Merck’s (NYSE:MRK) recently reported Q1 2014 financial results were within the bounds of our expectations. The company’s pharmaceutical revenues declined by 5% during the quarter, which included a negative impact of 2% due to currency movements.  The remaining 3% decline can be attributed to plummeting revenues from Nasonex, Singulair and Zetia/Vytorin due to the loss of their patent exclusivity, partially offset by the growth in diabetes, immunology and anti-infective drugs. The competition from generics has resulted in severe pricing pressure in the U.S. and Europe. The combined sales for the aforementioned drugs fell by 10.9% during the quarter, amounting to $1,555 million.  So where should investors place their faith? We believe that the answer lies in Merck’s advancement in diabetes and immunology, and its reasonably good R&D pipeline. The company has been working on a couple of promising phase 3 trials and awaits regulatory clearance for some new products.
We are in the process of reviewing our price estimate for Merck in the light of recent earnings, and will have an update ready soon. Our current price estimate for the company stands at $53, implying a discount of more than 5% to the market price.
Merck’s Diabetes And Immunology Drugs Are Helping It Cut Down The Revenue Decline
The growth in Merck’s diabetes and immunology drugs helped offset its revenue decline to an extent. The key drugs worth discussing are Januvia/Janumet, Remicade and Isentress. Januvia franchise’s sales increased by a moderate 5% excluding the impact of currency movements, amounting to $1,334 million.  The international markets now account for half of these sales, which implies that the impact of currency movements could be more notable going forward.  However, the global diabetes opportunity is huge and international expansion holds the key to unlock this potential. With obesity increasing, diabetes is affecting more people globally. In the U.S. alone, roughly 26 million people suffer from the condition. Owing to these factors, the global diabetes drug market has seen rapid growth rate in the last couple of years. According to GBI Research, a leading business intelligence provider, the type 2 diabetes drug market, which constitutes a significant chunk of the total diabetes drug market, is expected to grow from $26 billion in 2011 to $50 billion in 2021, in developed markets including the U.S., Japan and Europe. Additionally, China’s diabetes market is expected to grow 20% annually and reach $3.2 billion by 2016, according to IMS health. 
The combined sales of Merck’s immunology drugs Remicade and Simponi jumped 16% during the quarter. While Remicade saw a growth of roughly 10%, Simponi surged almost 45%, making it the fastest growing immunology biologic in the markets where it is available.  Remicade continued to grow despite the entry of biosimilars in certain European markets. However, this increase in competition was limited to only small markets and may intensify going forward. Isentress has done well too and the overall market for anti-infectives continues to grow.
Here Is What The Pipeline Holds
MK-3475 (or lambrolizumab) is Merck’s 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. In June 2013, Merck’s shares jumped nearly 5% on the news that 38% of the cancer patients under trial responded positively to this drug. Investors have welcomed the company’s decision to investigate the drug’s effectiveness in combination with other investigational agents. The drug is currently being studied in 17 clinical trials estimated to enroll over 4,000 patients across more than 30 types of cancer.  MK-3475 is a new class of drugs and could well be the future of cancer treatment. Bristol-Myers Squibb has a similar drug in clinical trial under the name nivolumab and is expected to garner $6 billion in peak sales. Currently these drugs are being tested for melanoma (skin cancer), and if their usage expands to other cancer types, it could open a much bigger market for these pharmaceutical companies. Merck has already initiated a study to identify other cancer types where the drug can have a therapeutic effect. The company could revive its oncology division if MK-3475 is successful.
In early April, Merck presented phase 2 trial data for its investigational Hepatitis C treatment and believes that it may soon enter phase 3 trials. The global Hepatitis C market is huge, as evident from growing sales of Gilead Sciences’ Sovaldi and Johnson & Johnson’s Olysia. If Merck were to capture 30% of global Hepatitis C treatment market by 2020, there can be 10% upside to our price estimate. For details see What If Merck Challenges Gilead Sciences In Hepatitis C Market?Notes: