Merck (NYSE:MRK) announced its quarterly earnings for Q3 2012 last Friday, in which it reported a marginal decline in revenues even as profits grew slightly, in-line with our expectations. The company recorded $11.5 billion in sales, down 4% y-o-y. The strengthening of the U.S. dollar weighed heavily on the growth even as growth in total sales was flat, excluding the currency impact. Pharmaceutical and animal franchise continued to show strong performance. As expected, net income (excluding non-recurring items) grew by 2% to $1.7 billion mainly due to the company’s cost-cutting efforts. 
Below we take a detailed look at the factors that impacted the company’s performance during the quarter.
Growth in the pharmaceutical division was largely hurt by loss of the U.S. patent exclusivity of Singulair in August, which was one of largest block buster drug in the company’s portfolio and brought in sales of nearly $5.5 billion in 2011. When the patent for a drug expires, competition from cheaper generic products developed by competitors inevitably eats into these businesses. This leads to a significant drop in sales for that drug because of the entry of cheap generic versions and a drop in average selling price of the drug. Sales of the drug more than halved post a steep decline in its prescriptions after the drug’s patent expiry. (Read Merck Updates: Singulair Prescriptions See A Steep Decline Post-Patent Expiry)
In line with our expectations, Januvia, Janumet, Isentress and Gardasil were the major growth drivers for the pharmaceuticals division as they witnessed double digit growth. In January, the FDA approved Isentress for use in children older than 2 years for HIV therapy. In February, Janumet, a once-daily treatment to control blood sugar, got the FDA approval for use in type 2 diabetes.
Growth in sales was also hurt by a decline in Remicade and Simponi as some marketing rights were transferred to Johnson & Johnson following an arbitration settlement agreement. Overall pharmaceutical declined by a 5%, including the currency impact.
Sales from emerging markets accounted for nearly 20% of total pharmaceutical sales in the third quarter with China leading international growth by an impressive 20%. European austerity, however, remained a concern for the company. Januvia and Isentress were the major drivers for international sales growth.
The animal health business, part of Legacy Pharma, Animal & Cons. Health division in our model, grew by healthy 7% y-o-y, excluding a 8% negative impact on foreign exchange. Sales were strong, particularly in the U.S. and Asia Pacific, on cattle and swine products. Sales from consumer care also grew by robust 10%, excluding a 2% currency impact. However, lower revenues of 15% from AstraZeneca LP as well as lower third-party manufacturing sales offset much of the growth.
On the operational front, while gross profit margins were mostly flat, we saw an improvement in overall profit margins due to a reduction in marketing and administrative costs. R&D expenditure were mostly in line with the last year as the company continued to keep its R&D spending intact to fend off patent cliffs in the next two years.
The company continues to face near-term headwinds due to patents expiring as close to 20% of the company’s 2011 revenues are subject to generic competition over the next two years. However, the long-term return lies in the company’s drug pipeline which remains strong. Merck recently closed trials for osteoporosis drug Odanacatib early after release of encouraging data and is well on track to receive approval for the drug. Odanacatib could bring in more than a billion dollar each year to Merck’s coffers. Insomnia drug Suvorexant could become a potential blockbuster drug as well. Further, the company’s experimental diabetes drug MK-3102, also significantly lowered blood sugar in phase II trials increasing the probability of the drug’s approval.
However, the stock has appreciated more than 35% in the last year and has surpassed our current $43 price estimate for Merck and so seems to have factored in these positive developments. We will soon update our price estimate to reflect the Q3 earnings.Notes:
- Merck Announces Third-Quarter 2012 Financial Results, Merck Press Release, Oct 16 2012 [↩]