound for obesity. Third-quarter tirzepatide sales that reached $4.37 billion were hardly any higher than second-quarter sales of $4.32 billion.

The good news

According to Lilly, tirzepatide revenue stagnated in the third quarter because U.S. wholesalers had overstocked in the previous quarter and were unwinding excess inventory. If this is the case, fourth-quarter sales could rocket higher.

In August, Lilly reported some clinical trial results that bode well for long-term tirzepatide demand. In the 176-week Surmount study, adults with prediabetes given the drug were 94% less likely to develop type 2 diabetes than folks given a placebo.

And recording IPRD expenses upfront won't stop Lilly from reporting growth rates rarely seen from established pharmaceutical companies. If we ignore last year's non-recurring sale of international rights to Zyprexa, third-quarter revenue shot up by 42% year over year to $11.4 billion.

In other good news, in September, the Food and Drug Administration (FDA) approved Lilly's new eczema treatment, Ebglyss. In the long-term ADjoin study, treatment with the monthly injection controlled eczema for up to three years in more than 80% of patients who initially responded. And in July, the FDA greenlit Lilly's Alzheimer's disease treatment, Kisunla. Sales have been limited but a recent approval in Japan could make it a significant growth driver in the quarters ahead.

Time to sell?

Despite falling on Wednesday, Eli Lilly stock is up by about 44% in 2024 as I write this. Expectations are high with the stock trading for about 63 times the midpoint of management's guided earnings range for 2024.

This is not a good time to buy Eli Lilly stock, but selling now probably isn't the right move either. Tirzepatide is the only GLP-1 plus GIP drug approved by the FDA to treat obesity and diabetes. A wholesaler-driven sales stagnation for one quarter isn't a reason to assume its growth trajectory will remain flat. Holding this stock through recent volatility looks like the best course of action.

Should you invest $1,000 in Eli Lilly right now?

Before you buy stock in Eli Lilly, consider this:

The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and Eli Lilly wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.

Consider when Nvidia made this list on April 15, 2005... if you invested $1,000 at the time of our recommendation, you’d have $865,595!*

Stock Advisor provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. The Stock Advisor service has more than quadrupled the return of S&P 500 since 2002*.

See the 10 stocks »

*Stock Advisor returns as of October 28, 2024

Cory Renauer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.