Why Merck May Stagnate In 2012

| About: Merck & (MRK)

Merck & Co (NYSE:MRK) is one of the largest pharmaceutical companies in the world. It has made the news with its plans to decrease its workforce by up to 12% in the coming years. In addition, it recently revealed its reliance on pharmaceutical growth in emerging markets, particularly China. It has been proactive in Chinese expansion by working with Simcere (NYSE:SCR) on moving supply chains to needy areas.

"The company and China's Simcere Pharmaceutical Group announced last week the establishment of a joint venture that will serve China's rapidly expanding healthcare needs by providing significantly improved access to quality medicines in major therapeutic areas."

Merck Q2 Earnings Release - July 29, 2011

Its recent earnings report provides fresh statistics for investors to work with; some good and some bad. Its biggest drug, Singulair, treats both asthma and seasonal allergies. More of Merck's presence in the allergy medication market comes from Nasonex (yes, the same heavily advertised drug with Antonio Benderas voice acting the bee).

Merck has heavy presence in other markets as well, including Januvia which is a huge player in treating diabetes. It has been doing so well that in the last year sales revenue from this drug alone have increased a whopping 35%. Other high growth drugs include Remicade (up 26% in sales year on year), which has a variety of uses including treating rheumatoid arthritis, Crohn's disease, ulcerative colitis, psoriasis, and other maladies. Lastly, there is Isentress which inhibits HIV-1 integrase (it is one of many weapons doctors can use against AIDS).

Despite this, Merck's patent expirations and relatively unexciting pipeline are a problem that should not be ignored by investors. The company is now trading at a P/E of 22.68, which is quite high. Compare this to rival Pfizer (NYSE:PFE) trading at a P/E of 16.55, or Johnson & Johnson (NYSE:JNJ) at 15.15. Let us take a closer look at the patents and conditions of Merck's best-selling drugs:

Singulair (Asthma, allergies) - Expiration on February 3rd of 2012: As mentioned before, this is their #1 drug which is a leader in both asthma and allergy medication markets. Their loss of exclusivity in 2012 will be bad news for the company.

Remicade/Infliximab (Anti-Inflammatory drug) - Expires in 2018 (Technically held by JNJ): Johnson & Johnson holds the rights to this best-selling drug in Central and South America, Asia Pacific, the Middle East and Africa. Nonetheless, Merck retains its marketing rights in other areas, but losing the market share and patent to JNJ does affect the drug's prospects.

Isentress/Raltegravir (HIV-1 inhibitor) - Expires in distant future, October 2022: Obviously nothing for Merck to worry about in the near future

Januvia (Diabetes) - Expires in the distant 2017: Once again, the expiration date is so far into the future that the pipeline will have ample time to create something new or better to treat diabetes.

While Merck has a strong portfolio of drugs for now, the pipeline isn't looking as robust as it could. With the official loss of migraine drug Telcagepant, and very strong competition in developing cholesterol medications (opposed to the problematic Vytorin and Zetia undergoing additional FDA approval now), it might hit some turbulence along the way. It needs that growth in China if it hopes to grow revenue substantially in the coming years. Lastly, the R&D budget has shrunk to $1.9 bln from $2.2 bln in 2010. Whether this is just reduced from integration and cost-cutting is hard to say, but since R&D is one of the top priorities of any pharmaceutical company it's not a very encouraging sign.

Don't let that completely turn you away from the stock though, Merck still has Januvia and Isentress profits and an aging population to prop up its markets. The firm also has emphasized its plans to reduce liabilities which could boost EPS significantly. In addition, it will not take as much damage as some other pharmaceutical companies in the short term from patent expirations (see Pfizer for instance, with its loss of Lipitor). Nonetheless, in the short run at least, Merck potentially has room to run.

Overall, Merck may be keeping some of the fastest growing drugs on its portfolio, but other than Chinese expansion (which every other pharmaceutical company is doing as well), there's not anything that exciting for Merck in 2012 other than cost-cutting measures which may end up backfiring.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.