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Bank of America Merrill Lynch’s Top 10 Picks for 2013, Part One: Eli Lilly & Co. (LLY), Pfizer Inc. (PFE)

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Hello and welcome, readers. I’d like to issue an informal apology for the delay in writing in recent weeks. I relocated from Ohio to Florida in August 2011, and only recently discovered that living in warm weather year-round doesn’t give Florida residents any immunity to the common flu. In fact, a large portion of South Florida seems to have caught some form of illness in the past month. I’m feeling better after an extended away period and look forward to catching up on writing very soon.

Recently I had the opportunity to attend the CFA Society of South Florida’s Annual Financial Forecast event in Boca Raton, Florida. The warm January weather here in the greater Miami / Palm Beach area serves as a good draw to bring Wall Street’s best minds from New York down to South Florida. This year’s event was the 24th annual, and the CFA Society was pleased to host Mary Ann Bartels, Head of Technical and Market Analysisat Bank of America Merrill Lynch. Bartels was joined on the investment panel by two leading economists, Rich Yamarone of Bloomberg and Don Rissmiller of Strategas Research Partners.

Eli Lilly & Co. (NYSE:LLY)

Mega Cap Stocks vs. S&P 500 index

During her presentation to the CFA Society of South Florida, Bartels discussed her views on the overall market and indicated that she prefers mega caps, best represented by the S&P 100 index. Mega caps are the largest and most established publicly-traded companies, and represent 57% of the S&P 500’s market capitalization.

Why does Bartels favor mega cap stocks? She believes the largest companies in the stock market are under-owned, and are beginning to exhibit signs of leadership as evidenced by Wal-Mart (NYSE:WMT)’s breakout from a multi-year trading range. Bartels cites an internal piece of research from Bank of America which shows the “Nifty 50” vs. the “Not-So-Nifty 450.” The chart indicates that the Nifty 50, or the 50 largest companies by market capitalization, have a major catch-up trade versus the next 450 stocks in market capitalization within the S&P 500.

Bank of America Merril Lynch’s Top 10 Picks for 2013

Given that Bartels has identified her “Top 10 Picks” on an allocation and strategic basis, the purpose of this article is to evaluate the fundamental case for investment.

Do I recommend these stocks based on traditional fundamental analysis?

Let’s take a closer look on a case-by-case basis. Counting down Bank of America’s top picks for the New Year, let’s begin with numbers 10, 9 and 8.

Eli Lilly & Co. (NYSE:LLY)#10

On January 29, Eli Lilly & Co. (NYSE:LLY) reported fourth quarter results, beating on both earnings and revenue. The $63 billion pharmaceutical giant posted a profit of $0.85 per share vs. $0.78 consensus and higher-than-expected revenue of $5.96 billion vs. $5.81 billion estimated.

Investors have expressed concern over Eli Lilly & Co. (NYSE:LLY) in recent years, as the company faces one of the most difficult “patent cliffs” among large pharmaceuticals. Many of the Eli Lilly’s drugs such as Zyprexa, Cymbalta, Gemzar, and Evista all face expiring patents in which generic competitors can produce the same drugs at a small fraction of the cost, eliminating some of Lilly’s large profit margins and revenue streams.

Nonetheless, Wall Street believes Eli Lilly’s pipeline is strong and can offset the expiring patent portfolio. The Indianapolis, IN headquartered Lilly is planning for five new regulatory filings during the 2013 calendar year.

On January 30, Citigroup raised its price target on LLY to $60 from a previous $55 following the company’s Q4 earnings report. In particular, Citigroup believes the drug ramucirumab has demonstrated strong initial data which should bode well for upcoming Phase III data points and regulatory approval. Ramucirumab is being studied for cancers of the breast, colon, liver, lung, and stomach.

Eli Lilly & Co. (NYSE:LLY) also has $1.1 billion remaining in its share repurchase program for 2013, after having repurchased $400 million of stock during the 2012 calendar year. Lilly also pays $1.96 per year in dividends, which is greater than a 3.6% yield based on recent market prices.

In other news, CEO John Lechleite told Reuters that he has no plans to spin off Eli Lilly’s animal health business Elanco. The inquiry was prompted by Pfizer (NYSE:PFE)’s decision to spin off its own animal health unit in a separate IPO. Pfizer’s Zoetis went public in late January and was the largest offering by a US firm since Facebook’s IPO last June.

I recommend that readers follow Bank of America’s advice and buy shares of Eli Lilly & Co. (NYSE:LLY). LLY’s fiscal year ends on December 31.

Pfizer Inc. (NYSE:PFE)– #9

On January 29, Pfizer Inc. (NYSE:PFE) released fourth quarter 2012 results, reporting better-than-expected earnings and revenue. Management provided guidance for the 2013 fiscal year of $2.20-$2.30 EPS, giving the stock a 12x forward P/E multiple. Revenue guidance stands at $56.2 billion to $58.2 billion.

Similar to Eli Lilly, Pfizer Inc. (NYSE:PFE) faces multiple patent losses between 2012 and 2015, which is the main reason the company has engaged in significant expense reduction and cost-cutting. Overactive bladder treatment Detrol and ED treatment Viagra both lost patent protection in 2012, and Celebrex will lose its protected status in 2014. A full expiration calendar is available within Pfizer’s annual report.

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