PRIMECAP's Strategic Exit from Eli Lilly: A Contrarian Signal Amid Sector Volatility?

In the second quarter of 2025, PRIMECAP Management reduced its stake in Eli Lilly and Co (LLY) by 17.76%, marking one of the most significant portfolio adjustments in its healthcare sector holdings. This move, which saw the sale of 2.6 million shares and a -1.79% portfolio impact, has sparked debate among investors: Is this a sign of waning confidence in the pharmaceutical sector, or a tactical rebalancing amid broader market volatility?

Context: A Stock in Retreat, A Sector in Transition

Eli Lilly's shares had already fallen 17.41% year-to-date by Q2 2025, pressured by a combination of factors. The company's late-stage trial for orforglipron, an oral weight-loss drug, reported a 12.4% average weight loss—below expectations for a blockbuster product. Meanwhile, Novo Nordisk's dominance in the GLP-1 space and regulatory scrutiny over market access for Zepbound added to the headwinds.

Yet the pharma sector as a whole remains a cornerstone of PRIMECAP's long-term strategy. The firm's $15.06 billion position in LLY, while reduced, still represents a 6.1% portfolio allocation, and its broader healthcare sector exposure (21.5% of the PRIMECAP Odyssey Stock Fund) includes heavyweights like Amgen (AMGN) and AstraZeneca (AZN). This suggests a nuanced approach: trimming a specific stock rather than abandoning the sector.

The Rationale: Rebalancing or Reassessment?

PRIMECAP's investment philosophy is rooted in bottom-up fundamental analysis and long-term value creation. The firm's decision to reduce its LLY stake aligns with its disciplined approach to capital allocation. When a stock's valuation outpaces its fundamentals—whether due to overhyped expectations or operational challenges—PRIMECAP often rebalances.

Consider the numbers: LLY's average price in Q2 was $777.85, down from a peak of $950 in early 2024. The stock's three-month return of -13.35% reflects a correction in investor sentiment, but its discounted cash flow (DCF) valuation of $369.54 per share and analyst price targets of $1,020 suggest long-term potential.

PRIMECAP's exit from LLY mirrors its Q1 2025 strategy of divesting underperforming positions, such as Altair Engineering (ALTR) and Las Vegas Sands (LVS). These moves were not sector-specific but rather part of a broader portfolio optimization. The firm's 14.1% allocation to pharmaceuticals in its Odyssey Stock Fund, including a 3.9% stake in AstraZeneca, underscores its continued faith in the sector's growth drivers: innovation in biologics, aging demographics, and demand for chronic disease treatments.

Contrarian Opportunity or Cautionary Tale?

For long-term investors, PRIMECAP's exit raises a critical question: Is this a contrarian signal to buy the dip, or a warning to reassess pharma's risks?

On one hand, LLY's fundamentals remain robust. Its pipeline includes not only Zepbound but also oncology and diabetes therapies with multi-billion-dollar potential. The company's R&D spending of $12 billion annually and a 2025 revenue forecast of $35 billion highlight its resilience. A 12.4% weight loss for orforglipron, while disappointing, still positions it as a top-tier competitor in a $100 billion obesity market.

On the other hand, the sector faces structural challenges. Pricing pressures, patent expirations, and regulatory hurdles could dampen margins. Novo Nordisk's Wegovy and Ozempic continue to dominate the GLP-1 space, and LLY's ability to differentiate its offerings will be key.

Investment Implications

PRIMECAP's move should not be interpreted as a bearish bet on pharma. Instead, it reflects a tactical adjustment to a stock that has underperformed relative to its intrinsic value. For investors, this presents an opportunity to evaluate LLY's long-term prospects independently of short-term volatility.

1. For Value Investors: The stock's current price of ~$770 may represent a discount to its DCF valuation of $369.54 (assuming a 10% discount rate). If LLY's pipeline delivers, the stock could rebound toward analyst targets of $1,020.
2. For Sector Allocations: The broader pharma sector remains attractive, with companies like AMGN and AZN offering diversified exposure to innovation and stable cash flows.
3. For PRIMECAP Followers: The firm's exit from LLY aligns with its strategy of rotating into undervalued opportunities. Investors should monitor its new positions in biotech and industrials for clues about its next bets.

Conclusion

PRIMECAP's reduction in Eli Lilly is best viewed as a rebalancing move rather than a sector-wide retreat. While the stock's near-term challenges are real, its long-term fundamentals and the broader pharma sector's growth drivers suggest that the exit is a tactical adjustment, not a verdict on the industry. For long-term investors, this could be a contrarian opportunity to reassess LLY's value proposition—and to stay attuned to PRIMECAP's evolving portfolio strategy.