Merck: Should You Buy It?

Aug.11.14 | About: Merck & (MRK)

Summary

Top line shrinked by 1% in the second quarter due to the continued generic erosion. However, disciplined expense management prevented the decline from trickling down to the bottom line.

The company has narrowed down its R&D focus on businesses that uphold the strength to become market leaders.

Sale of consumer care segment to Bayer AG against a consideration of $14.2 billion, which can be invested in areas where Merck has a competitive edge.

Merck has recently taken over Idenix Pharmaceuticals where the company’s drug, nucleotide, was the crown jewel for Merck in this acquisition.

Merck upholds solid future growth prospects, is undervalued and offers a higher than industry dividend yield of 3.16%.

The players of the drug manufacturing industry constantly grapple with the reality of patent expiries. Merck (NYSE:MRK), being one of the renowned companies in the industry, is continuously on the move to commercialize its new wave of innovative discoveries to maintain and add to its bottom line growth. The company has recently released its second quarter results for the fiscal year 2014.

Let's take a look at the company's recent performance and what it has in store for its investors.

Recent Performance At A Glance

Source: Merck Earnings Announcement

Pharmaceutical Segment

Starting with the top line, Merck saw its total revenue plunge by 1% in the second quarter of fiscal year 2014 on the back of continued generic erosion for Temodar and Nasonex. Intensifying competition also adversely affected the revenue earned from its hepatitis franchises; Victrelis and Pegintron. Additionally, the company also confronted biennial price declines in Japan. However, these negative pressures were mainly counterbalanced by the positive growth of 4% on the international front. Sales growth was witnessed in the treatments offered for inflammatory diseases (21%), higher sales of cholesterol controlling medicines (6%), higher demand for diabetic medicines and HIV integrase inhibitor in Europe and the emerging markets (2% each).

Animal Health Segment

Source: Merck Earnings Announcement

The segment's growth of 2% was mainly attributable to higher sales of Bravecto, the oral flea and tick treatment for dogs, which was successfully introduced in the US and Europe and higher sales of poultry and aqua products. On the contrary, the recall of Zilmax from the US and Canadian market during last year has negatively affected the segment's growth. Eliminating the negative effects of Zilmax, the segment's sales revenue had elevated by 9%.

Consumer Care

On the face of it, consumer segment registered a staggering growth of 19% in the most recent quarter primarily due to the solid sales of Claritin and Coppertone. However, the growth percentage is rather inflated due to an extraordinary unfavorable line item in the corresponding period last year. Eliminating this item, global sales had shot up by 4%. Moreover, the company intends to divest from this segment which raked in $583 million or 5.3% of the total revenue in the quarter under discussion. The divestiture is expected to close by the end of the current fiscal year.

Curbing Unnecessary Expenses

While the company's gross margin had shrinked to 55.2% in the second quarter this year from 61.1% in the same period last year, its disciplined expense management approach prevented the decline from trickling down to the bottom line. This can be supported by the company's expense to sales ratio which plummeted to 82.7% in the most recent quarter from 88.7% in the corresponding period last year. The company has undertaken productivity measures which led to a decline in its marketing expenses.

R&D Status

Source: Merck News Release

At the outset, the trimming down of R&D expenses may seem to upset an investor of a drug manufacturing company like Merck as R&D conducted today has a strong positive correlation with the company's future growth prospects. However, the situation is a bit different here. The company is trying to lower its spending by prioritizing its drug portfolio and making calculated investments in key therapeutic opportunities. The company has narrowed down its R&D focus on businesses that uphold the strength to become market leaders. It was the shift to this approach that the company decided to sell off its consumer care segment to Bayer AG (OTCPK:BAYZF) against a consideration of $14.2 billion, which can be invested in areas where Merck has a competitive edge.

Furthermore, the company plans to increase its R&D expenditure in the second half of the year.

The Crown Jewel

Merck has recently taken over Idenix Pharmaceuticals Inc. (NASDAQ:IDIX). Idenix's drug, nucleotide, was the crown jewel for Merck in this acquisition. The company aims to group this drug with its two currently under development drugs in an attempt to launch a triple-regimen solution for Hepatitis C. The therapy is expected to treat patients in less than two months. Although it may take a while before the medicine is available on the shelf of a drug store, the successful authorization can provide an active boost to the company's top and bottom line as Gilead's (NASDAQ:GILD) Sovaldi is highly censured for the exuberantly high price being charged.

The Road Ahead

Although overall sales revenue collected from the US region had plunged during the second quarter in 2014, volumetric growth is anticipated to continue during the remaining part of the year. The company also expects to see global sales growth coming from its Januvia franchise. Additionally, Merck is also expected to drive future growth from its international presence. Currently, outside US sales contribute nearly 50% of the total revenue. Specifically, emerging markets such as China, Brazil and Turkey will prove to be the main growth drivers for the company during the year.

Moreover, the company plans to introduce suvorexant, pembrolizumab and pembro in the near future.

Final Call

In the wake of the above mentioned future outlook and its recent acquisition of Idenix, the company upholds solid future growth prospects. The scrip is also undervalued based on its P/E valuation and offers a higher than industry dividend yield of 3.16%. Therefore, I recommend buying the stock.

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

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