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Merck (MRK) recently declared its third quarter results; its net earnings fell by 35% year over year to $1.12 billion and generated revenue of $11.03 billion, down from $11.49 billion for same period last year. The company initiated various trial phases of the drugs in its pipeline. One of the most promising drug MK-3475, or lambrolizumab, is an anti-programmed death 1, or anti-PD-1, drug that we expect may drive the company's growth in the future.

Trial phases for MK-3475

Merck is one of the leading contenders to win first approval from the regulatory bodies for its PD-1 cancer immunotherapy program. PD-1 is a protein that blocks the immune system to fight against tumors or cancerous cells. In April 2013, Merck's MK-3475 received "breakthrough treatment" designation by the FDA for treating advanced melanoma. The breakthrough treatment is intended to expedite the development and review of drugs that can be used alone or in combination to treat fatal diseases. Merck is testing the efficacy of MK-3475 in eight different clinical trials to treat patients suffering with different types of cancer like melanoma, non-small cell lung, gastric, triple negative breast, and hematological malignancies.

In the phase I trial of MK-3475, melanoma patients were treated with different doses of MK-3475 depending on their melanoma stages. In this trial, around 38% of the patients observed a 30% reduction of their tumor cells. Based on the phase I positive results, Merck commenced the phase II trial, testing the efficacy of MK-3475 in treating patients suffering with advanced melanoma, who were previously treated with other therapies. In phase II trial, it will test the efficacy in comparison to the immunotherapy antibodies with chemotherapy. Further, in phase III, it will compare MK-3475 with other competitor's drugs like Bristol-Myers Squibb's (BMY) Ipilimumab and nivolumab on patients that haven't been treated previously with any other drugs.

Additionally, Merck was simultaneously testing MK-3475 to treat Non-Small Cell Lung Cancer, or NSCLC, one of the most common types of lung cancer. The company announced the interim data of MK-3475's phase Ib expansion trial on previously-treated NSCLC patients. It reported that for the cohort of 38 patients treated with MK-3475 10mg/kg dose, the response rate was 24% with the average survival rate of 51 weeks in seven out of nine responders.

Based on the phase Ib trial data, Merck will commence the phase II and phase III trials comparing the 10mg/kg dose and 2mg/kg dose with Sanofi's Docetaxel, an anti-cancer drug. Merck is expected to present the results of its current ongoing trials, evaluating 10mg/kg every three week dose and 10mg/kg every two week dose regimens for MK-3475 in patients with NSCLC in 2014.

With MK-3475, designated with breakthrough treatment, we expect Merck will be a strong competitor to Roche's (OTCQX:RHHBY) MPDL3280A and AstraZeneca's MEDI4736. If MK-3475 posts superior results in its later trial phases, then it will enable Merck to capture a major chunk of the cancer drug market, enhancing its topline.

Opportunity for MK-3475

According to the American Cancer Society, Lung cancer is one of the leading causes of cancer-related death worldwide. It is estimated that around 1.4 million people worldwide die from lung cancer annually, and nearly 85% of lung cancer patients are diagnosed with NSCLC annually.

It is also expected that the lung cancer drug market in G7 countries, which include the U.S., U.K., France, Germany, Italy, Canada, and Japan will grow at a CAGR of 13.5% from 2015 to 2020, reaching $13 billion.

Further, melanoma is responsible for causing 75% of deaths related to skin cancer, and about 160,000 new melanoma cases are diagnosed every year globally. It is estimated that around 76,690 people in the U.S. will be diagnosed with melanoma and 9,480 people will die in 2013.

We expect MK-3475 success in both trial phases would help Merck strengthen its footprint in the oncology segment. Analysts expect MK-3475 has the potential to generate the annual sales of around $500 million a year for melanoma, and if MK-3475 is approved by the regulatory bodies for treating different forms of cancer, then we expect it could be a blockbuster drug for the company. Pharmaceutical analyst Tim Anderson expects that MK-3475 can generate peak sales of $3 billion during its life. We also believe MK-3475 has the potential to be a blockbuster drug for the company.

On competition side

Roche expects to develop "MPDL3280A" to efficiently treat lung cancer patients, as it was able to reduce the tumor cells in around 26% of smokers in its early trial phase. The dose of MPDL3280A is given once every three weeks, which improves the immune system and helps in blocking the PD-L1, a protein. Roche has initiated the late-stage phase trials for MPDL3280A. We expect Roche, as the world's largest cancer drug manufacturer, will be able to post positive trial phase results. This will help it receive faster regulatory approval for the commercialization of its drug, and this drug is expected to generate the peak sale of $3.5 billion over its life.

Bristol-Myers is another leading competitor in the cancer market with its combination therapy of Ipilimumab and Nivolumab. The company is currently testing drug combinations in various trial phases for treating different forms of cancers like triple-negative breast cancer, advanced melanoma, and NSCLC. These drugs were able to enhance the survival rate in 82% of 53 patients than with Ipilimumab alone. Analyst expects Ipilimumab will be able to generate sales of $1.1 billion this year, and currently most of the pharmaceutical experts expect Nivolumab will be available in the market before Merck's MK-3475 and generate $4 billion as peak sales.

There are huge opportunities for all three companies, according to Leerink Swann, the healthcare investment banker, who projected that the immuno-oncology drug market could generate $20 billion in sales annually. He also believes the combined annual peak sales of these drugs could collectively earn $10 billion for these companies. By looking at the potential peak sales of each drug, we expect the combined figure of $10 billion is quite achievable.

Conclusion

By developing MK-3475, Merck expects to strengthen its footprint in oncology; this will help it maintain and enhance its future revenue. With its vast experience in drug development, we expect the company will be able to build a strong drug portfolio. Merck may initiate various trials with MK-3475, and it may be one of the company's blockbuster drugs if it can treat multiple forms of cancer.

Additionally, in its recent 2013 guidance, Merck said it expects to generate EPS in the range of $3.48-$3.52 per share. It is trailing at a PE multiple of 27.28 and has a forward PE of 12.94, representing higher growth potential for the company in the future. The current downfall in its stock price could be looked at as a buying opportunity for the long term.

Source: Merck: Why Oncology Smells Like Money

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Satya Prakash, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.