Is Merck Overvalued?

With shares of Merck & Co. Inc. (NYSE:MRK) trading at around $47.11, is MRK an OUTPERFORM, WAIT AND SEE or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement

Merck has recently seen revenue and earnings declines. It has also given weak guidance. These are often bearish signals. However, is this one of those cases where such circumstances can be seen as an opportunity?

The biggest negative for Merck at the moment is patent expirations. This will lead to decreased revenue streams. Such a large headwind could be overcome if there was a strong pipeline, but that isn’t the case for Merck. Another big negative has been drug setbacks, including the failure of cholesterol drug Tredaptive (dangerous side effects). That said, there are a couple of bright spots. One is the potential for Vytorin, but a bigger bright spot is that the U.S. Food and Drug Administration (FDA) recent accepted Merck’s drug application for Noxafil. The following information is from Merck’s website:

Merck today announced that its New Drug Application for an investigational tablet formulation of the company’s antifungal agent, NOXAFIL® (posaconazole), has been accepted for review by the U.S. Food and Drug Administration (FDA).

Merck currently markets NOXAFIL Oral Suspension for prophylaxis of invasive Aspergillus and Candida infections in patients 13 years of age and older who are at high risk of developing these infections due to being severely immunocompromised, such as patients who have received hematopoietic stem cell transplants and have graft-versus-host disease, or patients with cancers of the blood who are experiencing prolonged low white blood cell counts (neutropenia) as a result of chemotherapy.

“Invasive fungal infections are a significant cause of illness and death among severely immunecompromised patients,” said Robin Isaacs, M.D., vice president, infectious disease clinical research, Merck Research Laboratories. “This filing for a tablet formulation of NOXAFIL is an example of Merck’s ongoing commitment to developing new therapy options for patients in the hospital setting.”

Merck is seeking FDA approval of NOXAFIL tablets for once-daily administration (following a twice-a-day loading dose on the first day of therapy). The company has filed a marketing authorization application for NOXAFIL tablets with the European Medicines Agency (EMA) and plans to seek regulatory approval for the tablet formulation in other countries around the world.”

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Now let’s get to some numbers. The chart below compares fundamentals for Merck, GlaxoSmithKline plc (NYSE:GSK), and Novartis (NYSE:NVS). Merck has a market cap of $142.02 billion, GlaxoSmithKline has a market cap of $116.75 billion, and Novartis has a market cap of $176.75 billion.

MRK

GSK

NVS

Trailing   P/E

23.49

16.44

18.77

Forward   P/E

12.27

13.86

13.13

Profit   Margin

13.05%

17.27%

16.53%

ROE

11.21%

60.92%

14.23%

Operating   Cash Flow

$10.02 Billion

$7.03 Billion

 $14.19 Billion

Dividend   Yield

3.80%

5.90%

2.20%

Short   Position

0.90%

N/A

N/A

 

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Let’s take a look at some more important numbers prior to forming an opinion on this stock…

E = Equity to Debt Ratio Is Strong  

The debt-to-equity ratio for Merck is slightly stronger than the industry average of 0.40. Debt management has been very good.

Debt-To-Equity

Cash

Long-Term Debt

MRK

0.37

$16.14 Billion

$20.57 Billion

GSK

2.71

$6.93 Billion

$29.42 Billion

NVS

0.29

$7.97 Billion

$19.73 Billion

 

T = Technicals Are Strong

Merck has performed well over the past three years. This has been in addition to a generous dividend yield.

1 Month

Year-To-Date

1 Year

3 Year

MRK

6.42%

16.18%

29.72%

48.00%

GSK

7.19%

13.20%

14.49%

44.18%

NVS

6.24%

18.42%

37.97%

52.45%

 

At $47.11, Merck is trading above all its averages.

50-Day   SMA

43.43

100-Day   SMA

43.33

200-Day   SMA

43.73

 

E = Earnings Have Suffered a Slight Setback              

Revenue has slowed, but not by much. The earnings setback in 2012 was miniscule. These aren’t positive signs, but they’re not reason for panic, either.

2008

2009

2010

2011

2012

Revenue   ($)in   billions

23.85

27.43

45.99

48.05

47.27

Diluted   EPS ($)

3.63

5.65

0.28

2.02

2.00

 

Looking at the last quarter on a year-over-year basis, there were declines in revenue and earnings. On a sequential basis, there was an increase in revenue and a decline in earnings.

12/2011

3/2012

6/2012

9/2012

12/2013

Revenue   ($)in   billions

12.29

11.73

12.31

11.49

11.74

Diluted   EPS ($)

0.48

0.56

0.58

0.56

0.30

 

Now let’s take a look at the next page for the Trends and Conclusion. Is this stock an OUTPERFORM, a WAIT AND SEE, or a STAY AWAY?

T = Trends Might Support the Industry

There are many positives for the industry at the moment, which include excellent valuations, strong cash flows, M&A activity, and improving pipelines. However, Merck doesn’t fall into the latter category. The biggest negative for the industry is the ever-increasing threat of generics.

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Conclusion

As has been indicated in this article thus far, there are many positives and negatives for Merck at the moment. The patent expirations, weak pipeline, and decline in revenue are potential warning signs. On the other hand, Merck still has solid margins, strong cash flow, and quality debt management. The strong cash position indicates that there will be many opportunities going forward.

All factors considered, Merck is a WAIT AND SEE.

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Disclosure: All content posted represents my opinion and views and should never be considered professional advice. You should do your own research and consult with a professional financial advisor before making any investment decisions. I am currently short technology, financials, the Russell 2000, and the euro.