Merck - Reasonably Valued and Poised for More Rapid Growth

On April 29th, Merck & Co., Inc. (MRK) released Q1 2021 results and on May 3rd it held its Merck/Organon Investor Day. I continue to think Merck is reasonably valued and is poised for more rapid growth following my review of the material presented at both events.

This brief article is a follow-up to my February 8th post in which I disclose the purchase of 300 shares for one of the 'Core' accounts within the FFJ Portfolio.

Business Overview

My February 8th post includes a brief Business Overview. I also encourage you to look at the MRK/Organon presentation from the May 3rd MRK/Organon Investor Day.

Q1 2021 Results and FY2021 Guidance

MRK's Q1 results are found here and here and the Earnings Presentation can be accessed here.

MRK's Q1 2021 results are weaker than those of Q1 2020. This decrease is attributed to:

  • higher costs associated with COVID-19 development programs;
  • a charge related to the discontinuation of certain COVID-19 development programs;
  • higher acquisition- and divestiture-related costs; and
  • pricing pressure.

The increase in operating expenses is driven largely by:

  • higher clinical development costs, including MRK`s COVID-19 program
  • increased investment in the early-stage pipeline;
  • higher provision costs in support of key growth drivers.

FY2021 Guidance

Below is earnings guidance that includes Organon. This guidance does not include revenue from the potential launch of molnupiravir.

Assuming Organon operates as an independent company for the full year, revenue guidance is $6.1B - $6.4B and MRK's full-year revenue from continuing operations guidance is $45.8B - $47.8B.

Operating efficiencies from the spin-off should be ~$1.5B over 3 years. This includes ~$0.5B in 2021.

Organon products versus overall MRK products are more profitable. MRK, therefore, expects its operating margin from continuing operations to be slightly lower in FY2021 versus what it would be without the spin-off. MRK's operating margin, however, is expected to accelerate and be higher within 12 - 24 months versus where it would be in the absence of the spin-off. Guidance calls for operating margin to be greater than 42% in 2024. By way of comparison, MRK's 2011 - 2020 operating margins are 18.68%, 20.9%, 17.41%, 15.82%, 19.11%, 13.81%, 16.94%, 21.12%, 26.13%, and 17.68%.

MRK expects its revenue and earnings growth rate to be higher after the Organon spin-off. Given the faster growth of MRK and the expected operating efficiencies as a result of the spin-off, combined with the faster growth Organon products should achieve in an independent structure, the combined EPS of MRK and Organon is expected to be higher within 12 - 24 months versus without the spin-off.

MRK expects receipt of a ~$9B special tax-free dividend from the Organon spin-off at the beginning of June. The plan is to deploy funds in value-enhancing strategic business development opportunities. In the absence of meaningful business development, the intent is to return cash to shareholders through share repurchases and a possible increase in the dividend payout ratio over time.

Free Cash Flow (FCF)

In FY2011 - 2020, MRK's FCF is $11, $8, $10, $6, $11, $9, $5, $8, $10, and $6 (billion).

I envision MRK's management will continue to manage the 'new' MRK in such a manner that FCF will not be an issue.

Credit Ratings

MRK should meet your requirements if you are an investor seeking an acceptable level of risk.

All 3 major rating agencies rate MRK's unsecured long-term debt as investment grade.

  • A1 (Moody’s) which is the top tier within the upper-medium grade category;
  • AA- (S&P Global) which is the lowest tier within the high-grade category;
  • A+ (Fitch) which is the top tier within the upper-medium grade category.

Moody's and Fitch define MRK as having a STRONG capacity to meet its financial commitments. The company, however, is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

S&P Global view MRK as having a VERY STRONG capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree.

Dividends and Dividend Yield

MRK's dividend history can be found here. The current $0.65/quarterly dividend yields ~3.5% based on the ~$75 purchase price I paid to acquire additional shares on May 3rd.

I hold shares in a taxable account and incur a 15% withholding tax. This lowers my dividend yield to ~2.95%.

Potential dividend increases and share repurchases are quite possible following the impending Organon spin-off.

Valuation

In the Q1 2021 Earnings Release, we see MRK's FY2021 GAAP estimate of $5.05 - $5.25 versus the prior $5.52 - $5.72.

In February I purchased 300 shares at $75.08. Using FY2021 $5.52 - $5.72 GAAP EPS guidance the PE range was ~13.13 - ~13.6.

On May 3rd I acquired 100 shares at $75.03. Using revised FY2021 guidance of $5.05 - $5.25, the PE range is ~14.3 - ~14.9.

MRK's FY2021 adjusted diluted EPS guidance of $6.48 - $6.68 in early February 2021 remains unchanged.

At the time of my February post, one of my sources of data reflected FY2021 mean adjusted diluted EPS estimates of $6.44 and a low/high range of $5.86 - $6.88 from 19 brokers.

Current estimates from 20 brokers are now FY2021 mean adjusted diluted EPS of $6.50 and a low/high range of $5.80 - $6.71.

The adjusted diluted PE range in February was ~10.9 - ~12.8. Now the range is ~11.2 - ~12.94.

Merck - Reasonably Valued and Poised for More Rapid Growth - Final Thoughts

My thoughts surrounding MRK's long-term prospects remain unchanged from those in my February 8th post. I view Merk as reasonably valued and poised for more rapid growth. I have, therefore, acquired an additional 100 shares to increase my MRK exposure to 400 shares in one of the 'Core' accounts within the FFJ Portfolio.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom.

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long MRK.

Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.