Should I Buy Merck? 3 Pros, 3 Cons

by Tom Taulli | February 27, 2013 1:54 pm

Should I Buy Merck? 3 Pros, 3 Cons

Ever since reaching multiyear highs near $48 in October, Merck’s (NYSE:MRK[1]) shares have fallen into a downtrend, trading near the $43 mark in Wednesday’s action.

The pharmaceutical giant has had to deal with a number of hurdles, including losing the patent protection on its mega-drug Singulair[2] and setbacks in the approval process for its osteoporosis drug odanacatib. As a result, Merck expects full-year earnings to drop as much as 5.7%.

Are the troubles too numerous to avoid this pharma giant, or has the multimonth pullback provided a decent price on an eventual turnaround stock? To see, let’s look at the pros and cons of Merck:

Pros

Powerful Platform: While Merck certainly is Big Pharma, its pharmaceuticals arm is only one of three core businesses — the other two being animal health and consumer products. Animal health — which focuses primarily on cattle and poultry — generates about $4 billion of the company’s nearly $47 billion in annual revenues and should provide long-term growth as populations in emerging markets adopt higher-protein diets. Merck’s consumer products include brands like Claritin, Coppertone and Dr. Scholl’s, and that category accounts for about $2 billion in sales.

Of course, the key business for Merck is pharma, and things are encouraging on that front. The company’s diabetes drugs — which include Januvia/Janumet — grew sales by about 25%, generating $5.7 billion in 2012. The company also has a variety of promising drugs in its pipeline — Suvorexant (insomnia), Vintafolide (cancer) and Anacetrapib (heart) all have the potential to drive billions of dollars in revenue. New vaccines including Zostavax (shingles) and V503 (HPV-related cancers) should help propel growth, too.

Foreign Markets: This is where Merck should find lots of growth over the long haul. The company’s emerging markets business increased by 13% last year; during this time, sales in China surged by 22% and crossed the $1 billion mark, and Merck still appears to be merely on the cusp of this huge market opportunity.

Financials: Merck continues to focus on realizing cost reductions. In 2011, the company reduced operating expenses by about $750 million, and in the past couple years, Merck has slashed its headcount from 104,000 to 82,000. Merck also remains committed to its shareholders, having returned $7.5 billion in the form of buybacks and dividends. MRK’s 4% yield is another big draw.

Cons

The Patent Cliff: This refers to something felt across the pharma sphere, when a company has to deal with the expiration of patents on major drugs. No doubt, Merck’s loss of the protection of Singulair has been painful, costing about $1.6 billion in revenues for 2012. The deterioration is likely to continue, as patents in the European Union also have recently expired.

Competition: Merck faces a number of rivals, from mega-operators to early-stage startups. For example, MRK is facing emerging competition for its diabetes franchise, from companies like Johnson & Johnson (NYSE:JNJ[3]) and Takeda. Its heartburn relief drug Pepcid faces competition from Eli Lilly (NYSE:LLY[4]). The Hepatitis-B vaccine Recombivax? GlaxoSmithKline (NYSE:GSK[5]). The list goes on and on.

Regulatory Risks: This not only includes the challenge of getting drugs through the approval process, but also the pressure from reform to reduce prices of prescription drugs. Healthcare expenditures are becoming an increasingly bloated part of budgets in the U.S. and Europe, which in turn could lead to limits on reimbursements and other subsidies. Also, substantial consolidation in the managed-care industry could make it tougher for pharma companies to negotiate better terms.

Verdict

Merck’s 2009 deal to buy Schering-Plough for $41 billion was risky, but turned out to be a huge boon; the company not only added more drugs to its pipeline, but helped achieve cost-efficiences, which in turn has helped alleviate the impact of the patent cliff.

Going forward, Merck is in a good position to benefit from some major categories with treatments for cancer, heart disease and diabetes. What’s more, the company continues to generate strong cash flows and has been aggressive with its dividend increases and share buybacks.

Lastly, its price-to-sales ratio of 2.7 is reasonable, and is less than the 3.4 ratio for other Big Pharma names like Pfizer (NYSE:PFE[6]) and Bristol-Myers Squibb (NYSE:BMY[7]).

So should you buy Merck? Yes — the pros outweigh the cons for now.

Tom Taulli runs the InvestorPlace blog IPO Playbook[8]. He is also the author of “How to Create the Next Facebook[9]” and “High-Profit IPO Strategies: Finding Breakout IPOs for Investors and Traders[10].”Follow him on Twitter at @ttaulli[11]. As of this writing, he did not hold a position in any of the aforementioned securities.

Endnotes:
  1. MRK: http://studio-5.financialcontent.com/investplace/quote?Symbol=MRK
  2. losing the patent protection on its mega-drug Singulair: http://www.nasdaq.com/article/singulair-patent-loss-hits-mercks-earnings-but-international-growth-helps-cm214242
  3. JNJ: http://studio-5.financialcontent.com/investplace/quote?Symbol=JNJ
  4. LLY: http://studio-5.financialcontent.com/investplace/quote?Symbol=LLY
  5. GSK: http://studio-5.financialcontent.com/investplace/quote?Symbol=GSK
  6. PFE: http://studio-5.financialcontent.com/investplace/quote?Symbol=PFE
  7. BMY: http://studio-5.financialcontent.com/investplace/quote?Symbol=BMY
  8. IPO Playbook: http://investorplace.com/ipo-playbook/
  9. How to Create the Next Facebook: http://www.amazon.com/gp/product/1430246472/ref=s9_simh_gw_p14_d0_i1?pf_rd_m=ATVPDKIKX0DER&pf_rd_s=center-3&pf_rd_r=0GRB6ZMCTYDZVNG7Q7NV&pf_rd_t=101&pf_rd_p=470938811&pf_rd_i=507846
  10. High-Profit IPO Strategies: Finding Breakout IPOs for Investors and Traders: http://goo.gl/pR2F3
  11. @ttaulli: https://twitter.com/ttaulli

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