Merck & Co., Inc. (MRK, Financial) is one of the largest healthcare companies and a leader in the global cancer drugs market.
Investment thesis
In recent weeks, Merck's share price has been under downward pressure, partly due to growing Wall Street concerns about the impact of the Inflation Reduction Act and the company's aggressive R&D policy. So, on October 19, 2023, the company entered into a deal with Daiichi Sankyo (DSNKY) for a total amount of up to $22 billion, the purpose of which is to develop three experimental drugs: ifinatamab deruxtecan (I-DXd), patritumab deruxtecan (HER3-DXd) and raludotatug deruxtecan (R-DXd) to combat various types of cancer.
On the other hand, third quarter 2023 financial results released at the end of October 2023 exceeded our expectations. So, the company's management raised the 2023 revenue guidance from $58.6-$59.6 billion to $59.7-$60.2 billion. Moreover, the demand for drugs and vaccines such as Keytruda, Gardasil/Gardasil 9, Welireg, and Lenvima continues to grow year-on-year due to their higher effectiveness relative to competitors and successful marketing strategies applied by Merck.
The first investment thesis is the growth in demand for Keytruda (pembrolizumab), which is a humanized monoclonal PD-1 antibody and a crucial Merck blockbuster. The drug contributed approximately 39.7% of Merck's total revenue for the third quarter of 2023 and continues to be the "gold standard" in the global cancer therapeutics market, which will continue to actively expand, including due to an increase in the number of patients.
Cancer Tomorrow - Global Cancer Observatory - IARC
So, Keytruda's total sales amounted to about $6.34 billion for the three months ended September 30, 2023, an increase of 16.8% compared to the previous year.
Author's elaboration, based on quarterly securities reports
The growth in sales of Merck's drug in the quarter and year-on-year was primarily driven by the expansion of its label and higher demand for it in the treatment of patients with such deadly diseases as non-small cell lung cancer (NSCLC), head and neck squamous cell carcinoma (HNSCC), melanoma, triple-negative breast cancer (TNBC) and renal cell carcinoma (RCC).
Author's elaboration, based on 10-Q
Besides, the company's year-over-year revenue growth was driven, in part, by its CEO's innovative business strategies to develop drugs and vaccines that potentially outperform competitors in terms of efficacy and safety profile. As a result, in a relatively short period, Merck products become the gold standard in treating and preventing various diseases.
So, in addition to the company's oncology franchise, growing demand for its vaccines is playing a key role in improving its financial position, mainly due to Gardasil/Gardasil 9. Gardasil/Gardasil 9 is one of the most popular products in the global human papillomavirus (HPV) vaccine market. Cumulative sales of Merck's vaccine were $2.59 billion, up 12.7% year-over-year, driven by rising prices, aggressive expansion of indications for its use over the past three years, and increased demand from China.
Author's elaboration, based on quarterly securities reports
As a result, growing demand for Merck's vaccines and branded medicines positively impacts its operating income margin, which amounted to 36.49% for the third quarter of 2023, an increase of 2.09% compared to the previous year. This financial metric outperforms its healthcare peers such as Pfizer (PFE, Financial), Johnson & Johnson (JNJ, Financial), AstraZeneca (AZN, Financial), and Bristol-Myers Squibb (BMY, Financial).
Author's elaboration, based on Seeking Alpha
Another investment thesis that makes Merck one of the most attractive long-term assets in the healthcare sector is its management's active use of a share repurchase program. It plays a crucial role in helping the company's EPS beat analysts' consensus estimates in the last nine out of ten quarters. So, Merck spent $466 million in the third quarter of 2023, which is 37.9% more than the previous quarter. At the same time, at the end of September 2023, the remaining authorization to repurchase the company's shares amounted to $4.1 billion, which, in our opinion, is sufficient to minimize the impact of short sellers during the current period of increased volatility in stock markets.
Author's elaboration, based on Seeking Alpha
Merck's Q3 2023 financial results and outlook for the 2H 2023
The company's financial results for the third quarter of 2023 were outstanding. Merck's revenue continues to grow year over year, and more importantly, it beat analysts' consensus estimates in nine of the last ten quarters, thanks mainly to increasing sales of its oncology and vaccines franchises.
Author's elaboration, based on quarterly securities reports
Merck is expected to release its financial report for the fourth quarter of 2023 on February 1, 2024. According to Seeking Alpha, Merck's revenue for the quarter is expected to be $14.22 billion to $14.8 billion, up 6.2% from analysts' expectations for the previous year. Simultaneously, according to our model, the company's total revenue will be slightly above this range and reach $15 billion.
Merck's year-over-year revenue increase will be driven primarily by continued growth in sales of its products such as Keytruda, Welireg, Gardasil/Gardasil 9, and Vaxneuvance.
Author's elaboration, based on Seeking Alpha
Due to the acquisition of Prometheus and the deal with Daiichi Sankyo, we expect Merck's operating income margin to reach 8.1% in 2023. On the other hand, this financial metric will rise sharply in 2024 to 33.6% due to increasing demand for its oncology products, higher prices for its vaccines and medicines, and the strengthening of the euro and the Japanese yen against the US dollar.
According to Seeking Alpha, Merck's fourth-quarter EPS is expected to be between -$0.15 and -$0.06, down sharply from the third-quarter 2023 consensus estimate due to the pretax charge of $5.5 billion. However, according to our model, Merck's EPS will be above the median of this range and reach -$0.06.
Author's elaboration, based on Seeking Alpha
Meanwhile, the Non-GAAP P/E [FWD] is 74.47x, which is 364.07% higher than the average over the past five years, which, as stated earlier in the article, is due to the company's active R&D program, one of the goals of which is expanding its drug portfolio ahead of the loss of Keytruda's exclusivity in the US in 2028.
Author's elaboration, based on 10-K
Conclusion
Merck is one of the largest healthcare companies and a leader in the global cancer drugs market.
At the same time, the key financial risks that need to be taken into account are increased competition in the global PD-1 and PD-L1 inhibitor market, the negative impact of President Biden's Inflation Reduction Act on the pharmaceutical industry, and decreased sales of Primaxin, RotaTeq, and Primaxin. These factors have weighed on Merck's share price, which has fallen more than 12% over the past six months.
Author's elaboration, based on Seeking Alpha
The company's total debt was about $34.86 billion at the end of the third quarter of 2023, up slightly from 2021. However, despite the company's EBITDA declining year-over-year due to the acquisition of Prometheus Biosciences and the deal with Daiichi Sankyo, its total debt/EBITDA ratio remains below 3x.
Moreover, given the company's stable free cash flow and relatively high rate of label expansion of its drugs, we do not expect it to have significant difficulty repaying the senior notes maturing between 2024 and 2061.
In addition, we would like to note that the company's growing gross margin, significant year-on-year sales growth of Keytruda, Welireg, Gardasil/Gardasil 9, and an extensive portfolio of product candidates are some of the key investment theses that make Merck attractive an asset for investors.
We continue our analytics coverage of Merck with an "outperform" rating for the next 12 months.
