Sooner or later, Merck (NYSE:MRK) will need to step up its efforts to mitigate the impact of loss of exclusivity of certain key drugs and adverse currency movements on its revenue growth. The recent quarters have unveiled a problem that is impacting the whole pharmaceutical industry. The R&D productivity has declined and the ability of the new drugs in pipeline to replace previous blockbusters is under doubt. Under these circumstances, where should Merck be focusing? The market for oncology, infectious diseases and diabetes is growing due to an increasing patient pool. This presents strong growth opportunity for Merck and other pharmaceutical companies. In addition, there is an opportunity to expand in Asia Pacific and Latin American regions which accounted for just about 10% of Merck’s revenue in 2012.
Our current price estimate for Merck stands at $52, implying a slight premium to the market price
Stepping Up Vaccination Efforts
Merck needs to make efforts to ensure that its HPV (human papillomavirus) vaccine Gardasil continues its topline growth. Japanese government’s decision to suspend proactive recommendation of HPV vaccine has impacted the drug’s sales in the recent quarter. While this raises some concern, there is another issue that the company needs to tackle domestically in the U.S. The vaccination rates have been relatively low for Gardasil and other HPV vaccines. According to The Journal of American Medical Association (JAMA), only about 54% of girls received at least one dose of an HPV vaccine in 2012, with just 33% receiving the full course of 3 shots.  In comparison, about 85% of teens received vaccination for tetanus, diphtheria and whooping cough during the same period. This essentially indicates that Garadasil is missing out on a lot of potential customers, and could effectively increase its sales by another 60% if steps were taken to increase the awareness about the necessity of the vaccine.
We expect Gardasil’s sales to exceed $1.8 billion in 2013, up 50% from $1.2 billion in 2009. If HPV vaccination rates were to increase to the levels of other vaccines, the revenues from Gardasil could jump to close to $3 billion in the next few years. This vaccine accounts for roughly 15%-20% of Merck’s anti-infective division’s revenues (reflected as Legacy Pharma), which in turn constitutes roughly 30% to the company’s value according to our estimates. This implies that 5% of Merck’s value can be attributed to Gardasil based on our current revenue projections. The scenario discussed above could add $1 billion in incremental revenues leading to a some upside to Merck’s stock. The upside will be relatively small because Merck is a large diversified pharmaceutical company and no single drug accounts for a substantial portion of its revenues.
Expansion In Oncology
The FDA had granted breakthrough status to Merck’s lambrolizumab in April 2013, which is an investigational PD-1 specific monoclonal antibody for the treatment of advanced malignancy. The drug essentially enables a patient’s immune system to detect cancerous cells that are otherwise extremely hard to identify. T cells can then target and kill these exposed tumor cells. The company can leverage this success to tap into the growing oncology (cancer therapeutics) market, assuming that the drug passes phase 3 trials and is approved by the FDA for commercial sale. The opportunity in oncology comes from the fact that global incidence of Cancer is likely to increase from about 12.7 million in 2008 to 21.3 million in 2030.  In addition, the number of deaths are likely to show a similar growth trajectory as depicted in the chart below. Cancer is a not a single disease, it has in fact more than 200 types and thousands of subtypes affecting more than 60 organs. That gives an opportunity for the company to develop novel therapies and capture niche markets
Staying Resilient In Diabetes Market
Although Merck is facing some competition from Johnson & Johnson in diabetes market due to latter’s launch of Invokana, it still has a dominant position in the U.S. Besides defending this position, the company needs to address international diabetes market where most of the growth potential lies. Increasing urbanization in some of the biggest Asian economies is resulting in an higher incidence of lifestyle related diseases including diabetes. While there are roughly 26 million people that suffer from this condition in the U.S., China’s problem is even worse.  A report suggests that 11.6% of Chinese adults have diabetes and around 40% of adults between the age of 18 and 29 are on the verge of developing it.  That puts China’s diabetes patient count at 114 million individuals, and this figure is likely to go higher. According to IMS health, China’s diabetes market is expected to grow 20% annually and reach $3.2 billion by 2016. 
Merck’s type 2 diabetes treatment drugs Januvia and Janumet have witnessed strong volume growth in international regions, but their sales in the U.S. have suffered recently due to competition from J&J’s Invokana. 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. While the trend may continue in the near term, the company will need to take steps to ensure that Januvia gets back on growth track. 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.Notes:
- Merck, Glaxo HPV vaccines held back by more than sex and money, FiercePharma, Nov 26 201 [↩]
- J&J’s Investor Presentation [↩]
- National Diabetes Fact Sheet, 2011, CDC [↩]
- China ‘Catastrophe’ Hits 114 Million as Diabetes Spreads, Bloomberg, Sept 4 2013 [↩]
- China Diabetes Triples Creating $3.2 Billion Drug Market, Bloomberg, Nov 5 2012 [↩]