This post looks at whether Merck stock is a good buy following a transformational divestiture and acquisition in 2021.
In my February 8, 2021 Merck & Co., Inc. (MRK) stock analysis at Financial Freedom is a Journey I disclose 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.
Fast forward to the beginning of 2022 and MRK:
- has spun off Organon & Co. (created through the spinoff of MRK’s women’s health, trusted legacy brands and biosimilars businesses) in early June 2021;
- has released Q3 and YTD results and FY2002 guidance at the end of October 2021;
- has successfully completed the ~$11B (net of cash on hand) acquisition of Acceleron Pharma Inc. on November 22 2021; and
- is scheduled to release Q4 and FY2021 results on February 3 2022.
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Is Merck Stock A Good Buy? – Overview
MRK is a ~$200B market cap drug manufacturer. It is engaged in research to prevent and treat diseases that threaten people and animals such as cancer, infectious diseases (eg. HIV and Ebola), and emerging animal diseases.
This brief video highlights MRK’s discoveries over its 130+ year history.
While familiarizing oneself with MRK’s history is of interest, of greater importance is MRK’s outlook. In this regard, I recommend investors review MRK’s website, the FY2020 10-K, and the most recent Form 10-Q.
The following is a schedule of revenue for Q3 and YTD 2021.
Loss of Exclusivity
MRK is heavily dependent on a few drugs for a large percentage of its revenue. This heavy dependence on a few key drugs always raises the concern about the loss of exclusivity. Looking at MRK’s top-selling drugs we see that it has a few years remaining before they lose exclusivity.
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%). 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; 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%). 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%). YTD2021 they have generated $4.144B of total YTD revenue of $35.183B (~11.8%).
Management is keenly aware of the company’s heavy reliance on a few key drugs. It, therefore, undertook a strategic review and a decision was made to radically restructure the company to better prepare for the future.
On February 5, 2020, MRK announced its intent to separate to enhance the focus of both MRK and a newly created company to better meet the needs of patients and customers and to achieve faster growth and greater value for all stakeholders.
The rationale for the spin-off was to allow MRK to benefit from strong growth across its current pillars of Oncology, Vaccines, Hospital and Animal Health while aspiring to be the premier research-intensive biopharmaceutical company.
The plan is for MRK Merck to achieve over $1.5B in operating efficiencies by 2024 and to achieve a Non-GAAP operating margin greater than 40%.
The creation of Organon would enable this separate and distinct company from pursuing global leadership and sustainable growth in Women’s Health through its trusted Legacy Brands and rapidly expanding Biosimilars products.
Upon learning that MRK would receive ~$9B from this proposed spinoff, I envisioned that a transformative acquisition would follow shortly. Sure enough, the spinoff closed June 2021 and on September 30, 2021, MRK announced the proposed ~$11B (net of cash on hand) acquisition of Acceleron.
Developing drugs that eventually receive all the appropriate approvals before going to market is an extremely lengthy proposition and costs can be substantial.
The product pipeline currently reflected on MRK’s website is as of October 27, 2021. Looking at this pipeline we see 71 programs in Phase 2, 25 programs in Phase 3, and 3 programs Under Review.
Developing a drug that meets all the stages of approval AND which can one day be profitable is not an easy process. A review of the development and approval process on the FDA – US Food & Drug Administration website gives investors some indication as to why drug companies with drugs in Phase 3 are sometimes acquired for billions of dollars.
We can see from the following descriptions that a drug can be ‘light years’ from receiving all approvals and being economically viable when it is only in Phases 2 and 3 of development!
In Phase 2 studies, researchers administer the drug to a group of patients with the disease or condition for which the drug is being developed. Typically involving a few hundred patients, these studies are not large enough to show whether the drug will be beneficial.
Phase 3 of a clinical trial usually involves up to 3,000 participants who have the condition that the new medication is meant to treat. Trials in this phase can last for several years. The purpose of phase 3 is to evaluate how the new medication works in comparison to existing medications for the same condition.
MRK’s Acceleron acquisition has accelerated MRK’s business development strategy!
At the time of the acquisition announcement, Acceleron’s lead product candidate, Sotatercept, was in Phase III studies for the treatment of patients with pulmonary arterial hypertension; this drug has the potential to become a foundational agent that can be added to the current standard of care in the treatment of this disease.
MRK and Gilead Collaboration
In addition to being better prepared for the future through the acquisition of Acceleron, MRK collaborates with other pharmaceutical companies to develop and market drugs that have the potential to generate revenue for several years.
For example, on March 15, 2021, MRK and Gilead both announced an agreement 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.
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 was stopped early due to positive results.
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.’
Subsequent to the Q3 Earnings call, MRK applied for and received Emergency Use Authorization (EUA) from the U.S. FDA. It also submitted marketing applications to other regulatory bodies worldwide. As of the end of December 2021, it has received special emergency approval for the use of molnupiravir in various countries (eg. US, UK, Japan).
Animal Health Segment
In keeping with MRK’s strategic decision to become a faster-growing company, I envision MRK one day deciding to spinoff its Animal Health segment. The proceeds from this sale could then be deployed to focus on acquisitions that would further enhance the focus on growth areas thus hopefully leading to higher revenue and EPS growth rates.
The reason I mention this is that in FY2012, MRK’s Animal Health segment generated annual revenue of ~$3.4B. In FY2020, this segment generated FY2020 revenue of ~$4.7B and revenue of ~$4.3B in the first 3 quarters of FY2021.
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.
MRK currently has its ‘hands full’ with the Organon spinoff and the Acceleron acquisition so I would not expect a spinoff of its Animal Health business until the ‘dust settles’ on these other 2 major transactions.
Is Merck Stock A Good Buy? – Financial Review
Q3 and YTD2021 Results
MRK is scheduled to release Q4 and FY2021 results on February 3, 2022; there is little point in analyzing Q3 and YTD2021 results.
The following images are provided merely as a high-level indication of MRK’s performance and guidance.
Is Merck Stock A Good Buy? – Credit Ratings
MRK is now very different from MRK of a year ago. Let’s see how the major rating agencies view MRK’s current senior unsecured domestic long-term debt and outlook.
The current ratings are:
- Moody’s: A1 (stable outlook)
- S&P Global: A+ (stable outlook)
- Fitch: A+ (stable outlook)
All 3 ratings are the top tier of the upper-medium grade category. These ratings define MRK as having a STRONG capacity to meet its financial commitments. It is, however, somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
These ratings are acceptable for investors with a low tolerance for risk.
Is Merck Stock A Good Buy? – Dividends and Share Repurchases
Dividends and Dividend Yield
MRK’s dividend history is accessible here. Merck is a dividend growth stock and the last quarterly dividend increase was 6.2% to $0.69 per share from $0.65 per share. The company raised the dividend for 12 consecutive years making the stock a Dividend Contender. The growth rate was 5.4% in the past decade and ~7.4% in the trailing 5-years.
MRK has recently distributed its first quarterly $0.69 dividend. With shares currently trading at ~$79, the dividend yield is ~3.5%.
If you are a Canadian resident like me who holds MRK shares in a taxable account, there is a 15% dividend withholding tax. This reduces the quarterly dividend to $0.5865 and the dividend yield drops below 3%.
MRK has historically generated ample Cash Flow from Operations and Free Cash Flow thus enabling it to easily service its declared dividends.
In a number of investor and analyst presentations, management has stressed that dividend distributions are a key component of the company’s balanced approach to capital allocation. This was reiterated in the Q3 2021 earnings presentation where we see that dividend distributions ended up being the 3rd capital allocation priority.
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. Purchases will be made over time in open-market transactions, block transactions on or off an exchange, or privately negotiated transactions.
Over the trailing 12 months, dividend distributions and share repurchases amounted to $7.3B. The Condensed Consolidated Statement of Cash Flows found on page 5 of 59 in the Q3 2021 Form 10-Q shows that dividends paid to stockholders far outweighed the amount spent on share repurchases; it only repurchased $0.822B (11 million shares) of its common stock during the first nine months of FY2021.
In May 2021, MRK restarted its share repurchase program, which had been temporarily suspended in March 2020. As of September 30, 2021, the remaining share repurchase authorization was $5.1B.
Is Merck Stock A Good Buy? – Current Valuation
In my February 8, 2021 MRK post at Financial Freedom is a Journey, I disclose the purchase of MRK shares at $75.08. At the time, MRK projected FY2021 adjusted EPS of $6.48 – $6.68 thus resulting in an adjusted forward PE range of 11.24 – 11.59 which compared favourably with levels in recent years.
Shortly following the release of Q3 and YTD2021 results, MRK’s shares were trading at ~$90. Based on management’s FY2021 diluted EPS guidance of $4.71 – $4.76, the forward diluted PE was ~19.
In addition, management’s FY2021 adjusted diluted EPS guidance was $5.65 – $5.70 leading to a forward adjusted diluted PE of ~16.
The earnings estimates reflected in the 2 online trading platforms I use and the ~$90 share price resulted in forward adjusted diluted PE valuations of:
- 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.
Fast forward to January 6, 2022 when this post is being composed. Shares are trading at ~$79.50 and the forward adjusted diluted earnings estimates are slightly different. Based on current information, the forward adjusted diluted PE valuations are now:
- FY2021: mean of $5.78 and a low/high range of $5.60 – $6.40 from 19 brokers. The forward adjusted diluted PE using the mean estimate is ~13.8 and ~12.4 if I use $6.40.
- FY2022: mean of $7.23 and a low/high range of $6.35 – $8.19 from 23 brokers. The forward adjusted diluted PE using the mean estimate is ~11 and ~10 if I use $8.19.
- FY2023: mean of $7.22 and a low/high range of $6.35 – $7.88 from 19 brokers. The forward adjusted diluted PE using the mean estimate is ~11 and ~10 if I use $7.88.
The low valuation is an indication that the investment community does not yet expect a high degree of growth from MRK. This is not surprising since the investment community is likely waiting to see whether the transformational changes will lead to higher growth management is touting.
Is Merck Stock a Good Buy? – Final Thoughts
MRK comprises a very small portion of our overall holdings and at the moment I have no intention of adding to my position.
As a long-term investor, I purposely initiated a position in MRK in the hope that the transformational divestiture and acquisition would lead to MRK becoming a faster-growing company. I am also cautiously optimistic MRK will eventually spin off its Animal Health segment at which time MRK shareholders would likely receive shares much like those we received when Organon was formed.
In my opinion, the current MRK is much different from the MRK with which many investors may be familiar. I think the direction MRK has taken makes it a company that presents the opportunity for growth that is superior to historical levels. In exchange for this higher growth potential, however, is slightly higher risk.
The company now aspires to be the premier research-intensive biopharmaceutical company and no longer has the steady/reliable slow growth women’s health, trusted legacy brands and biosimilars businesses.
I do not dispute MRK has the potential to generate superior investor returns by following a new strategic direction. Investors, however, may no longer want to look at MRK through the same lens as in the past.
I wish you much success on your journey to financial freedom.
Disclosure: I am long MRK.
Another article by Charles Fournier is Is Visa A Good Stock To Buy?
Author Disclosure: I disclose holdings held in the FFJ Portfolio and the dividend income generated from these holdings. I do not disclose details of holdings held in various tax-advantaged accounts for confidentiality reasons.
Author Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.
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I am a self-taught investor and run the Financial Freedom is a Journey blog. I have invested in the North American equities markets for over 34 years. I retired from a career in banking and continue to invest as this is something about which I am passionate.