Merck‘s (NYSE:MRK) shares fell slightly on weak Q3 2013 earnings. The company’s revenue growth is under severe pressure due to the continued impact of the loss of patent exclusivity of certain key drugs, adverse currency movements and the weakness in diabetes drug sales in the U.S. The R&D (research and development) productivity has declined over the years, and the strategy of developing drugs for major diseases is not working. The landscape of the global pharmaceutical industry is shifting towards more niche, innovative and genetically targeted medicines and Merck needs to adapt. The company’s best bet lies in investing in growth areas of immunology and oncology (cancer treatment), where the overall market is growing and a large number of disease sub-types offer good potential for the development of niche drugs. Let’s take a closer look at the third quarter results and understand Merck’s issues.
We are in the process of updating our price estimate for Merck in the light of recent earnings, and will have an update ready soon. Our current price estimate for Merck stands at $51.63, implying a premium of 15% to the market price.
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Januvia & Janumet Franchise Suffered As Expected
While Merck’s type 2 diabetes treatment drugs Januvia and Janumet saw strong volume growth in international markets, their sales declined 8% in the U.S.  We did not expect anything different as Januvia had started showing weakness in the beginning of the third quarter. The U.S. DPP-IV prescription data, which is essentially data for dipeptidyl peptidase-4 inhibitor drugs that are used for treatment of type 2 diabetes, suggests that Januvia is losing sales in the U.S. According to BMO Capital Markets, the three week prescription data for the third quarter indicated that Januvia franchise’s prescriptions had declined by 1.7%.  The drug’s sales seem to have suffered following Invokana’s launch by Johnson & Johnson (NYSE:JNJ) in April and given its Q3 performance, we expect the prescription volume to continue to decline in the fourth quarter as well. The overall market has been stable which implies that Invokana is taking away some volume from Januvia, which is one of Merck’s biggest drugs with over $4 billion in sales in 2012. The company acknowledged this new competition during its Q3 2013 earnings conference call. 
We currently account for Januvia’s revenues under Alimentary & Metabolism drugs division, which constitutes roughly 15% to our price estimate for Merck. Januvia’s importance can be gauged from the fact that the exclusion of the drug’s sales from Merck’s revenue forecast leads to downside of about 5-10% to our price estimate. That’s a lot of value for a single drug in a diversified company like Merck.
Patent Issues And Japan’s New Policy Subdued The Overall Growth
The competition from low priced generics again impacted Merck’s growth, and this trend is likely to continue for the foreseeable future. Loss of exclusivity of several major drugs including Singulair, Propecia, Clarinex and Maxalt has put pressure on the company to improve its R&D productivity. Asthma drug Singulair has had the biggest impact and has continually weighed on Merck’s revenues for the past few quarters. Worldwide sales of Singulair, a once-a-day oral medicine for chronic treatment of asthma and relief of symptoms of allergic rhinitis, stood at $5.5 billion for 2011. However, this figure declined to $3.85 billion in 2012 following its patent expiry in August same year. For the first 9 months of 2013, Singulair revenues stood at a meagre $989 million, implying a massive decline of 73% over the comparable period in 2012. 
In addition, Merck’s business suffered from weakening of Yen and Japanese government’s decision to suspend proactive recommendation of HPV (human papillomavirus) vaccine. This impacted the sales of Gardrasil, which has otherwise performed extremely well over the last few quarters. Japan is the third biggest market for Merck after the U.S. and Europe, and accounted for 12.3% of its revenues in 2012. Notes: