by Tom Taulli | July 27, 2012 12:43 pm
In today’s trading, Merck’s (NYSE:MRK) shares hit a 52-week high, reaching nearly $45. That’s thanks to the pharma giant posting a solid earnings report, with profits of $1.05 a share. The street was looking for $1.01.
As markets remain volatile — and the world economy starts to falter — Merck is certainly an attractive option for investors. Keep in mind that the stock has returned an average of almost 16% for the past three years.
Yet can the momentum continue? Or is Merck getting overextended? To decide, let’s take a look at the pros and cons:
Cost Cutting. Over the past few years, Merck has streamlined its operations, such as with nixing some drug efforts and laying off employees. It’s been painful, but the company is starting to benefit from stronger margins.
Innovation. This is the key to growth, and Merck has continued to invest in research and development. For example, the company is getting lots of traction from its diabetes drugs Januvia and Janumet. These should be long-term tonics for growth.
Merck also has a robust pipeline of drugs. Examples include odanacatib, which treats osteoporosis, and suvorexant, which deals with sleep disorders.
Emerging Markets. No doubt, Merck should see long-term opportunity here as middle classes continue to grow around the world. In the latest quarter, about 18% of its revenues came from these markets. Yet it’s still the early stages of this megatrend.
Patent Cliff. The huge phrama companies — like Pfizer (NYSE:PFE) and Bristol-Myers Squibb (NYSE:BMY) — are facing the expiration of patents on key drugs. And Merck is no exception. One of its top drugs, Singulair, will come off patent in August, and it will face tremendous competition from generic versions. Keep in mind that the drug accounts for about 12% of Merck’s business.
Regulatory Risks. With the slowing economies in Europe and the U.S., governments will inevitably be pressured to cut back on spending programs. A big target is likely to be health care spending. The result could be cost pressures on prescription drugs.
FDA Approval Process. Merck has a good track record in getting OKs on new drugs. But if the company has a losing streak, it could be a big problem. Drug development is costly and time-consuming, so a few failures can loom large.
Even though Merck will suffer from Singulair’s loss of patent protection, the company has taken actions to soften the impact. A key has been its investments in R&D, which have being yielding results. Merck will probably also look at acquisitions to bolster its pipeline.
While the stock price is a bit lofty — with a price-to-earnings ratio of 20 — it’s reasonable given Merck’s fairly stable cash flows. Plus, the dividend yield is an attractive 3.9%.
So in light of these factors, the pros outweigh the cons on the stock.
Tom Taulli runs the InvestorPlace blog IPOPlaybook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli. As of this writing, he did not own a position in any of the aforementioned securities.
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