Would you want to buy stock in a pharmaceutical company whose biggest selling product, worth over $5 billion in annual revenues, is about to go generic?
Merck (MRK) sells a large number of prescription drugs, produces and markets vaccines for people and animals and is also the purveyor of a number of well-known consumer health products, like Claritin, Coppertone, and Dr. Scholl's. In the latest quarter, pharmaceuticals (including human vaccines) provided 86% of revenues but grew only 3%, whereas the company had higher growth in consumer care (7%) and animal health (8%) categories.
The growth in pharmaceuticals was impacted by large drops in revenues from Remicade, Cozaar and Hyzaar. The drop in Remicade was related to a transfer of marketing rights to Johnson & Johnson (JNJ) during the year. Declines of Cozaar and Hyzaar sales were expected after company lost marketing exclusivity in the U.S. and Europe in 2010. On the other hand, the company reported double digit growth in four of its products: Januvia, Janumet, Isentress, and Gardasil.
Januvia and Janumet are both used to improve control of blood sugar in patients with type II diabetes, which is currently at epidemic stage in the U.S. and is increasing rapidly throughout the developed economies. Isentress is used in combination therapy to treat HIV infection. Gardasil is a vaccine for human papilloma virus, which causes genital warts in men and cervical and other cancers in women.
Gardasil may be Merck's most interesting product. A cancer vaccine may seem so evidently desirable as to be non-controversial, but It came up in the Republican presidential debates. Ron Paul and Michele Bachmann criticized Rick Perry for his executive order to put Gardasil on the state's list of required vaccinations for school attendance, a move that was overturned by the state's legislature. The Family Research Council worries that vaccination would give young girls a false sense of security regarding sex (the possibility of pregnancy or HIV infection apparently doesn't inspire enough fear). Social conservatives are sure that their daughters don't need the vaccine because they won't be having sex until after they are safely married to someone clean, who couldn't possibly have genital warts. Of course the main promoter of the whole mandatory vaccination idea was Merck itself. They were treading politically dangerous waters, from which they have since pulled back. Nevertheless, sales have increased 33% versus the same quarter a year ago. There are about 470,000 cases of cervical cancer worldwide, causing 250,000 deaths annually, so it is likely that sales growth will continue for a while.
Merck's biggest seller is Singulair, used to treat asthma. Its sales are second to market leader Advair, marked by GlaxoSmithKline (GSK) but ahead of the newer entry, Symbicort, made by AstraZenica (AZN).
The diabetes drug Januvia may overtake Singulair as Merk's largest selling product by next year. Januvia is the market leader in a field that includes Tradjenta from Eli Lilly (LLY), Onglyza from AstraZenica, Victoza from Novo Nordisk (NVO) and Merck's own combination drug, Janumet. Januvia and Janumet both contain sitagliptin, which increases insulin secretion and decreases secretion of glucagon. Janumet also contains metformin, which increases insulin sensitivity.
Singulair appears to have reached market saturation, with minimal sales growth, but even worse, Merck's patent expires in August 2012, which will lead to the incursion of generics into this market.
Do not cry for Merck's lost patent. For one thing, Singulair supplies only about 11% of Merck's revenues. Besides which, the company has a full pipeline of drugs waiting in the wings. The company recently received FDA approval for Zioptan, a prostaglandin analog used to treat glaucoma, and has announced plans to file a New Drug Application (NDA) for suvorexant, to treat insomnia. Merck will soon seek approval for a next generation HPV vaccine and for odanocatib, a cathepsin K inhibitor, used to treat osteoporosis. Merck has two more drugs under review, ridaforalimus for sarcoma, and combination drug, ezetimibe and atorvastatin, to prevent atherosclerosis by controlling cholesterol. There are 19 Merck drugs in Phase III trials, and 13 drugs in Phase II trials.
Is Merck a buy at current levels? Of 23 analysts covering the stock, 15 rate it as a buy or outperform, despite predictions of a small fall off in earnings, from $3.83 per share in 2012 to $3.70 in 2013 (the Singulair effect).
The price to earnings ratio for Merck is about 17 compared to a sector average of 25. The price to sales ratio is about 2.5 versus a sector average of almost 4. The dividend yield of 4% is twice the industry and sector average. The price is therefore cheap relative to its peer group on fundamentals.
Investors have parked a lot of money in the stocks of large pharmaceutical companies because they are seen as fairly safe and because of demographics. The average age is increasing in the U.S. and, as baby-boomers get old and feeble, they tend to consume more pharmaceuticals. The situation is even more extreme in Western Europe and Japan. In 2005, the 65 and over age group in Japan was already 21% of the population, and has certainly increased percentage-wise since then.
Merck offers the stability of a wide portfolio of drugs and vaccines, along with the security of a huge pipeline, which promises high earnings in the future. I see Merck as a short term hold and a long term buy. There is bound to be some investor anxiety attending the expiration of the Singulair patent in August. Although Merck has an abundance of new drugs coming online, none is likely to be a huge enough blockbuster to significantly boost the bottom line in a company that already has $45 billion plus in revenue. While there is no immediate reason to jump in, Merck's impressive pipeline is likely to provide earnings growth in the years to come.