Why We Expect Merck’s Oncology Segment To Outperform In The Coming Years

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Merck’s (NYSE:MRK) oncology business accounts for around 15% of the company’s valuation, according to our estimates. Oncology is the only segment for Merck where we expect double-digit revenue growth in the coming years, while most of the other segments – including cardiovascular and musculoskeletal – are forecast to see revenue declines, or modest growth. In fact, the only other segments where we expect near-term revenue growth is anti-infectives and alimentary & metabolism drugs. Even for alimentary & metabolism drugs, the growth will likely be short lived given that key drugs Januvia and Janumet’s sales are maturing, and they will face biosimilar competition, as the patent expires in 2022. Anti-infectives as a segment is expected to perform well, courtesy of Gardasil and Zepatier (also see – The Outlook For Merck’s Anti-Infectives Drug Business). In this note we focus on the company’s Oncology segment and its future implications for Merck.

Significant Ramp Up In Keytruda Sales

Merck’s current oncology portfolio primarily consists of Keytruda, which accounted for over 60% of revenues in 2016, while the rest can be attributed to Emend, and Temodar. Looking at Keytruda, it was first approved by the FDA in 2014 for advanced melanoma. Since then, the drug has received several approvals in different therapeutic areas, including metastatic, non-small cell lung cancer, head and neck cancer, Hodgkin’s lymphoma, urothelial carcinoma, and for certain types of advanced gastric cancer. Keytruda has become a blockbuster drug for Merck, with y-o-y sales doubling in 2016, and we expect it to grow by another 2x in 2017 to around $3.2 billion. While the expected peak sales for the drug are touted to be as high as $16 billion, we currently estimate the sales to ramp up to over $6 billion by the end of our forecast period. We believe our estimate is reasonable given that Keytruda has seen its usage expand to multiple areas. The drug has large addressable market because of its approval for lung cancer. The commercial opportunity is huge due to the larger population of potential patients. Lung cancer is one of the most prevalent cancer types in the world, both in terms of incidence and mortality. It is estimated that around 14% of all new cancers are lung cancers and 25% of cancer deaths are due to lung cancer in the U.S.

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There are certain risks to our estimates. The competition is growing, and the number of drugs in the immuno-oncology class is increasing. Bristol-Myers Squibb’s (NYSE:BMY) Opdivio is expected to generate sales of around $4.5 billion in 2017, and we expect the figure to increase to north of $5.5 billion by 2023 (Also see – Why Opdivo Is The Most Important Driver For Bristol Myers Squibb’s Future Growth). Similarly, Johnson & Johnson’s (NYSE:JNJ) Imbruvica, Zytiga and Darzalex are expected to generate sales of around $5.5 billion in 2017, and the figure is expected to grow to around $10 billion by the end of our forecast period. These drugs will likely expand their usage to additional cancer types over time, so Merck will likely try to get a first mover advantage in as many indications as possible. There could also be a significant upside to our estimates depending on future approvals for the drug and its penetration in other therapeutic areas. It should be noted that Keytruda is currently being tested under 9 programs in phase 3 trials, and it is reasonable to expect that some of these trials will be positive enough to bag regulatory approvals.

Overall, we believe that oncology as a segment will outperform Merck’s other business segments, with an estimated average annual growth rate of  over 15% in the next 5 years. This compares with an estimated low-single-digit decline in Merck’s company-wide sales during the same period. Also, the oncology segment’s contribution to Merck’s overall revenues will likely grow 2.7x from 6% in 2016 to over 16% in 2024.

We currently have a price estimate of $65 for Merck, which is around 15% ahead of the current market price.

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