LLY: Whether High R&D/Sales is Defensible – an Empiric Dissent

Richard

Over the last 20 years, LLY accounts for roughly 5pct of peer group R&D spending, but only about 2pct of peer group innovation. This disconnect is worsening: LLY’s share of peer group R&D spending recently exceeded 5pct of the peer group’s; however patent activity implies LLY’s share of peer group mid- to early-stage innovation will fall to just more than 1.6pct

From 1994 to 2013, LLY spent $3 of R&D to produce the same amount of innovation the average peer produced for just $1 of R&D spending

LLY not only spends more and produces less output overall, the quality of its innovation appears sub-par, and the company has achieved leadership in very few research areas:

As indicated by citation patterns, the quality of innovation in LLY’s mid- to early stage pipeline is less than 75pct of the average quality for peers’ mid- to early-stage pipelines; and,

Of the top 20 research areas that constitute more than 80pct of the innovation in LLY’s mid- to early-stage pipeline, LLY ranks among the top 3 in only 2 of these areas. LLY’s average rank in these twenty research areas is tenth

Whether LLY’s late-stage and filed projects deliver is of course highly relevant to the share price, but is irrelevant to the question of whether LLY’s high level of R&D spending is warranted. The company’s R&D productivity is demonstrably worse than peers (who on average have negative returns to R&D spending) across at least two decades, and is worsening. LLY can and should address the root causes, so that its levels of R&D productivity warrant competitive levels of spending. Absent a clear path to acceptable productivity, LLY should not invest in R&D beyond the minimum required to complete its current late stage programs, and should return the resulting free cash to its shareholders

For our full research notes, please visit our published research site

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