Over the past decade, returns for Merck (NYSE:MRK) shareholders have not been healthy, coming to an awful -2.7%. That performance pales in comparison to the 1990s, when Merck was a high-flyer.
Despite all this, Merck continues to be highly profitable and has a strong global platform. In fact, the company has been making strides to launch blockbuster drugs.
Can Merck finally get some momentum back for investors, or is the stock a value trap? Let’s take a look at the pros and cons:
Pros
Lean and mean. Merck is making the tough choices to cut costs. The company recently announced 13,000 layoffs while still in the process of cutting 17,000 positions.
Merck also is taking decisive actions to terminate drug development programs that are not getting traction.
Research and development. Merck does not intend to starve this category. The company realizes that – in order to get more growth – it will need to build a strong drug pipeline. For 2011, Merck plans to spend $8 billion-$8.3 billion on R&D.
Acquisitions also will likely to be a key in bolstering innovation. Merck’s huge $41.1 billion deal for Schering-Plough has certainly been critical in terms of improving the pipeline as well as allowing for more cost cutting.
Emerging markets. This will be a key source of growth for Merck. The company has been aggressive in making investments in places like China, which is seeing 30% growth.
Merck recently struck a joint venture with Simcere Pharmaceutical that will be helpful in expanding Merck’s footprint in key cities in China.
Cons
Competition. Over the next few years, Merck will lose patent protection on some huge drugs, such as Singulair for treating asthma. Unfortunately, the company does not have enough prospects in its pipeline to compensate for the void. The result will be a hit to revenue as generic drug operators offer low-cost alternatives.
Regulatory pressure. With the budget battles in Washington, it seems inevitable there will be further cutbacks in programs like Medicare. In fact, this is a trend in other countries as well, especially in Europe. In other words, there will be a drag on growth for companies like Merck.
Liability exposure. As drugs get more complicated and pervasive, the risks increase of harmful side effects. A prime example is Merck’s disaster with Vioxx back in 2005. The company has worked hard to improve quality control, but risks can’t be completely eliminated.
Verdict
Merck has been making the right choices to position the company. The cost cuts will be important as well as the continued focus on research and development. In addition, there are major opportunities in emerging markets.
Merck also has strong cash flows and a hefty dividend, which has a yield of 4.5%.
The pros outweigh the cons for investors.
Tom Taulli’s latest book is “All About Short Selling” and he has an upcoming book called “All About Commodities.” You can find him at Twitter account @ttaulli. He does not own a position in any of the stocks named here.
