Should You Buy Merck Stock At $85?

After a 28% rise since the March 23 lows of this year, at the current price of around $85 per share we believe Merck’s stock (NYSE: MRK) looks attractive and it has more room for growth. MRK stock has moved from $66 to $85 off the recent bottom compared to the S&P which moved 55%, with the resumption of economic activities as lockdowns are gradually lifted. MRK stock has partially recovered to the levels it was at before the drop in February due to the coronavirus outbreak becoming a pandemic. Furthermore, MRK stock is also up 63% from levels seen in early 2018.

Some of the 63% rise of the last 2 years is justified, given a 16.7% growth in the company’s revenues from $40.1 billion in 2017 to $46.8 billion in 2019. Merck also managed to grow its net margins from 27.2% to 28.6% on a Non-GAAP basis, and this clubbed with a 6.1% reduction in total shares outstanding due to share repurchases, translated into over 30% growth in Merck’s earnings on a per share basis. Given the steady top and bottom line growth, the P/E multiple has also expanded. We believe the stock is likely to see more upside despite the recent uptick and the potential weakness from a recession driven by the Covid outbreak. Our dashboard, ‘What Factors Drove 63% Change in Merck Stock between 2018 and now?‘, has the underlying numbers.

Merck’s P/E multiple changed from 13x in 2018 to 17x in 2019. While the company ‘s P/E is 16x now, there is a potential upside when we look at forward earnings growth, as well as compare the multiple with historical levels, 17x as recently as late 2019.

So what’s the likely trigger and timing for further upside?

The global spread of coronavirus has resulted in postponement of elective surgeries, and fewer visits to doctors, especially in the quarter just ended, as health care institutions primarily focus on Covid-19 and other emergency cases. This directly impacts pharmaceutical companies, such as Merck. Though the company reported a 8% decline in sales, its earnings grew 5% from $1.30 to $1.37 on a per share and Non-GAAP basis in Q2 2020. This can be attributed to a decline in all expense heads. That said, the company will likely see both revenues and earnings growth for the full year, led by continued expansion of Keytruda, and the opening up of economies aiding the overall business growth.

While Keytruda remains the biggest growth driver for Merck, the company’s decision to spin-off its Women’s Health and old drugs business would mean higher revenue growth and better margins for the company. Keytruda itself managed to grow its sales a strong 29% in Q2 2020, despite the adverse market conditions. It also secured 5 regulatory approvals thus far in 2020, including that for first-line treatment for colorectal cancer.

Overall, Merck appears to be poised for steady revenue and earnings growth led by Keytruda expansion as well as improved margins, and the stock trading at just 16x its trailing earnings, and under 15x its 2020 expected earnings, appears to be an attractive level for investors wiling to invest for the long-term. This compares with levels of 19x for Johnson & Johnson and 21x for Eli Lilly, based on expected 2020 earnings.

Looking at the broader economy, over the coming weeks, we expect continued improvement in demand and subdued growth in the number of new Covid-19 cases in the U.S. to buoy market expectations. Following the Fed stimulus — which set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations become important in finding value. Though market sentiment can be fickle, and evidence of a sustained uptick in new cases could spook investors once again.