What’s Happening With Merck Stock?

[Updated 12/2/2020] Merck Update

Merck (NYSE: MRK) recently announced that it has sold its equity investment in Moderna. Merck has benefited from a whopping 7x surge in Moderna stock this year, given its Covid-19 vaccine development. Though, despite the recent rise, Moderna stock still looks attractive in our view.

Last month, Merck announced the acquisition of VelosBio – a biotech company focused on targeting the ROR1 surface protein – to strengthen its oncology portfolio. The deal, valued at $2.8 billion, would give Merck access to VLS-101, an early stage treatment targeting cancer cells that express ROR1. VLS-101 appears to be a great fit for Merck as it has already received FDA fast track and orphan drug designation for use in mantle cell lymphoma, and Merck can expand the trials for its use in other indications as well.

While Merck has seen some positive developments of late, its stock hasn’t seen much growth. In fact, MRK stock is down 12% thus far in 2020, despite it sales growing 1.4% to $35.5 billion over the last 3 quarters. EPS growth was even higher at 15% (y-o-y) led by margin expansion. We know that Merck’s sales have been impacted by the Covid-19 pandemic, and the company estimates the impact to be $2.4 billion for the full year 2020. Despite this impact, it has managed to expand its sales as well as earnings, primarily due to the continued market share gains for its blockbuster drug, Keytruda, a trend expected to continue over the coming years.

Overall, Merck stock currently appears to be attractive in our view given the drop in price this year. At the current price of $81, it is trading at under 13x its 2021 expected EPS of $6.36, compared to levels of 18x seen over the recent years, implying the stock has more room for growth. Our dashboard, Buy Or Sell Merck Stock, provides more details.

[Updated 11/05/2020] Merck’s Valuation

Merck’s stock (NYSE: MRK) lost more than 28% – dropping from $92 at the beginning of the year to $66 in late March – then jumped 21% to around $80 now. That means it has partially recovered to the levels where it started the year. That said, MRK stock has underperformed the broader markets, with the S&P 500 which fell 31% followed by a 53% recovery.

Why? Merck is not immune to the current crisis. The company stated that it expects the Covid-related business disruptions to hurt its sales in the near term. Merck now expects revenues of $47.6 billion to $48.6 billion for the full year 2020, assuming $2.35 billion of Covid headwind for the year. This compares with $47.2 billion to $48.7 billion guidance provided in Q2, with an impact of $1.95 billion from Covid headwinds. Beyond the impact of the current pandemic, generic competition for several drugs, primarily the company’s diabetes franchise (Januvia and Janumet) will likely be a drag on the company’s top line in the near term.

But is this all there is to the story?

Not quite. Despite the recent underperformance and the impact of the current pandemic, Trefis estimates Merck’s Valuation at about $102 per share, roughly 27% above the current market price based on two key opportunities.

The first opportunity we see is to Merck’s Revenue growth over the coming years. Merck’s Revenues have seen a 17% growth from around $40.1 billion in 2017 to $46.8 billion in 2019 and we expect it to increase to $48.0 billion in 2020, primarily led by higher Keytruda sales. Keytruda, the company’s largest drug in terms of sales (roughly 24% of the company’s total sales), has secured more approvals in 2020, including that for bladder cancer, skin cancer, colorectal cancer, and classic Hodgkin’s lymphoma. Keytruda was already approved for indications in lung cancer, cervical cancer, head & neck cancer, renal cancer, and bladder cancer, among others. Note that lung cancer alone accounts for roughly 50% of the drug’s total sales.

Keytruda’s standalone sales have grown a whopping 8x from $1.4 billion in 2016 to over $11 billion in 2019. The drug’s patents are protected till 2028, implying that the peak is still far off. In fact, it is estimated that Keytruda sales will double from the levels in 2019 to over $22 billion by 2025, making it the largest drug in terms of revenue. Currently, AbbVie’s Humira is the largest selling drug across the globe with roughly $20 billion in annual sales, but it will face patent expiry in 2023.

Looking at Merck’s performance thus far in 2020, despite the impact of the pandemic, the company has managed to grow its sales marginally (1%) to $35.5 billion. This can be attributed to 30% growth in Keytruda sales, which offset the decline seen in some of the company’s other drugs and vaccines, as people avoided visiting hospitals for non-emergency and non-Covid cases. The company’s bottom line of $4.62 per share on an adjusted basis, reflects a 15% growth over the prior year quarter earnings of $4.02 per share.

Now with the opening up of economies, the healthcare institutions have begun attending to procedures, which were deferred earlier. This means a gradual increase in hospital visits, number of procedures performed, and higher number of prescriptions issued, boding well for Merck’s businesses, including vaccines.

The second key opportunity stems from Merck’s valuation multiple compared to its peers. The stock now trades at 13x its projected 2020 adjusted earnings per share of about $6.04. In comparison, to earn close to $6 per year from a bank, you’d have to deposit about $600 in a savings account today (assuming 1% interest rate), so about 100x desired earnings. At Merck’s current share price of roughly $80, we are talking about a P/E multiple of around 13x based on expected 2020 adjusted earnings of $6.04, and we think a figure closer to 17x will be appropriate.

The 17x figure is in line with the levels seen in 2018 and 2019. We know that 2020 EPS growth will be impacted due to the pandemic. The estimated adjusted EPS of $6.04 in 2020 compares with $4.34 and $5.19 figures seen in 2018 and 2019 respectively. With Keytruda expected to see strong growth and the expansion of vaccines, clubbed with margin expansion due to better product mix and cost cutting measures, this will result in strong earnings growth over the coming years. In fact, we estimate the 2021 Adjusted EPS to be $6.40 per share, and at the current price of $80, MRK stock is trading at just 12x 2021 (expected) earnings.

Also, Merck’s P/E multiple is lower compared to some of its peers, such as Johnson & Johnson, which currently trades at 17x its average consensus 2020 earnings of $8.01, while Eli Lilly trades at 20x its expected earnings of $7.22. Merck, which has managed to post earnings growth thus far in 2020 despite the Covid-19 impact, primarily due to Keytruda, is actually trading at a lower multiple when compared to some of the other pharmaceutical giants, making it an attractive opportunity for over 25% gains, in our view.

Looking at the broader economy, its recovery and timing hinge on the containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Following the Fed stimulus — which set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations become important in finding value. Though market sentiment can be fickle, and evidence of an uptick in new cases could spook investors once again.

What if you’re looking for a more balanced portfolio instead? Here’s a high quality portfolio to beat the market, with over 100% return since 2016, versus 55% for the S&P 500. Comprised of companies with strong revenue growth, healthy profits, lots of cash, and low risk, it has outperformed the broader market year after year, consistently.

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