Fitch Raises Outlook on Eli Lilly (LLY) to Stable; Affirms Ratings

Fitch Ratings has affirmed Eli Lilly & Co. Inc.'s (NYSE: LLY) ratings, including the Issuer Default Rating (IDR) at 'A'. The Rating Outlook has been revised to Stable from Negative. A full list of ratings follows at the end of this release.

The ratings apply to approximately $5.3 billion of debt at June 30, 2013.

KEY RATING DRIVERS
Fitch believes Lilly will maintain a credit profile supportive of its 'A' rating despite facing significant operational headwinds during 2014. Fitch's rating actions are based on the following:

--Lilly faces significant patent risk with three of its top drugs, which account for roughly 30% of total firm sales and are scheduled to lose patent protection during the next two years.

--Fitch expects LLY will return to top-line growth during 2015-2016 with the annualizing of patent expiries and continued strength in established and new products such as Amyvid, Alimta, Cialis, Effient, Erbitux and Tradjenta/Jandueto.

--Fitch believes Lilly's late-stage pipeline, particularly strong in treatments for diabetes and cancer, offers the company numerous opportunities to sustain longer-term growth.

--Fitch anticipates margin compression in 2014 due to Cymbalta's patent expiry. However Lilly's cost cutting measures should result in a leaner cost structure, paving the way for margin expansion in 2015-2016 as sales rebound.

--Fitch forecasts that Lilly will generate roughly $1.8 billion of FCF (cash flow from operations minus capital expenditures and dividend payments) in 2013 and approximately $900 million - $1 billion in 2014.

--Relatively aggressive share repurchases from now through 2017 are incorporated in Fitch's forecast. However, cash dividend increases are expected to be modest and acquisitions targeted.

--With leverage (total debt/EBITDA) of 0.76 times (x) for the latest 12-month (LTM) period ended June 30, 2013, Fitch looks for Lilly to operate with debt leverage of 1.1x-1.3x during 2014.

--Fitch assumes the company will maintain adequate liquidity during the upcoming patent cliff, supported by FCF generation, balance sheet cash and availability on its revolving credit facility.

SIGNIFICANT PATENT CLIFF
Lilly faces significant patent expiries through 2014. Its largest selling drug, Cymbalta, loses U.S. patent protection in December 2013 (Europe - August 2014) and accounts for roughly 24% of totally company sales. Evista loses U.S. market exclusivity in March 2014 and accounts for approximately 4% of total firm revenues. In addition, Fitch expects further sales erosion for Zyprexa and Humalog which U.S. patents expired in 2011 and 2013, respectively.

REBOUND WITH PATENT PROTECTED PRODUCTS
Fitch expects Lilly will return to top-line growth during 2015-2016, achieving annual sales in excess of $20 billion. The negative effect of near-term patent expiries on revenues will have effectively annualized in early 2015. Currently marketed drugs including Amyvid (Alzheimer's diagnosis), Alimta (cancer), Cialis (erectile dysfunction), Effient (cardiac thrombosis), Erbitux (cancer) and Tradjenta/Jandueto (diabetes), in aggregate, have decent intermediate-term growth potential. These drugs, combined, generate roughly $5.2 billion in annual revenues for Lilly and address large and growing treatment markets.

IMPROVING PIPELINE
Lilly has improved its growth prospects for the intermediate- to longer term, as it has been making significant progress in building its late-stage pipeline. The company currently has four drug candidates in registration to treat diabetes, gastric cancer and pancreatic insufficiency. In phase III development, Lilly has a growing number of therapeutics, including three to treat cancer and two to treat diabetes. In addition, its phase III pipeline contains drugs to treat lupus, psoriasis, high cholesterol, depression and rheumatoid arthritis. The company has partnered with Boehringer Ingelheim in its efforts to develop diabetes medications.

EFFORTS TO SUPPORT MARGINS
Fitch expects Lilly to remain focused on controlling costs in order to support margins while balancing its need to invest in growth. The company faces a number of operational headwinds, including the anticipated near-term patent expiries. As such, Lilly has cumulatively taken approximately $620 million out of SG&A during the last 18 months (ended June 30, 2013). During the same period, the company has remained steadfast in funding longer term growth by increasing research and development spending by roughly $460 million. Nevertheless, Fitch anticipates materially compressed EBITDA margins (24%-25%) during 2014 and improvement thereafter.

POSITIVE BUT SUBDUED FCF
Fitch forecasts positive, but lower FCF of approximately $900 million during 2014, as Lilly contends with the loss of profitable U.S. sales of Cymbalta and Evista. Expected cash flow from operations of roughly $4.1 billion should be sufficient to fund $2.2 billion in cash dividends and $900 million in capital expenditures. Fitch believes FCF will grow from 2014 levels over the long run, as revenues and margins recover.

RELATIVELY AGGRESSIVE CASH DEPLOYMENT
Fitch incorporates roughly $5 billion in share repurchases from now through 2017-2018, funded with FCF and cash on hand. However, Fitch models only incremental dividend increases and targeted acquisitions during the same forecast period, which will not likely stress Lilly's balance sheet.

LEVERAGE TO INCREASE IN 2014
Fitch looks for Lilly to operate with debt leverage of 1.1x-1.3x in 2014 during the height of the patent expiries. This is a sharp increase from current leverage of 0.76x. Fitch recognizes that there is some uncertainty surrounding its forecasted leverage range for 2014, since the forecast will be influenced by the level of profitability the company will generate during the period, as well as the discipline Lilly exercises regarding balance sheet debt. Fitch assumes Lilly will refinance the $1 billion senior unsecured notes maturing in March 2014.

ADEQUATE LIQUIDITY
Fitch assumes Lilly will maintain adequate liquidity, supported by FCF generation, balance sheet cash and availability on its revolving credit facility. At June 30, 2013, the company had approximately $4.7 billion of cash and short-term investments, full availability on its $1.2 billion credit facility which matures April 7, 2015 and roughly $6.6 billion in noncurrent investments. Lilly generated approximately $2.1 billion in FCF during the latest 12-month (LTM) period.

At June 30, 2013, Lilly had approximately $5.3 billion in debt outstanding. Fitch believes the company's debt maturities are manageable with roughly $1 billion maturing in 2014, $200 million in 2016 and $1 billion in 2017. Fitch's forecast assumes that Lilly will refinance these maturities with new debt issuances.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a revision of the Rating Outlook to Positive include:

--Revenues continue to expand for recently launched patent protected products, including Amyvid, Alimta, Cialis, Effient, Erbitux and Tradjenta/Jandueto.

--The company employs adequate cost controls to generate sufficient profitability while limiting increases in debt to maintain leverage sustainably below 1.3x.

--Cash is deployed conservatively, with the majority of the planned $5 billion share repurchase program funded through cash flow as opposed to debt issuance.

Future developments that may, individually or collectively, lead to a Negative Rating Outlook and/or a one notch downgrade to 'A-'/'F2' include:

--Operational stress from, but not limited to, patent expiries drives leverage durably above 1.7x.

--Free cash flow deteriorates without the expectation of a timely trend reversal.

Fitch has affirmed the following ratings on Eli Lilly:

--Long-term IDR at 'A';
--Senior unsecured debt rating at 'A';
--Bank loan rating at 'A';
--Short-term IDR at 'F1';
--Commercial paper rating at'F1'.

The Rating Outlook has been revised to Stable from Negative.

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