Bad Times Continue To Hit Merck's Animal Health Segment

| About: Merck & (MRK)


Merck continues to face major hindrances in its efforts to reintroduce Zilmax in the market.

Withdrawal of Zilmax plopped down the animal health segment’s contribution by almost 5% on a year-over-year basis.

However, the research has been procrastinated for now as meatpackers continue to remain unconfident about selling beef produced during the company’s research.

In the meanwhile, companies like Eli Lilly are fully leveraging on this market opportunity to sell its substitute drug, Optaflexx.

It may take a while before Merck is able to regain its lost market share and reputation in the beef industry.

The management of Merck (NYSE:MRK) is trying a different strategy now. It is trying to work backwards by re-launching previously recalled drugs from the market along with discovering new drugs. However, the company continues to face major hindrances in its efforts to reintroduce Zilmax due to safety concerns that led to its recall from the market last year.

Let's take a look at the background story behind this news and its current status.

The Background Story

An active threat that Merck's animal segment began facing last year was that beef producers and sellers saw their confidence shattered in the company's cattle muscle-building drug, Zilmax. The largest US meat processor, Tyson, saw its animals being destroyed following the intake of Zilmax. Thereafter, many leading meatpackers followed Tyson in discontinuing the intake of Zilmax to their cattle. This had an adverse impact on Merck's existing animal segment sales and tarnished its market image as well. Also, the regulatory authority began to heavily scrutinize the company's submissions before finally approving them.

Majority of the cattle supplied to slaughterhouses in the US were given either Zilmax or Optaflexx at the time when Merck pulled off its product. This paved way for other competitors to grab Merck's market share. Zilmax had collected $160 million in annual sales in the United States and Canada in the fiscal year 2012, and was contributing a stable cash flow to Merck's animal health business, which contributes approximately $3.3 billion in global sales of the company on an annual basis. Withdrawal of Zilmax plopped down the animal health segment's contribution by almost 5% on a year-over-year basis. Applying the net profit margin of 10.46% of the most recent quarter back then, this approximately dented the company's net earnings by approximately $16.74 million or $0.01 on a per-share basis.

Current Status

The company is currently working on reviving Zilmax which was used by beef producers for weight gain of cattle in the US and was recalled from the market in August 2013 on the premise that it was affecting animal health and making it difficult for them to walk.

The pharmaceutical giant has stated that it plans to examine the effect of Zilmax on a sample of approximately 250,000 animals in the most extensive randomized, controlled study of any drug fed to cattle. Although the sample size of cattle involved would symbolize less than 1% of the total US cattle slaughter per annum, it represents a market value of nearly $500 million based on the current market prices for slaughter-ready cattle and make approximately 100 million kilograms of beef.

However, the research has been procrastinated for the time being due to the fact that major meatpackers continue to remain unconfident to be able to sell beef that would be produced while the company's research is being conducted. The market reaction is quite unwelcoming despite the fact that the beef of cattle fed on Zilmax has been pronounced safe for human consumption by the US Food Drug and Administration "FDA". Currently, Merck needs a lot of backing from the two main meatpackers, Tyson and Cargill, which cover almost 60% of the total production. The two main demand driving companies continue to show their reluctance in using Zilmax.

According to a statement made by Craig Wilson, vice president and general merchandise manager at Costco Wholesale Corporation (NASDAQ:COST), "We don't want to fiddle with it as long as there's a known animal-welfare issue". "Costco is not going to agree to take the meat until we've got the right assurances in place."

Due to the lack of consumer confidence in the US, meatpackers may look into the option of selling beef in the markets abroad. However, the possibility remains quite low as many markets, including China, Russia and the European Union, forbid the use of Zilmax.

South Korea, the fifth largest foreign buyer of US beef, recently procrastinated its plan to relax the restrictions on Zilmax-fed beef for a month at minimum. The country was an active buyer of more than 200 million pounds.

Competitive Landscape

Taking advantage of Merck's Zilmax exit from the market, Eli Lilly's (NYSE:LLY) Optaflexx became the top priority choice of US feedlot operators to accelerate the weight gain in their animals. The sales of Optaflexx continue to experience a rising demand curve.

Moreover, other players are also thinking of ways to grab a chunk of the market share freed up by Merck's withdrawal. Zoetis Inc (NYSE:ZTS), previously part of Pfizer (NYSE:PFE), intends to launch its weight gain drug for cattle during the current year.

Final Verdict

In the wake of the current problems that have surrounded the company's animal health segment, it may take a while before Merck is able to regain its lost market share and reputation in the beef industry. Therefore, I recommend staying away from the stock for the time being.

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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