2017 Will Be A Critical Year For Keytruda And Merck

Merck (NYSE:MRK) recently reported its Q1 2017 earnings, and while the results beat consensus estimates, the company’s stock didn’t move much because of concerns around Keytruda’s future growth. The drug is doing very well right now, but the lung cancer market is getting increasingly crowded, with Bristol-Myers Squibb acknowledging that there are uncertainties in first-line lung cancer treatment. Investors likely want to see more from Keytruda, and the upcoming FDA reviews are likely to give us some color regarding the drug’s near term trajectory. However, Zepatier and Gardasil provided a positive surprise and helped alleviate the impact of the revenue decline of legacy and off-patent drugs. We think that Merck’s near term performance is likely to be tied more to Keytruda than any other drug.

Our price estimate of $67 for Merck is nearly 10% above the market. We are currently reviewing our price estimate in light of the recent earnings and will update it shortly.

Merck’s Near Term Performance Is Tied To Keytruda

If there is one single drug that will add the most to Merck’s incremental sales in the next 5 years, it will likely be Keytruda. The immuno-oncology drug has so far been approved for advanced melanoma, advanced non-small cell lung cancer, hodgkin’s lymphoma, and head and neck squamous cell cancer. For lung cancer, in particular, the drug is expanding in first-line therapy. Keytruda’s sales in Q1 2017 amounted to $584 million, implying 134% growth over the same quarter last year. For the full year, we expect sales to cross $2.9 billion. Merck mentioned that IMS data suggests that Keytruda is the most prescribed drug in the first-line lung cancer treatment. Additionally, Merck’s second-line lung cancer treatment share has been relatively stable.

The numbers certainly look impressive, but there are risks to be considered. The competition is growing and the number of drugs in immuno-oncology class are increasing, with one recent addition being AstraZeneca’s Imfinzi. We expect these drugs to expand their usage to additional cancer types over time. So Merck has to try and get the first mover advantage in as many indications as possible. The FDA is currently evaluating the Keytruda filing based on keynote-021 study, which tests Keytruda in combination with chemotherapy for first-line treatment of non-squamous, non-small cell lung cancer. This has the potential to expand the drug’s market opportunity as it also includes patients with low or no PD-L1 expression, thereby eroding some of the advantage that Opdivo enjoys. However, this should be seen as a long term opportunity, and it is unlikely that the sales will jump immediately as it is not a response to pent-up demand.

Zepatier And Gardasil Help As Legacy Drugs Decline

We were previously somewhat skeptical about how Gardasil’s revenue will trend as practitioners move from 3 doses to 2 doses. It appears that the growth in demand, including public sector purchases, and pricing changes by Merck have more than offset the impact of the dosage change. Gardasil’s sales grew nearly 47% to $532 million in the first quarter. Additionally, Zepatier is ramping up well. The hepatitis C drug is approved for genotypes 1 and 4 of the virus. Merck expects to strengthen its position in Hepatitis C market with Zepatier mainly on pricing and safety. In early 2016, the company conducted a trial and concluded that Zepatier had fewer side effects compared to market leader Gilead Sciences’ Harvoni and Sovaldi. Additionally, Zepatier’s wholesale acquisition price for treatment is nearly 30% lower than Harvoni’s list price. This is important because newer Hepatitis C drugs, though effective, have been criticized for their high pricing. Merck has a good opportunity to gain volume share in the Hepatitis C market, but we remain cautious as Gilead has previously demonstrated its capacity of killing HCV competition with launches of more effective drugs.

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