DAY (3/15) - PRRN CHALLENGE!
Hello! I am Priya, and thank you so much for being here! :)
16/03/2025
Yes I missed a day, and yes I promise I will patch up :')
But oh well today I did a lot of reading!
I mostly focussed on the MDA today as well, and I would say it mostly centered around 2 things:
1) The major threats in the pharma industry and how Eli Lilly in particular tackles it
2) Some really interesting accounting concepts I had not seen being applied before
THREATS?
1)Pharma benefit entities merging with private payors: So a pharmacy benefit entity has the role to negotiate with pharmaceutical manufacturers and obtain medicines at cheaper rates for their clients, who will most likely resell it.
This is effectively a vertical integration which reduces the pharma company's pricing powers. Needless to say this will reduce the net realized prices that Eli Lilly can make, but also they would need to estimate how much discounts that this would amount to so they can adjust the prices of their own D2C products accordingly.
2) Tight supply: For products like Mounjaro and Trulicity Eli Lilly can only make so much quantity yet the demand is massive. To deal with this the company is now expanding its manufacturing facilities in many parts of US and Europe. The company is also trying to maximize the utility of each product sold by for instance, selling multiple use insulin pens and single use vials.
3) Speed of new drug discovery: I read about an interesting insight yesterday. Eli Lilly effectively cannot predict which one of their R&D's will actually work out. There's no way to budget a research project, or determine what the value from it would be, as each stage in the research is a gamble!
However I came across an ebook on AI in pharma today which states that the use of data anlytics and AI can reduce this time by upto 4x. Interestingly they say that majority of the data in this sector is unstructured text (research papers, findings etc) which AI can help to structurize. Based on this information AI may even be able to predict which scenario has the highest chance of success!
Credits: tungnguyen0905 at Pixabay
4) New tax rules: Pharma companies are getting exposed to new kinds of tax rules everyday, which could actually be harmful. It discourages pharma companies from investing and expanding which will truly be dangerous.
The OECD, for instance, has proposed, and seems to have convinced many countries to, adopt a new regime where all juridictions atleast charge 15% corporate tax, to avoid the transfer scheme some companies do, where they transfer profits to low tax juridictions to save up on money.
It also proposes that if a company does not have physical presence in a country but is extracting large amounts of revenue from it, then they should be taxed there.
The EU seems to be ready to onboard this plan and this comes at a significant cost. Even in 2023, net operating cash flows at Eli Lilly have fallen quite significantly just because of taxes. And expenses like acquired in-process research and development (acquiring someone else's ongoing developments) are not deductible for tax purposes. Thus taxes are quite high :')
Credits: Geralt from Pixabay
5) Government setting prices: As we discussed 2 days ago, the government has now listed a certain section of drugs for which it will be deciding prices. This is obviously discouraging.
Accounting concepts?
You see, I do love finance but deep down I love my accounting <3
I love organizing information, and going line by line in an FS has truly helped me make sense of what I've been reading.
So coming back,
Revenue: Eli Lilly's revenue comes primarily from its contracts with customers and from 'other sources'. These other sources include royalties, selling off the rights of their developments, and even joint operations.
Naturally revenues grow in 2 ways: either we sell more, or price it higher. As we mentioned in our first article, the demand for Eli Lillys' focus area where we talk about cancer medicines, or diabetic treatments, is only increasing and can be expected to increase so no doubt there is a volume so strong, that the supply is constricted.
However as we discussed yesterday 2022 saw very extreme rates of inflation, as it saw a new dawn from COVID lockdowns. When economic conditions worsen this way, even pharma, which is generally seen to have inelastic demand, succumbs to pricing pressures.
There are certain drugs that are exclusive and some that are generics. When the economy is not doing well, patients prefer more generic treatments to test if they work. This reduces the revenue of the more premium products. Now Eli Lilly has manufactured so many medications that they fall roughly within both categories. However, the more expensive drugs have not made as much money as the cheaper ones in 2023.
This is called an unfavourable segment mix and this has attacked Eli Lilly quite well in 2023.
However, inflation isn't always a bad thing. In fact controlled inflation will always be much more desirable than deflation. Why is this relevant, you ask? Because due to the very same inflation we see much stronger employment data, which means more people get more access to insurance.
They no longer rely on discounts from manufacturers (many manufacturers like EL run a scheme called 'savings card scheme') since insurers will reimburse them. This leads to higher realized prices that bolster revenue!
Credit: Fidsor at Pixabay
2) Contingent liabilities: I did study this in my ACCA but interesting to see some practical insight! So many pharma companies, including Eli Lilly, outsource their R&D to other smaller companies and track their milestones. They actually have a considerable amount of contingent liabilities that they would have to pay, in case some milestones are achieved.
I came to the conclusion that this would be a great KPI to track. A company would only pay contingent liabilities if milestones are being achieved, so it would be a good way to track the successes of the company and its outsourcing decisions.
I also noticed an interesting terminology, non tradeable contingent right, which is also a contingent payment promised upon acquisition of another company or its assets, which cannot be traded in a financial market.
3) Reinterpretations of seemingly common FS items!: I realized that when acquiring a subisdiary (considering how rampant it is in pharma) a company needn't always give out the exact value of its subsidiary's net assets. What it presents is an estimated fair value that it is allowed to change after its reporting!
I also realized development expenditures, if their launch has been postponed due to whatever reason, will be subject to impairment.
Also, in addition to all the different status (s?) that the FDA provides to the pharma sector, they also provide some companies that research on sensitive disease areas (pediatric disease/tropical disease/suspected biowars) an asset called a priority review voucher that fastens the approval process and gets the product into the market. Many smaller pharma companies have benefitted from selling such vouchers to larger companies for a hefty fee.
Finally I realized that like all MNC's Eli Lilly makes the effort to hedge all their foreign currency and interest rate risks by using appropriate derivative instruments like swaps, futures and forward contracts. They do have a large amount of debt from the face of it, but I would need to understand the industry's perspective before I comment on that.
OVERALL ANOTHER GREAT DAY OF LEARNING! SEE YOU ON DAY 4... :)
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