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Shares of Merck (NYSE:MRK) continue to see weakness following the release of a disappointing set of third quarter results. The weak sales of current top-selling drug JANUVIA causes nervousness among investors.

Prospects for increased competition for JANUVIA will most likely undo all the positive impacts of the previously announced job cut programs. Given this continued revenue pressure and the high payout ratio, I remain on the sidelines.

Third Quarter Results

Merck generated third quarter revenues of $11.03 billion, down 4.0% on the year before, and below consensus estimates of $11.12 billion.

Merck reported GAAP earnings of $1.12 billion, down 35.0% on the year before. GAAP earnings per share fell from $0.56 to $0.38 per share.

Non-GAAP earnings fell by 6.9% to $2.73 billion, with non-GAAP earnings per share falling by three cents to $0.92 per share. Analysts were looking for non-GAAP earnings of $0.88 per share.

CEO and Chairman Kenneth C. Frazier commented on the third quarter developments, "This quarter we delivered solid financial results, with strong contributions from our vaccine, immunology and HIV businesses, and effective cost management. We are improving productivity and focusing our R&D and commercial resources more precisely to enable our investments in the best opportunities for innovation and growth."

Looking Into The Results

The reported 4% decline in revenues was driven by the impact of patent expiry and a 2% negative impact from foreign exchange movements.

The huge discrepancy between non-GAAP and GAAP earnings was driven by sizable acquisition related costs and restructuring costs. Pre-tax acquisition related costs came in at $1.20 billion, with restructuring costs totaling another $967 million.

Pharmaceutical sales fell by 4% to $9.5 billion. Merck reported a 5% fall in revenues for its top selling drug JANUVIA, totaling $927 million. Sales of SINGULAIR more than halved, coming in at $280 million. Double-digit revenue growth in GARDASIL and REMICADE could not offset the declines.

Animal health and consumer care revenues both fell by 2%, entirely explainable due to unfavorable exchange rate movements.

To offset the poor revenue developments, Merck cut both marketing & administrative expenses, as well as in research & development expenses.

And The Outlook

Merck now sees full-year non-GAAP earnings between $3.48 and $3.52 per share. GAAP earnings per share are seen between $1.61 and $1.79. Note that earlier this month, Merck still guided for non-GAAP earnings of $3.45 to $3.55 per share.

Merck sees full year sales down 5 to 6% compared to 2012, as foreign exchange rates depressed revenues by some 2.5%.

Valuation

Unfortunately, Merck has not provided a balance sheet yet with its third quarter earnings report. The company ended its second quarter with $18.1 billion in cash and equivalents. Merck has about $28.1 billion in debt outstanding, for a net debt position of about $10 billion.

For the first nine months of the year, Merck has generated revenues of $32.7 billion, down 8.0% on the year before. Net earnings attributable to common shareholders fell by 31.1% to $3.6 billion, with GAAP earnings coming in at $1.20 per share. At this pace annual revenues are seen just below the $45 billion mark, with GAAP earnings coming in around $5.1 billion.

Factoring in losses of 3% in Monday's trading session, with shares trading around $45 per share, the market values Merck at $132 billion.

This values equity in the firm at around 2.9 times annual revenues and 25-26 times annual GAAP earnings.

Merck pays a quarterly dividend of $0.43 per share, for an annual dividend yield of 3.8%.

Some Historical Perspective

Over the past decade, shareholders in Merck have seen zero capital gains, and have been totally reliant upon dividends for their returns.

Shares rose from lows of $25 in 2004 to peak at $60 by the end of 2007. Shares fell back to lows of $25 in 2009 again to increase to highs of $50 earlier this year. At the moment of writing, shares are currently trading at $45 per share again.

Between 2009 and 2012, Merck has increased its annual revenues by nearly 75% to $47.3 billion, driven by the acquisition of Schering-Plough. Earnings came in just above the $6 billion mark on a GAAP-metric over the past two years.

Investment Thesis

The main disappointment in Merck's earnings statement are sales of JANUVIA, and combined sales of the drug with Janumet. Combined sales fell by 1% to $1.4 billion, indicating that the drug might no longer report revenue growth.

JANUVIA was introduced in 2006, and has seen unsteady revenue developments since its introduction, with sales now falling short on consensus estimates. Given that JANUVIA is the top-selling drug of Merck, investors are very disappointed. Merck was surprised and concerned about sales shortfalls, driven by increased competition from competing drugs.

These competing drugs include Onglyza, developed by Bristol-Myers (NYSE:BMY) and Tradjenta, which has been developed by Boehringer Ingelheim and Eli Lilly (NYSE:LLY). Merck sees continued rebate and discounting in the marketplace, with market shares continuing to slip away.

Besides weakness being seen for JANUVIA, sales of SINGULAIR which was once the top-selling drug of Merck, halved again on the back of generic competition.

Earlier this month, Merck already announced that it would cut operating costs by some $2.5 billion by 2015. These cost cuts should be achieved through 8,500 job cuts, some 10% of the global workforce. Note that these job losses come on top of already announced job cuts of 7,500 workers.

Besides focusing R&D efforts, Merck is also contemplating the sale or joint venture of its animal health, and or consumer business.

Two weeks ago, I last took a look at Merck's prospects. At the time, analysts at Jefferies were downgrading the shares. I concluded to agree with Jefferies as I see little appeal for Merck's shares despite cost cuts. Especially on a GAAP basis shares trade at high multiples despite a lack of prospects for immediate revenue growth. The benefit of the cost cuts hardly offset lost revenues from SINGULAIR. While Merck stresses the use of non-GAAP earnings in its financial reporting, the gap between GAAP and non-GAAP earnings are large and persistent.

I furthermore noted that while the dividend yield looks appealing, the payout ratio is quite high leaving little room to raise the dividend.

I continue to reiterate my opinion. I wouldn't pick up any shares at the moment despite the current dividend yield of 3.8%. Given the high payout ratio and continued pressure on revenues, shares offer little appeal to me at the moment.

I remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Merck - Surprised Weakness In Januvia Is Causing Renewed Worries For Investors

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