Merck: Worth a Look as a Defensive Play

Investopedia Advisor submits: With the economy slowing, and consumer spending on the wane, I think it makes sense to buy defensive stocks, particularly in the pharmaceutical industry. And among my favorites right now is Merck (MRK).

Before I delve into why I like Merck, you need to be aware of its litigation risk. For those unaware, Merck is the subject of numerous lawsuits initiated by patients who claim that they have suffered ailments after consuming its one-time flagship product, Vioxx, an anti-inflammatory drug. While the company has insurance coverage, and has done quite well defending itself in the courts thus far, gauging the ultimate financial impact to the company is difficult to say the least.

Here is what I like about the company:

Balance Sheet & Cash Flow Statement
Merck has more then $10 billion (with a ‘B’) in cash. That’s about $4 a share. Its debt load is minimal, and it has roughly $6 a share in plant, property and equipment recorded at cost. (For the record, I would suggest that the true value of this line item is actually much greater as real estate prices have skyrocketed in recent years).

Further, Merck is a cash machine. For the first six months of 2006 it kicked off about $3.5 billion in operating cash flow.

Restructuring/Cost Saving Plans
In November 2005 the company began an aggressive restructuring program. As part of the program, management announced plans to sell or close five manufacturing sites, two pre-clinical sites by 2008 and eliminate 7,000 positions. And although some near-term costs will be realized to cover severance expenses, the move is expected to save the company about $4 to $5 billion by 2010.

Drug Pipeline
It now has drugs for 17 indications/illnesses in Phase I trials, 11 in Phase II, and 5 in Phase III. In short, its pipeline is now full of potential blockbuster drugs that could bring on a host of new, positive research coverage, as well as some very good press.

Acquisitions On The Horizon?
Merck has plenty of cash, and shareholders want it to use that cash to enhance shareholder value. To that end, I have always thought that the company would pair up in some way with Bristol Myers Squibb (BMY), or Schering Plough (SGP). Why those companies?

Because both companies, as well as Merck, have a significant presence in New Jersey, which means that they could probably consolidate facilities, and eliminate several layers of management (and the associated wage and health care costs) with ease.

I also think that Bristol Myers and Schering’s broad product pipeline that focuses on everything from cardiovascular problems, to virology, to oncology (cancer) would be complimentary to Merck, and their goal of coming out with relevant, timely, and lucrative new products.

Bottom Line
Where can the stock go? Based upon the fundamentals, I think the stock is worth $50 over the next 12 months. And if the company is able to overcome its legal woes, I think the shares could go materially higher from there.

MRK 1-year chart:

By Glenn Curtis, Contributor - Investopedia Advisor

At the time of release Glenn Curtis did not own any shares in any of the companies mentioned in this article.