VALUATION HIGHLIGHTS

1. Oncology Drugs constitute 48% of the Trefis price estimate for Merck's stock.
2. Vaccines constitute 17% of the Trefis price estimate for Merck's stock.
3. Animal Health & Others constitute 12% of the Trefis price estimate for Merck's stock.

WHAT HAS CHANGED?

Coronavirus Impact On Merck's Stock

Merck lost more than 28% – dropping from $92 at the beginning of 2020 to around $66 in late March 2020 – then grew 17% to around $77 now (as of Aug 18, 2021). That means it has partially recovered to the pre-pandemic levels.

Why? While the Covid-19 outbreak and associated lockdowns resulted in an uncertain outlook for the broader markets, the multi-billion-dollar Fed stimulus announced in late March helped the markets stage a strong recovery. Investors are now expecting a quicker economic rebound with economies opening up gradually, which will bode well for pharmaceutical companies, such as Merck.

Q2 2021 Performance

Merck's Q2 results were below the street estimates. Its revenue of $11.4 billion was up 22% y-o-y. While the oncology segment posted strong growth led by Keytruda, which saw 23% growth to $3.4 billion, the demand for vaccines also rebounded with Gardasil sales surging 88% to $1.2 billion, bolstering the overall top-line growth.

Merck reported earnings of $1.31 on a per share and adjusted basis, compared to $1.02 in the prior year quarter, reflecting a 28% growth. Note that the company took a $1.7 billion charge for the April 1 acquisition of Pandion Therapeutics.

Merck now expects full-year revenue to be in the range of $46.4 billion to $47.4 billion, and earnings to be in the range of $5.47 to $5.57 per share. These revised forecasts are well below its earlier provided estimates because of the revenue lost from the spinoff.

Women's Health Business Spinoff

Merck in January 2020 announced that it will spin off its Women's Health business, along with legacy brands and biosimilars into a new company. The revenue of around $6 billion for the new entity are expected to decline y-o-y in 2021, led by loss of market exclusivity of Zetia in Japan, and Nuvaring in the US.

Loss of Marketing Exclusivity

Several of Merck's drugs have lost market exclusivity in the recent years. This includes Zetia, Vytorin, Invanz, Dulera, Nasonex, and NuvaRing. The patent loss has resulted in slower sales amid competition from other players. Zetia, for instance, generated sales of $2.6 billion in 2016, which declined to $482 million in 2020, after the drug lost its marketing exclusivity in 2017.

Strong Growth In Gardasil Sales

Merck has seen success with Gardasil, which is a vaccine used for prevention against HPV (human papillomavirus) virus, which has been linked to certain types of cancers, and thus it is an important vaccine. The vaccine will likely see increased sales given the immunization across various countries. Europe, as well as China, will likely drive the vaccine's future sales growth.

Keytruda Is One of The Top Selling Drugs In Immuno-Oncology Space

Keytruda is witnessing increased acceptance, and it is now the one of the top selling drugs in the immuno-oncology space, which is currently led by AbbVie's Humira, which garnered over $19 billion sales in 2019. The sales growth for Keytruda over the recent past was largely led by gains in lung cancer. Keytruda sales are seeing strong growth outside the U.S. as well. In the U.S., Keytruda was approved for the adjuvant treatment of patients with melanoma with involvement of lymph node(s) following complete resection in Q1 2019. The drug captured another two approvals ~ expanded monotherapy label for first-line treatment of non-small cell lung cancer (NSCLC), and a combination with Inlyta (axitinib) as first-line treatment for patients with advanced renal cell carcinoma (RCC) in 2019. The drug is expected to garner more approvals for different indications in the future, given it is currently under 11 programs in phase 3 pipeline. This will continue to aid the sales growth for Merck in the near term, and beyond.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Key drivers of Merck's value that present opportunities for upside or downside to the current Trefis price estimate for Merck:

Commercial Launch of Phase 3 Drugs

• Late Stage Pipeline: Merck has a handful of new compounds in its late stage pipeline, with potential peak sales of over $2.0 billion. Our valuation reflects probability-adjusted sales of phase 3 drugs. If all phase 3 drugs are approved within the next 3 years, it could imply roughly 5% upside potential to our price estimate.

Keytruda's Progress Halts

• Merck's Oncology Revenues: Merck's blockbuster oncology drug, Keytruda, has received regulatory approvals for several indications, including skin, lung, and Hodgkin's lymphoma, among others. We estimate that the drug could garner as much as $21 billion in peak annual sales. However, considering the effort big pharma firms are putting in immuno-oncology, there is a chance that a new competing drug could halt Keytruda's growth, and it peak halts around $15 billion. In such a situation, there could be over 15% downside to our price estimate.

BUSINESS SUMMARY

Merck ranks among the world's largest pharmaceutical companies in terms of revenues. The company delivers innovative health care solutions through its prescription medicines, vaccines, biologic therapies and animal health products which it markets directly and through its joint ventures. The firm's operations are managed through the company's three main divisions, namely Pharmaceutical, Animal Health, and the Alliances division. Merck sold its consumer care business to Bayer in 2014.

SOURCES OF VALUE

Oncology Drugs Portfolio

Merck has a strong portfolio of oncology drugs, led by Keytruda. The segment sales have increased from less than $1.0 billion in 2014 to over $15.8 billion in 2020, and we forecast it to grow north of $28.0 billion by the end of our forecast period in 2027. Most of this growth can be attributed to Keytruda. Merck's other drugs in oncology portfolio include Emed, Temodar, and alliance revenue from Lynparaza and Lenvima. Additionally, the division is unlikely to see any decline in revenues because Keytruda's patent is protected till 2026.

KEY TRENDS

Impact of Coronavirus

Merck's stock price declined 5% from around $85 levels at the end of January, when the WHO declared a global health emergency, to $81 levels as of April 28. This can be attributed to fears of the global economy going into recession, after the coronavirus outbreak into several countries, and an oil price war, with Saudi Arabia increasing production, which led to over a 75% decline in oil prices (WTI moving from $51.56 on January 31, 2020 to $13.50 on April 28, 2020). The Covid-19 crisis has impacted the overall hospital visits and new patient starts volume. This has impacted the sales of pharmaceutical companies, including Merck. The vaccine business, in particular, is one of the worst hit segments for Merck. That said, its cancer drug, Keytruda, will continue to be a top selling treatment option, and bolster the company's overall sales growth.

Gardasil Success

Merck has seen a stellar success with Gardasil, a vaccine used for prevention against HPV (human papillomavirus) virus, which has been linked to certain types of cancers, and thus it is an important vaccine. The vaccine will likely see increased sales given the immunization across various countries. Europe, as well as China, will likely drive the vaccine's future sales growth.

Loss of Patents Impacting Sales

Like other major pharmaceutical companies, Merck is also battling against the impact of patent expiry of its several major drugs including Singulair, Remicade, Propecia, Clarinex, Maxalt, Cozaar, and Hyzaar. Out of these, asthma drug Singulair has had the biggest impact and has continually weighed on Merck’s growth for the past few years.

Growing Threat of Generic Products

The fast growing pharma market in emerging economies or referred to as the 'Pharmerging' economies have the capability and technical prowess to manufacture generic versions of blockbuster drugs. These generic drugs are often sold at prices that are substantially cheaper then their branded counterparts, thereby severely affecting big pharma's ability to generate profits in the long run. Merck's drugs could face potential threat from biosimilars in the future, which are generic versions of biologics.

Globalization of Healthcare Reforms

Governments around the world are trying to rein in fiscal spending in order to manage their budget deficits. Since healthcare costs are one of the biggest components of any national budget, it is expected that an increase in healthcare legislation and reforms around the world will hurt revenues for the entire pharmaceutical sector.

Merck's Focus on Vaccines

Merck is focused on vaccines, and currently has 2 new vaccines in its phase 3 pipeline, which could potentially generate over $1 billion in peak sales. Ebola is spreading in the Congo in 2018, and Merck’s Ebola Vaccine is currently being used for vaccination. Merck's Erbevo, a vaccine used to treat Ebola, was approved by the US FDA in December 2019.