by Lawrence Meyers | October 20, 2011 9:00 am
Today, we’re looking at Dow Jones Industrial Average component Merck (NYSE:MRK). You know it’s a diversified medical conglomerate, but how diversified is it?
The Pharmaceutical segment provides therapeutic and preventive agents for the treatment of human disorders in the areas of bone, respiratory, immunology, dermatology, cardiovascular, diabetes and obesity, infectious diseases, neurosciences and ophthalmology, oncology, vaccines, and women’s health and endocrine. Its Animal Health segment discovers, develops, manufactures and markets animal health products (who knew?). The Consumer Care segment develops, manufactures and markets over-the-counter products for common ailments.
The key driving factors regarding MRK are research and development, the economy and competition. R&D is one of the major reasons the company purchased Schering-Plough a few years back. For serious diseases that require pharmaceutical intervention, the economy isn’t much of a factor, but it certainly is with regards to Merck’s over-the-counter products. Even worse, Merck faces competition in this area as well (and with some of its pharmaceuticals). So it helps that Merck is so large and generates a lot of cash to sustain its R&D and dividend.
Stock analysts looking out five years on Merck only see annualized earnings growth at 4.5%. At a stock price of $32, on FY 2011 earnings of $3.73, the stock presently trades at a P/E of 8.5. Pfizer (NYSE:PFE) and GlaxoSmithKline (NYSE:GSK) are the closest competitors, with P/Es of 17 and 22, respectively, so Merck is very much on the low end of the valuation scale.
Merck’s financials are solid. The company carries $14 billion in cash and $15.7 billion in low-interest debt. Trailing 12-month cash flow was $9 billion, which is twice the amount of free cash flow necessary to pay its 4.7% dividend. Merck makes a lot of money and reinvests that cash right back into its R&D units to find the next blockbuster drug.
No insider purchases have been made in a long time, which is discouraging but not unexpected for a company this ancient.
Merck’s solid cash flow and history are enough for me to warrant putting a 6 P/E on it, but on projected 2015 earnings of $5.21 per share (factoring in the 4.7% compounded dividend yield reinvested), we get a price target of $31. Thus, I see MRK as being fully valued without much upside. This is the classic stock for a retirement account, but I’d dump MRK if you have it in a regular account.
As of this writing, Lawrence Meyers did not own a position in any of the aforementioned stocks. Check out Lawrence Meyers’ take on other Dow Jones stocks here.
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