The stock price of Merck (NYSE: MRK) reached its 52-week high of around $82 in Sep 2020. It has since hovered in the range of $70-80 for the better part of the last year, and it currently trades at levels of around $72. We believe that MRK stock is undervalued at its current levels, and investors can use the recent dips as a buying opportunity for long-term gains, in our view. MRK stock is down more than 15% over the last year or so, despite revenue increasing 6% over the same period. Looking at a longer time period, MRK stock is up only 28% from the levels of around $56 seen toward the end of 2017, significantly underperforming the broader markets, with the S&P 500 rising 63%. The growth in Merck’s earnings was partly offset by a decline in its P/E multiple, resulting in slower stock appreciation.
Looking at its fundamentals, Merck’s total revenue actually grew 21% to $48.5 billion over the last twelve-month period, compared to $40.1 billion in 2017. The revenue growth can largely be attributed to market share gains for its mega-blockbuster drug – Keytruda – approved for multiple types of cancer treatments. Merck’s net income more than doubled since 2017 to $5.6 billion over the last twelve month period, driven by both a rise in revenues as well as margin expansion. The company also repurchased more shares over the recent years, resulting in a 7% fall in total shares outstanding since the end of 2017. As such, on a per share basis, Merck’s earnings surged 150% to $2.20 for the last twelve month period, compared to $0.88 in 2017. Despite a large EPS growth over the recent years, Merck’s P/E multiple has contracted 49% to 33x currently, compared to levels of 64x seen in 2017, and we believe that the multiple will likely expand over the coming years. Our dashboard, Buy Or Fear Merck’s Stock has the underlying numbers.
For Merck much of the revenue growth over the recent years has been led by its oncology drug – Keytruda – which saw its sales double from $7.1 billion in 2017 to $14.4 billion in 2020. Though the Covid-19 pandemic surely impacted the sales growth for some of its drugs due to fewer hospital visits, and a lower vaccination rate for Gardasil and Proquad, this trend reversed in Q2, with Gardasil sales surging 88%. There are concerns over slowing sales of Januvia and Janumet, which are nearing their patent expiration. However, Merck is seeing steady growth in other areas, including its Animal Health business as well as Lynparaza and Lenvima alliance revenues. There has been a rise in pet ownership during the pandemic and this has resulted in an increased demand for animal health pharmaceuticals products at large, including those offered by Merck.
Merck’s cash-cow – Keytruda – continues to gain share in several markets given its approval in multiple indications, including, lung, head & neck, bladder, renal, and skin cancer among others. Keytruda’s patents are protected for another seven years and it alone will likely garner over $25 billion in annual sales by 2026. With its recent spin-off of its women’s health, legacy brands, and biosimilars businesses, Merck can now focus on more profitable drugs, implying better margins going forward.
Overall, there are more positives for Merck to look forward to than the pessimism surrounding slowing sales growth for some of its drugs. Going by our Merck’s Valuation, with an adjusted EPS estimate of $5.65 and a P/E multiple of 16x in 2021, this translates into a price of $91, which is over 26% above the current market price of around $72.
While MRK stock may see higher levels, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Freeport vs UnitedHealth.