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Summary

  • Merck's plan to sell off the animal health and consumer care businesses should allow management to focus more on driving growth and shoring up its pipeline.
  • With plans to ramp up spending for research and development, Merck's future looks brighter than ever.
  • With the stock trading at around $56, or 9% below the median analyst target of $60, Merck is the best bargain in Big Pharma.

Second only to the tech sector's 29% gain, healthcare stocks have been on a strong run, gaining 26.41% in the trailing 12 months. With stocks like Johnson & Johnson (NYSE:JNJ) and Pfizer (NYSE:PFE) trading at or near 52-week highs, investors are having a hard time finding bargains.

Although Merck (NYSE:MRK) has fallen out of favor of late due to (among other things) an eroding pipeline, the company has a few drug candidate that have received strong reviews. And if the company's first-quarter earnings serve as indication, Merck's strong focus on cost-cutting should offset near-term pipeline headwinds. And with a bit of luck, the company's immuno-oncology candidate, MK-3475, should be able to bridge fears of expiring patents with a strong revenue generator.

Not much was expected ahead of the first-quarter report. Revenue of $10.26 billion was down 3% year over year. Total pharmaceutical sales fell by 5% to $8.45 billion. But when factoring adverse effects of currency fluctuations, which impacted revenue by 2%, the results weren't that bad. Despite adverse currency moves, the company saw a 3% jump in its top-selling drug JANUVIA/JANUMET, which is used to lower blood sugar levels.

Not surprisingly, revenue was hit hard by (among other things) a 3% decline from former blockbuster drugs like Singulair, Nasonex, and Zetia/Vytorin -- all of which had expiring patents. Combined, these drugs contributed to an 11% revenue decline during the quarter. But we knew this was coming. The pricing pressure due to the availability of cheaper alternatives was noticeable - particularly in the U.S. and Europe.

It was nonetheless encouraging that Merck was able to offset the declines with growth in diabetes, immunology and anti-infective drugs. What's more, the 10% surge in Merck's immunology drug Remicade was a bright spot. But hardly a surprise. But no one expected the 45% surge in Simponi, a drug used to batter rheumatoid arthritis. In the markets where it's available, Simponi has become the fastest growing immunology drug. And that Remicade continues to grow at all shows the power of Merck's brand, given that there is a wide array of biosimilars in certain European markets.

From a profitability standpoint, the company reported non-GAAP earnings of $2.60 billion, which was up by 0.6% year over year. Granted, it's not a robust number. But on a GAAP basis, earnings was up close to 8% year over year. The discrepancy between non-GAAP and GAAP earnings has to do with a $1.13 billion acquisition-related charge and $326 million worth in restructuring costs. And when you factor the rate at which the company has repurchased shares, the combination contributed to a earnings-per-share increase of 5 cents, reaching 57 cents per share.

All told, it was not a blowout quarter. But it was not nearly as bad as anyone predicted. The more pressing question is about Merck's future, which I believe is rosier than the current share price presumes. On more than one occasion, management has made it known that its chief priority is to become a strong player in the areas of immune-oncology.

To that end, Merck's new immuno-oncology candidate, MK-3475, should help the company emerge as a worthwhile challenger to Bristol-Myers Squibb (NYSE:BMY) and Roche (OTCQX:RHHBY), which already have strong market positions in oncology. MK-3475 has delivered positive clinical trial data in the treatment of advanced melanoma. Industry experts believe it can become superior to nivolumab, Bristol-Myers' strong-selling cancer drug.

There is clearly more work for management to do, including the company's plan to sell off the animal health and consumer care businesses, which should allow Merck to focus more on driving growth and shoring up its pipeline. Add the fact that management has discussed plans to ramp up spending for research and development, Merck's future looks brighter than ever. With the stock trading at around $56, or 9% below the median analyst target of $60, Merck is the best bargain in Big Pharma.

Source: Why Merck Is Big Pharma's Best Bargain