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In my February 8, 2021 Merck & Co., Inc. (MRK) stock analysis I disclosed that my findings led me to initiate a 300 share position in one of the 'Core' accounts in the FFJ Portfolio.
I subsequently analyzed Q1 2021 results and FY2021 guidance in my May 3, 2021 MRK stock analysis and disclosed the purchase of an additional 100 shares.
With the October 28, 2021 release of Q3 and YTD results and FY2002 guidance I revisit MRK to determine if I should acquire additional shares.
Merck - Stock Analysis - Business Overview
In addition to a brief Business Overview in my February 8th post, the company's website, the FY2020 10-K, and the most recent Form 10-Q contain a wealth of information.
The following is a high-level overview of some recent meaningful transactions.
Organon Spin-Off
In my previous posts, I touched upon the impending spin-off of Organon & Co. (OGN).
On May 17, 2021, MRK completed the spin-off for which it received $9B. In exchange for the spin-off, MRK declared a special dividend distribution of one-tenth of a share of OGN common stock for every MRK common share outstanding as of the close of business on May 17, 2021.
When the terms of the OGN spin-off were announced I suspected MRK would be looking to deploy the sale proceeds to fund a major acquisition.
MRK and Gilead Collaboration
On March 15, 2021, both companies announced that they agreed to co-develop and co-commercialize long-acting treatments in HIV that combine Gilead’s investigational capsid inhibitor, lenacapavir, and MRK’s investigational nucleoside reverse transcriptase translocation inhibitor, islatravir, into a two-drug regimen with the potential to provide new, meaningful treatment options for people living with HIV.
The global HIV market is expected to grow to $30.6B in 2024 and Physicians want multiple treatment choices to customize therapies for people living with HIV.
The pre-exposure prophylaxis (PrEP) market for HIV is expected to more than triple by 2029, reaching $9.7B. In the U.S., 50% of at-risk individuals could be on PrEP regimens by 2026.
Pandion Therapeutics, Inc. Acquisition
On February 25, 2021, MRK announced that it had entered into a definitive agreement to acquire Pandion Therapeutics, Inc.. Pandion is a clinical-stage biotechnology company developing novel therapeutics designed to address the unmet needs of patients living with autoimmune diseases. . Total consideration paid of $1.9B included $0.147B of transaction costs primarily comprised of share-based compensation payments to settle equity awards.
In April 2021, completed the acquisition.
Acceleron Pharma Inc. Acquisition
On September 30, 2021, MRK announced that it entered into a definitive agreement with Acceleron Pharma Inc. under which MRK, through a subsidiary, will acquire Acceleron for $180/share in cash for a total equity value of ~$11.5B; the rationale for the acquisition is reflected in this News Release.
The acquisition of Acceleron brings MRK a compelling late-stage asset with strong potential to address the unmet need of a patient population that suffers from a disease that has a high risk of mortality.
Its lead product candidate, Sotatercept, is currently in Phase III studies for the treatment of patients with pulmonary arterial hypertension. Based on MRK's confidence in the strong science underpinning Sotatercept's clinical profile, it believes the Phase III trials will confirm the positive clinical effects achieved in Phase II. If so, and assuming regulatory approvals, MRK believes Sotatercept has a multibillion-dollar peak sales opportunity, with an opportunity to help drive revenue growth later into this decade and the next.
The closing of the tender offer is subject to certain conditions which include the receipt of applicable regulatory approvals. The transaction is expected to close in Q4 2021.
COVID-19 (molnupiravir)
On October 1, 2021, MRK and Ridgeback Biotherapeutics announced that molnupiravir, an investigational oral antiviral medicine, significantly reduced the risk of hospitalization or death in at-risk, non-hospitalized adult patients with mild-to-moderate COVID-19. At the interim analysis, molnupiravir reduced the risk of hospitalization or death by approximately 50%.
At the recommendation of an independent Data Monitoring Committee and in consultation with the U.S. Food and Drug Administration (FDA), recruitment into the study is being stopped early due to positive results. MRK plans to apply for Emergency Use Authorization (EUA) to the U.S. FDA as soon as possible based on its findings and plans to submit marketing applications to other regulatory bodies worldwide.
On the Q3 earnings call, MRK's CFO stated:
'We expect the global opportunity to be ~$5B - ~$7B through 2022, including ~$0.5B - ~$1B expected to be realized this year. This assumes emergency use authorization in December. As a reminder, we will share any profit equally with our partner, Ridgeback. MRK is responsible for recording global revenues and costs and will reflect the profit share within the cost of sales.'
Loss of Exclusivity
Keytruda
MRK's leading product is its Oncology product 'Keytruda'. Keytruda is used alone or with other drugs to treat certain types of cancers.
In FY2020 it generated $14.38B of MRK's $41.518B total revenue (~35%) and YTD2021 it has generated $12.609B of total YTD revenue of $35.183B (~36%).
MRK loses its market exclusivity in 2028.
Gardasil / Gardasil 9
The Gardasil / Gardasil 9 vaccines are HPV vaccines that protect against infection with human papillomaviruses (HPV). HPV is a group of more than 200 related viruses, of which more than 40 are spread through direct sexual contact. Gardasil 9 has, since 2016, been the only HPV vaccine used in the United States.
In FY2020 these drugs generated $5.277B of MRK's $41.518B total revenue (~12.7%) and in YTD2021 they have generated $3.894B of total YTD revenue of $35.183B (~11.1%).
MRK loses its market exclusivity in 2028.
Januvia / Janumet
MRK loses market exclusivity on its Type 2 diabetes drug Januvia, combined with its combo offshoot Janumet, in January 2023.
In FY2020 these drugs generated $3.938B of MRK's $41.518B total revenue (~9.5%) and in YTD2021 they have generated $4.144B of total YTD revenue of $35.183B (~11.8%).
Animal Health Segment
In mid-2021, MRK completed the spin-off of Organon to boost its focus on growth areas, realize higher revenue, and EPS growth rates. I have no crystal ball but I suspect some consideration will be given to the potential spin-off of the Animal Health segment.
In FY2012, MRK's Animal Health segment generated annual revenue of ~$3.4B. MRK's Animal Health segment generated FY2020 revenue of ~$4.7B and YTD2021 revenue of ~$4.3B.
In contrast, Pfizer (PFE) announced its plan to spin off its Animal Health business into Zoetis (ZTS), a newly created public company in mid-2012; the spin-off was completed in January 2013. In FY2012, PFE's animal health segment generated ~$4.3B in annual revenue. It now generates ~$6.5B - $7B.
The spin-off from PFE has allowed ZTS to be a more focused company and its growth has far outpaced that of MRK's Animal Health segment in just under a decade.
I appreciate that the Organon spin-off was a much larger part of MRK's business than the current Animal Health business; it was generating ~$9B - $10B in annual revenue before the spin-off. Nevertheless, a spin-off of the smaller Animal Health business would allow that segment to become more focused and potentially provide greater returns to investors. MRK would also generate a significant influx of cash which would allow it to further increase its focus on growth areas, realize higher revenue, and EPS growth rates.
Merck - Stock Analysis - Financials
Q3 and YTD2021 Results
Details of MRK's Q3 and YTD2021 results are reflected in the Form 8-K and Earnings Presentation.
The Pharmaceutical segment generated $11.5B of MRK's total Q3 revenue while the Animal Health segment generated $1.4B.
Source: MRK - Q3 2021 Earnings Presentation - October 28, 2021
Capital Allocation
Despite FY2021 being a year of transition, MRK has allocated capital appropriately as reflected below.
Source: MRK - Q3 2021 Earnings Presentation - October 28, 2021
Source: MRK - Q3 2021 Earnings Presentation - October 28, 2021
FY2021 Guidance
Merck - Stock Analysis - 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.
- Moody's: A1 is the top tier within the upper-medium grade category.
- S&P Global: A+ is the top tier within the upper-medium grade category; this rating has been lowered 1 tier from the AA- rating assigned at the time of my May 3, 2021 post.
- Fitch: A+ is the top tier within the upper-medium grade category.
All ratings 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.
Dividend and Dividend Yield
MRK's dividend history can be found here.
When I wrote my previous posts, MRK was trading at ~$75. With a $0.65 quarterly dividend, the dividend yield was ~3.5%.
Shares are now trading at ~$90 and MRK recently distributed its 4th consecutive $0.65 quarterly dividend. This results in a ~3% dividend yield.
On the Q3 earnings call, management reiterated its commitment to increasing the dividend. Given this, I anticipate MRK will announce a $0.03 - $0.04 increase to its quarterly dividend with the first ~$0.68 - $0.69 dividend payable early January 2022. If this does materialize and the stock price remains stable, the dividend yield still will be ~3%.
In FY2011 - Fy2020, MRK's average shares outstanding (in millions) were 3,094, 3,076, 2,996, 2,928, 2,841, 2,787, 2,748, 2,679, 2,580, and 2,541. For the 9 months ending September 30, the total was 2,539.
In 2018, MRK’s Board of Directors authorized purchases of up to $10B of MRK’s common stock for its treasury. The treasury stock purchase authorization has no time limit.
In May 2021, MRK restarted its share repurchase program, which had been temporarily suspended in March 2020 and purchased $239 million (3 million shares) of its common stock during Q2 2021. As of June 30, 2021, the remaining share repurchase authorization was $5.6B.
To the extent MRK has excess cash, it will return it to shareholders through share repurchases.
Valuation
Management's FY2021 diluted EPS guidance is $4.71 - $4.76. With shares trading at ~$90, the forward diluted PE is ~19.
Management's FY2021 adjusted diluted EPS guidance is $5.65 - $5.70. With shares trading at ~$90, the forward adjusted diluted PE is ~16.
The following earnings estimates are reflected in the 2 online trading platforms I use. There is a huge disparity in estimates and this is likely because some brokers are revising their estimates; I expect the disparity will narrow over the coming days. For now, however, MRK's forward adjusted diluted PE valuations are:
- FY2021: mean of $5.86 and a low/high range of $5.64 - $6.78 from 11 brokers. The forward adjusted diluted PE using the mean estimate is ~15 and ~13 if I use $6.78.
- FY2022: mean of $7.34 and a low/high range of $6.35 - $8.60 from 13 brokers. The forward adjusted diluted PE using the mean estimate is ~12 and ~10 if I use $8.60.
- FY2023: mean of $7.26 and a low/high range of $6.59 - $7.95 from 9 brokers. The forward adjusted diluted PE using the mean estimate is ~12 and ~11 if I use $7.95.
The brokers' earnings estimates reflected on the online trading platforms have been changing almost daily after the release of MRK's Q3 results as brokers update their revised estimates; the number of brokers who have submitted their guidance is currently 6 - 8 brokers fewer than when I previously wrote about MRK. As additional guidance is provided, I think the low end of earnings estimates will increase. This would lower the forward adjusted diluted PE levels thereby making shares more attractively valued than at present.
- Final Thoughts
MRK's share price has risen ~20% after my purchases earlier in 2021. I now deem the shares to be fairly valued and no longer undervalued.
I surmise that some consideration is being given to the potential spin-off of the Animal Health segment. If MRK were to do what PFE did almost a decade ago, it might result in superior growth in the Animal Health segment and MRK could use the proceeds from the spin-off to further boost its focus on growth areas, realize higher revenue, and EPS growth rates.
Despite the above, it is not my intent to increase my MRK exposure at this point.
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long MRK. I do not hold a position in PFE and do not intend to initiate a position within the next 72 hours.
Disclaimer: I do not know your circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decisions without conducting your research and due diligence. You should also consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
