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Merck: Keytruda Growth Remains Strong

GuruFocus.com
·6 min read

- By Nathan Parsh

Pharmaceutical giant Merck & Co. Inc. (NYSE:MRK) reported earnings results at end of October that topped what Wall Street analysts had expected. The company also raised its guidance for the second consecutive quarter. Merck followed this up with a dividend increase earlier this week.

I take the beat and raise along with a dividend increase as a bullish sign for Merck. Let's look at the company's most recent earnings along with its valuation to see why I believe this is a good time to buy.


Quarterly highlights

Merck reported third-quarter earnings results on Oct. 27. Revenue improved 1.2% to $12.6 billion, which was $338 million above consensus estimates. Adjusted earnings per share of $1.74 was a 23 cent, or 15.1%, improvement from the previous year. Earnings results were 31 cents ahead of expectations. Adjusted net income improved 14% to $4.4 billion.

Pharmaceutical sales grew 2% to $11.3 billion, mostly due to Keytruda.

Keytruda continues to be Merck's top-performing product. Sales for Keytruda grew 21% year over year to $3.7 billion. This growth stems from an increase in demand for non-small cell lung cancer indications. The drug has also seen higher demand in the areas of bladder, head and neck cancers.

Keytruda is also benefiting from an increase in approvals. For example, the drug was approved during the quarter by the U.S. Food and Drug Administration for treatment of adult patients with relapsed or refractory Hodgkin lymphoma. In Japan, the drug was approved for treatment of patients with recurrent esophageal cancer.

The drug is experiencing a combination of increased demand in current indications along with a growing number of approved indications. In all likelihood, Keytruda will be one of the best-selling pharmaceuticals this decade. Merck maintains patent protection on the drug until 2028 in the U.S., 2030 in the European Union and 2032 in Japan.

Keytruda supplied much of the growth for Merck during the quarter, but the drug accounted for less than 30% of total sales. This shows that the company isn't overly reliant on one product to bring in most of its revenue.

Sales for Januvia/Janumet, which treats diabetes, grew 1% to $1.3 billion. Demand in international markets offset pricing pressure in the U.S. Bridion, an injection used to reverse the effects of certain drugs that block normal neuromuscular function in adults undergoing surgery, improved 13% to $320 million. This product benefited from better global demand.

Vaccine sales were mixed. Gardasil, which is used to prevent HPV, declined 10% $1.2 billion from the previous year. Demand for the vaccine was impacted by school closures related to the pandemic. Merck's pediatric vaccines, which are used to prevent chickenpox, measles, mumps and rubella, combined for $576 million, which was an 8% decline from the previous year. On the other hand, Pneumovax 23, which is used to prevent serious sinus or ear infections and pneumonia, grew 58% to $375 million due to higher volumes in the U.S., Europe and Japan. Rotateq, which is used to prevent rotavirus in infants and children, was up 16% to $210 million.

Animal health sales improved 9% to $1.2 billion. Currency exchange lowered results by 3%. Greater demand for vaccines for companion animals was the primary driver of growth though strength in parasitic control products also aided results. Livestock sales were higher due to an uptick in global demand for poultry and swine products.

Merck's results would have been higher if it weren't for the coronavirus pandemic. The company estimates that Covid-19 reduced pharmaceutical revenue by $475 million in the quarter, bringing the year-to-date impact from Covid-19 to $2.1 billion. Much of this weakness in the quarter was due to lower demand for Gardasil.

Following third-quarter results, leadership expects adjusted earnings of $5.91 to $6.01 per share for the year, up from prior guidance of $5.63 to $5.72 and above analysts' estimates of $5.72. Revenue is projected to fall in a range of $47.6 billion to $48.6 billion, compared to $47.2 billion to $48.7 billion previously. The midpoint is just above consensus estimates.

Merck announced on Nov. 17 that it was raising its quarterly dividend 6.6% to 65 cents, which gives the stock a current yield of 3.2%. This is above the five-year average yield of 3%, but below the 10-year average yield of 3.5%. Merck has now raised its dividend for 10 consecutive years.

Even with a beat and raise and a dividend increase, Merck still trades with a low valuation.

Valuation

Using the current share price of $81.47 and the midpoint for the updated earnings estimate for the year, Merck has a forward price-earnings ratio of 13.7.

Value Line says the stock has had respective five- and 10-year average price-earnings ratio of 15.5 and 13.7. The stock trades in line with its long-term average price-earnings ratio, but shares appeared undervalued against the recent average.

Applying estimated earnings per share to the five-year average earnings multiple results in a price target of around $92, which would be a 13% gain from the most recent price.

GuruFocus also finds that Merck is trading below its intrinsic value.

Merck: Keytruda Growth Remains Strong
Merck: Keytruda Growth Remains Strong

GuruFocus has assigned Merck a GF Value of $86.40, which gives the stock a price-to-GF Value ratio of 0.94 using the current share price. This ratio earns the stock a rating of fairly valued. Shareholders of Merck would be looking at a 6.1% gain from current levels were shares to reach the GF Value. Add in the dividend and the total return would be in the high single-digit range.

Final thoughts

Despite the headwinds from the COVID-19 pandemic, Merck turned in another solid quarter. Revenue and earnings per share results showed positive growth from the previous year and were above what analysts had expected. The company also raised its earnings guidance and tightened its revenue expectations.

Keytruda continues to post exceptional growth and is well on its way to becoming one of the best-selling pharmaceuticals of this decade. The drug doesn't begin to lose patent protection until the end of the decade. Even better, the drug continues to see an expansion in indications, which will likely allow for continued growth.

Add in a reasonable valuation, compared to both the historical average and the GF Value, and a solid dividend raise and Merck remains an attractive investment in my view for those looking for exposure to the health care sector.

Disclosure: The author has no positions in any stocks mentioned in this article.

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This article first appeared on GuruFocus.