Merck Over Roche For 25% Gains?

by Trefis Team
Roche Holdings
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Two pharmaceutical giants – Merck (NYSE:MRK) and Roche (OTCMKTS:RHHBY) – have seen their stock price grow over 20% since March 23 lows, significantly underperforming the broader markets, which rallied over 40% through June 5 from the lows. This can partly be attributed to the fact that these stocks fell less compared to the broader markets in the decline between early February and March 23. The lockdown in various parts of the world has had a negative impact on the pharmaceuticals industry worldwide, due to the postponement of elective surgeries and hospital visits for non-emergency cases, resulting in lower prescriptions issued. This will likely have an impact on business of both the companies. That said, we believe Merck will likely fare better than Roche because of its continued expansion of Keytruda to different oncology therapeutic areas, while Roche bets on its new drugs to drive future growth.

Our conclusion is based on our detailed dashboard analysis, ‘Is Merck Expensive Or Cheap vs. Roche?wherein we compare trends in key metrics for the two pharmaceutical giants over the recent years to determine their relative valuations under the current circumstances. We summarize parts of this analysis below.

Merck Will Likely Outperform Roche Over The Coming Months

Merck’s P/E based on 2019 earnings has declined from over 17x in 2019 to 15x currently, while Roche’s multiple has grown from 16.0x to 16.9x. The decline in Merck’s multiple can be attributed to its exposure to Animal Health and Vaccines business, which will see more impact due to the current Covid-19 pandemic. However, we believe that the growth in Merck’s blockbuster drug, Keytruda, will likely offset the decline, if any, from the above two businesses. Keytruda has been on a stellar run with a whopping 20x sales growth from $0.6 billion to $11.1 billion between 2015 and 2019. To add, the drug’s sales grew 45% even in Q1 2020, when most of the businesses started to face headwinds from the Covid-19 crisis. 

Roche’s multiple on the other hand appears high, considering that the company’s revenues and margins are at a greater risk compared to Merck’s, given that it has to now face biosimilar competition for some of its blockbuster drugs, including Herceptin and Avastin. Notably, Roche’s P/E is at the highest level of the last 4 years and it is 26% above the figure at the end of 2018. On the other hand, Merck’s P/E is 7% lower from the same level seen at the end of 2018. One factor that explains the movement in Roche’s multiple is strong performance of its relatively new drugs, which thus far have more than offset the declines from the older drugs that face biosimilar competition. Having said that, we believe Merck’s stock, based on fundamentals and valuation, will likely offer better returns compared to Roche over the coming months. 

But How Long Will Merck’s Stock Remain Under Pressure?

  • The expected timeline for recovery in global economic conditions, and in Merck’s stock, hinge on the broader containment of the coronavirus spread. Our dashboard forecasting US Covid-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus.
  • Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a complete macro picture and complements our analyses of the coronavirus outbreak’s impact on a diverse set of Merck’s multinational peers. The complete set of coronavirus impact and timing analyses is available here.
  • We believe there will be a recovery in demand for most sectors by late June or early July, with gradual lifting of lockdowns and a gradual rise in number of Covid-19 cases remaining within the manageable capacity of hospitals and care providers.
  • Although most companies will report poor Q2 results starting mid-July, market expectations will be buoyed by a visible improvement in the situation on the ground.

Overall, we believe Merck’s stock price at levels of $80 could offer 25% gains, and it provides a buying opportunity for investors willing to be patient. We also consider an outlier case on Keytruda Upside, assuming the drug manages to garner leadership position in other therapeutic areas, and be worth over $200 billion, compared to $208 billion market capitalization for Merck currently. 

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