Merck (MRK) reported second quarter results which, like other major pharmaceutical companies, showed a relatively weak top line performance, though, in this case, relatively stronger margins helped to compensate. Revenues declined by 11%, falling slightly short of expectations. Pharmaceutical revenue fell 12% with some growth in Januvia/Janumet (up 5%) and Remicade (up 2%). Januvia contributes a significant 15% of revenue, as does the combined Vytorin/Zetia businesses, which contributed more than 11%. However, Merck has relatively fewer big contributors to revenue when compared to its peers. Apart from pharmaceuticals, animal health declined by 2% and consumer health by 11%, though the underlying performance was stronger than the figures suggest. The performance was boosted by better than anticipated margins, but these were not particularly good overall. Gross margins declined by 1.5% and operating net income fell by 22% from the previous year, but operating margins were just ahead of expectations partly because of lower expenses on research and development.
Merck is often criticized for its drug development pipeline but there have been some important developments. Phase 1 data on lambro (the anti-PD1 drug lambrolizumab) in the treatment of lung cancer should come later this year, and positive data is expected to expand on the multi-billion dollar potential of this drug other than the treatment of melanoma. Merck is also expected to reveal interim data on its BACE inhibitor MK-8931 in the treatment of Alzheimer's disease at the end of this year, and this again will attract a lot of attention.
The company has spent a lot of money on research and development (almost $8 billion in 2012 alone), and has 44 drugs in the pipeline in various stages of testing, including 6 being reviewed by the FDA and 15 in phase 3 testing. However, there have been setbacks such as the osteoporosis drug, odanacatib, which the company had expected to file for FDA approval in the first half of 2013, but will now do so in 2014 in order to gather additional data. If odanacatib is approved, Barclays Capital expects peak annual sales of over $2 billion by 2020. Another promising drug that has been granted "breakthrough" status in late April by the FDA is lambrolizumab (MK-3475), which is used for the treatment of melanoma and non-small cell lung cancer. Analysts expect that this drug could generate peak revenues of $450 million annually just for the treatment of melanoma.
Patent cliff problems
Fortunately, no single drug going off patent will have the kind of impact on the company that the patent expiry of Singulair did. At its peak, Singulair contributed revenues of more than $5 billion. However, some smaller successful drugs will soon face this problem. The cholesterol-treatment combination of Zetia and Vytorin, will lose patent protection in 2017, and a generic version of Zetia we'll be allowed to launch in December 2016. Together, these drugs contributed $4.2 billion in revenues last year which was more than 10% of the total. Nasonex's first patents will expire next year, but generic competition is unlikely to materialize until 2018. The drug delivered more than $1.2 billion in sales next year.
Should the company restructure
In 2011, Merck began eliminating up to 13,000 jobs in order to achieve cost savings of up to $1.5 billion by 2015, and this was on top of previously announced layoffs. Because of the weak sales performance, many analysts believe that research and development spending should be cut from the approximate $4 billion now that accounts for 18.5% of revenues. There have been disappointments in the research and development program, such as the delay in seeking approval for an osteoporosis drug, FDA rejection of a sleeping pill, and a decision by the agency to cancel an advisory committee meeting to review a surgery drug. And last December, Merck canceled its Tredaptive cholesterol pill after a study showed it failed to prevent heart attacks, strokes and deaths. There is mounting pressure on the company to improve returns to shareholders especially after its $41 billion acquisition of Schering-Plough failed to deliver the anticipated results.
The company has a market cap of almost $146 billion and has more than $13 billion in cash and cash equivalents and provides investors with a dividend yield of around 3.5%. It announced a plan share repurchase of around $5 billion from Goldman Sachs, in addition to the authorized repurchase program of $15 billion, of which around $7.5 billion will be implemented over the next year. The Street has reiterated a buy rating because of its "solid financial position with reasonable debt levels" and Zacks has reiterated a neutral rating while maintaining its $50.00 target price. Equity analysts at BMO Capital Markets have downgraded Merck from an "outperform" rating to a "market perform" rating with a $51.00 price, and analysts at Jefferies Group reiterated a "buy" rating but lowered its target price from $56.00 per share to $54.00 per share. I do not expect any significant short term growth but the company is solid with an attractive dividend yield, and would make a good addition to a long-term value portfolio.