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Merck & Co.: Attractive Valuation With Margin Stability In Focus

Jan. 04, 2022 12:46 PM ETMerck & Co., Inc. (MRK)20 Comments


  • This article focuses on the margin stability of Merck & Co.
  • Its marginal efficiency of capital, a key indicator for its future profitability, has been under some pressure.
  • However, its recent OGN spinoff and Acceleron acquisition are expected to improve return on capital.
  • Combined with the attractive valuation, I am bullish and expect an annual total return in the double-digit range for the next few years.

Merck Annouces Job Cuts

Marko Georgiev/Getty Images News

The investment thesis

This article focuses on the margin stability of Merck & Co. (NYSE:MRK). More specifically, you will see that its marginal return on capital employed ("MROCE") has been under pressure in recent years. To me, return on

This article was written by

Envision Research profile picture

** Disclosure: I am associated with Sensor Unlimited.

** Master of Science, 2004, Stanford University, Stanford, CA 

Department of Management Science and Engineering, with concentration in quantitative investment 

** PhD,  2006, Stanford University, Stanford, CA 

Department of Mechanical Engineering, with concentration in  advanced and renewable energy solutions

** 15 years of investment management experiences 

Since 2006, have been actively analyzing stocks and the overall market, managing various portfolios and accounts and providing investment counseling to many relatives and friends.

** Diverse background and holistic approach 

Combined with Sensor Unlimited, we provide more than 3 decades of hands-on experience in high-tech R&D and consulting, housing market, credit market, and actual portfolio management. We monitor several asset classes for tactical opportunities. Examples include less-covered stocks ideas (such as our past holdings like CRUS and FL), the credit and REIT market, short-term and long-term bond trade opportunities, and gold-silver trade opportunities. 

I also take a holistic view and watch out on aspects (both dangers and opportunities) often neglected – such as tax considerations (always a large chunk of return), fitness with the rest of holdings (no holding is good or bad until it is examined under the context of what we already hold), and allocation across asset classes.

Above all, like many SA readers and writers, I am a curious investor – I look forward to constantly learn, re-learn, and de-learn with this wonderful community.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of MRK either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Comments (20)

Envision Research profile picture
Thanks all for reading and commenting! There are some questions regarding ROCE and MROCE, and here I want to add more explanations:

Q1. is ROCE the same as ROC, or what in SA is Return on Total Capital?
No. ROCE is the profit earned on the capital ACTUALLY employed, and it is not same as ROC. Because not $ in the asset is actually employed. A good example is a business that sits on a large amount of idle cash. Even more details can be found in my earlier article.


Q2. Is anyone of the following common profit margin metrics equivalent to MROCE? net profit margin, EBIT margin, EBITDA margin, et al.

None. If you think of all those common margin metrics as speed, then MROCE would be equivalent to acceleration. MROCE measures the *rates at which profit margin changes*.
thirdcamper profile picture
@Envision Research Right, so is a plebeian to find these metrics?
FrankTrades profile picture
Covid drug called into serious question. https://youtu.be/IPncEwOY1bo
thirdcamper profile picture
Two questions, one comment.

Questions: 1) How does one use this method using commonly available statistics? QA, for example, tracks profit margin, EBIT margin, EBITDA margin - which of those, if any, is equivalent to MROCE? 2) I gather ROCE is the same as ROC, or what in SA is Return on Total Capital?

Comment: To evaluate a pharma company properly, you need an analysis of the pipeline. One can't just go off the financial metrics. I haven't seen anyone on SA do it recently. It's the prospect of a diminishing pipeline that has investors skittish on MRK, as well as its clock getting cleaned recently by PFE in the covid contests.
A huge risk is Januvia losing patent. Sales around $5.0 Billion.
This is not a Biosimilar, so the patent cliff will be steep.
BM Cashflow Detective profile picture
Instead, for me the "reversed P/FCF/G/Y ratio" and "combined CROIC / P/FCF/G/Y ratio" (Super Magic Formula for Dividend Stocks) are the two most important key figures for analyzing a company.

Because they show the still far too little noticed elephants in the room, because Merck will mutate into a real free cash flow generating monster in the next two years.

An own assessment check with regard to quality, valuation and growth expectations comes to the following result.

Valuation check with the "reversed P/FCF/G/Y ratio".

September 2021 FCF $8,158b / year.

December 2024 FCF $19.667b / year! Based on 5 analysts.

(Estimated FCF mid term growth consensus +47.86%!) + (Dividend yield FWD +3.59%) / (P/FCF ratio FWD 11.21) = (Growth / P/FCF ratio 4.59!).

A "ratio between growth plus estimated dividend and price / free-cash-flow-ratio" of over 0.9 indicates a price discount compared to the normal price for the growth potential. If the "ratio between growth plus estimated dividend and price / free-cash-flow-ratio" is above 1.6, the company is usually in an exceptional situation that should be examined more closely. Yes it should. Especially this time.

(0.9 x 100 / 4.59 = 19.61% Extremely discounted value!).

(100% - 19.61% = 80.39% Discount, undervalued, margin of safety!).

Quality check with the “Super Magic Formula for Dividend Stocks”.

TTM CROIC 13.6% = 19.61% Discounted Value.

Combined CROIC / P/FCF/G/Y ratio = 69.4% actual CROIC = 100% fully valued.

Thus an additional and natural CROIC leverage potential of sensational 55.8% which is not priced in the previous CROIC.

Benchmark: Sector Healthcare CROIC -22.1%.

Estimated mid term return potential of very high 89.97% CAGR.

(Growth +47.86%, yield +3.59%, mid term mean reversion potential +38.52%).

After then, Company is a "Super-UltraMega Magic Formula Dividend Stock" and an aggressive buy.

I'm long $MRK

With a current valuation of P/FCF ratio FWD of low 11.21, the coming free cash flow increase is not at all reasonably priced in. Merck is a sleeping and underrated giant. Here the motto can only be, buy quickly before others notice the mistake. Perhaps Merck has been a boring investment so far. But that should soon be over. Merck will do what you expect from a good investment. Make a lot of money and that with an additional enormous efficiency.
@BM Cashflow Detective - Thanks as always! What are your thoughts right now on $MRK vs:
Love_ Money profile picture
@BM Cashflow Detective Great post. Very few in SA community can match BM’s analytical capabilities. Given your great contribution here, I recommend “BM cashflow detective” be promoted to the position of “BM Cashflow Sheriff”. Or if you like British system, “Sir BM cashflow detective”.
BM Cashflow Detective profile picture

In any case, I like and own all four stocks.

Okay, let's take a good look at the current differences.

1. $MRK (Estimated FCF mid term growth consensus +47.86%!) + (Dividend yield FWD +3.59%) / (P/FCF ratio FWD 11.21) = (Growth / P/FCF ratio 4.59!)

Reversed P/FCF/G/Y ratio = 4.59, 19.61% discounted value.

Combined CROIC / P/FCF/G/Y ratio = 69.4% actual CROIC.

2. $BMY (Estimated FCF mid term growth consensus +15.38%) + (Dividend yield FWD +3.48%) / (P/FCF ratio FWD 8.48) = (Growth / P/FCF ratio 2.22)

Reversed P/FCF/G/Y ratio = 2.22, 40.54% discounted value.

Combined CROIC / P/FCF/G/Y ratio = 40.2% actual CROIC.

3. $AMGN (Estimated FCF mid term growth consensus +20.96%) + (Dividend yield FWD +3.41%) / (P/FCF ratio FWD 11.75) = (Growth / P/FCF ratio 2.07)

Reversed P/FCF/G/Y ratio = 2.07, 43.48% discounted value.

Combined CROIC / P/FCF/G/Y ratio = 39.6% actual CROIC.

4. $ABBV (Estimated FCF mid term growth consensus +3.89%) + (Dividend yield FWD +4.17%) / (P/FCF ratio FWD 11.80) = (Growth / P/FCF ratio 0.68)

Reversed P/FCF/G/Y ratio = 0.68, 132.35% premium value.

Combined CROIC / P/FCF/G/Y ratio = 16.62% actual CROIC.

Funny, unintentionally you have already put the correct order in place. After that, Merck, Bristol-Myers Squibb and Amgen are a "buy".

However, AbbVie is now only a "hold" due to the good performance lately. A good example of how value can only be destroyed due to a rise in price for the investor, as AbbVie is of very high quality overall. Just remarkable.
captaindividend profile picture
I hold Merck in the portfolio and keep reading positive articles ... but to me feels like a dead parrot stock - missed the recent opportunity to off load unfortunately
NVE$TOR profile picture
@captaindividend same here, should of sold when it hit 90. but then again how would we know that pfizer's "magic pill" would randomly do better per news the next day... so is the market, irrationality everyday
malinois000 profile picture
@captaindividend Add me to the disappointed list that wishes he would have sold after the spike this year. However, at least at pays a nice divy while we wait.
Envision Research profile picture
@malinois000 I stopped being disappointed by missing the top (or bottom) a long time ago. Accepting my inability to time the market actually made me a better investor - and more importantly, a calmer person.
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