Merck (NYSE:MRK) announced its quarterly earnings for Q4 2012 last Friday, where it reported an expected decline in revenues. The drug maker recorded $11.7 billion in sales, down 5% year-over-year. Singulair’s patent expiry was the major factor impacting overall pharmaceutical growth whereas growth in consumer healthcare and animal franchise remained strong. The strengthening of the U.S. dollar also weighed on revenues. Net income (excluding non-recurring items) declined by 15% to $2.5 billion. 
We are updating our $49 price estimate for Merck, to reflect the earnings and recent developments.
Patent Cliff Hurts Revenues
Overall pharmaceutical revenues declined by 3%, excluding the currency impact. The growth in the Pharmaceutical division was largely hurt by the loss of U.S. patent exclusivity of Singulair in August. The drug has seen an accelerating decline in prescriptions since then as cheap generic versions continue to replace it has declined over 60% to near $500 million from $1.5 billion in Q4 2011. 
Of the other major drugs, Vyotrin, a combination of Merck’s own Zocor and Zetia to prevent cardiovascular events, also weighed on growth as U.S. prescriptions declined due to concerns around its efficacy. While the drug has proven to be effective in lowering cholesterol, there is little statistically significant evidence that it reduces chances of heart attacks, strokes and other cardiovascular problems and may not add major benefits to statins like Pfizer‘s (NYSE:PFE) Lipitor, a conventional treatment for reducing cholesterol. However, the key point that came out of earnings call is that data monitoring committee has requested interim analysis data of IMPROVE-IT, a large study that is being conducted to prove efficacy of Vyotrin, and any positive outcome there will put it on growth trajectory before June 2013, the current expected deadline of the study. 
With double digit growth, mainly due to their expansion to new indications and a continued uptake in their demand, Januvia, Janumet and Gardasil were amongst the major growth drivers for the pharmaceuticals division. In February, Janumet, a once-daily treatment to control blood sugar, got the FDA approval for use in type 2 diabetes. Gardasil benefited from continued strong uptake in males while public sector purchasing, especially from emerging markets, also fueled growth.  A decline in Istentress, due to weak sales in international market owing to timings of tenders,  surprised us even as sales grew in the U.S. following FDA’s approval for use in children older than 2 years for HIV therapy in January 2012.
As expected, Japan grew by an impressive 9% growth despite price cuts in 2012. Strong volume growth of Januvia, Gardasil and Zetia more than offset the pricing pressure in the country. Sales from emerging markets grew 8% and accounted for nearly 20% of total pharmaceutical sales in the Q4 2012 with China leading the international growth. 
The animal health business, part of Legacy Pharma, Animal & Cons. Health division in our model, grew by healthy 6% y-o-y, excluding a 3% negative impact on foreign exchange. Sales were strong, particularly in the U.S. and Asia Pacific, on cattle and poultry products. Sales from consumer care also grew by robust 9% due to higher sales of certain OTC drugs. However, lower revenues of 23% from AstraZeneca LP as well as lower third-party manufacturing sales offset much of the growth in Legacy Pharma, Animal & Cons. Health division. 
Gross Margins Decline
On the operational front, while gross profit margins declined due to change in product mix, we saw a reduction in marketing and administrative costs as well as R&D expenditures following management’s cost cutting efforts.
What To Look Forward To In 2013?
Merck’s 2013 earnings are expected to decline on account of lost sales due to the patent expiry for Singulair. Further, Temodar and Propecia, which collectively bring around $1 billion in sales, are set to see generic competition from 2013. Further, gross margins are also under pressure though we think this is already factored in Merck’s share price and progress on new drugs will drive the stock price going forward.
Concerns have been raised as Merck decided to delay its blockbuster potential drug Odanacatib by 2014 and this could weigh on the stock in short term. However, the drug maker announced its plans for additional filings, including V503, a vaccine that targets certain HPV-associated cancers. In addition, it will seek approval for two allergy immunotherapy products, one for grass allergies and the other for ragweed allergies during 2013. 
The drug maker is already awaiting FDA approval for Suvorexant and is confident of receiving the same in next few months. Further, after getting delayed in 2012, Atorvastatin/Ezetimibe combo should also receive approval during 2013. Any positive news here will drive the stock price of the company.Notes:
- Merck Announces Full-Year and Fourth-Quarter 2012 Financial Results, Merck, Feb 01 2013 [↩] [↩]
- Merck CEO Discusses Q4 2012 Results – Earnings Call Transcript, Seeking Alpha, Feb 01 2013 [↩] [↩] [↩] [↩] [↩] [↩]