Company Overview: Merck & Co., Inc. (ASX: MRK) is engaged in offering prescription medicines, biologic therapies, vaccines, and animal health products and operates under four segments namely, Pharmaceutical, Animal Health, Healthcare Services and Alliances. Merck’s other well-known product portfolio comprises Remicade (Immunology), Januvia and Janumet (Diabetes), Vytorin and Zetia (Cardiovascular), Emend and Keytruda (Oncology), Cozaar/Hyzaar, Nasonex, Dulera, Singulair, Fosamax (Diversified Brands), Ivanz, Cubicin, Bridion (Hospital Acute Care), Isentress & Zepatier (Virology), ProQuad, Gardasil, RotaTeq (Vaccines), and NuvaRing and Implanon (Women’s Health).
 

MRK Details
 

 
Higher Investments & Synergies from Acquisitions are Key Catalysts: Merck & Co., Inc. (NYSE: MRK) is a global healthcare company, which is involved in offering health solutions through its prescription medicines, biologic therapies, vaccines, and animal health products. The company boasts a portfolio of six blockbuster drugs with PD-L1 inhibitor, Keytruda, authorized for numerous types of cancer, which alone represents more than 25% of its pharmaceutical sales. Keytruda has played an active role in pushing Merck’s steady revenue growth over the past few years. Merck has been active on its acquisition front. In 2009, the company acquired Schering-Plough for $41.1 billion, one of its biggest acquisitions. Other key acquisitions include Idenix Pharmaceuticals, made in 2014, Cubist Pharmaceuticals in 2015 and Rigontec in 2017. Among the recent acquisitions, the company bought ArQule, which added ARQ 531, ArQule’s novel, oral Bruton’s tyrosine kinase inhibitor, to its product pipeline, in 2019.
 
In 2019, the company reported total sales of $46.8 billion, soaring 11% from the prior corresponding period. While the Pharmaceuticals segment represented ~89% of total sales, Animal Health products generated ~9.4% of total revenues. The company’s main drug Keytruda sales went up 58% year over year in 2019 and stood at $11 billion.
 
In the 1QFY20, both the revenues and earnings increased year over year. The company witnessed a CAGR of 4.4% and 21.7% in total revenue and net income, respectively, over the period of FY15-FY19. The company has been investing in new technology to evaluate the drugs or to adopt market improvements in order to advance the citizens’ access to suitable health care as well as medicines. Cash dividend declared increased from $1.81 per share in FY15 to $2.26 per share in FY19. 
 

Past Performance Highlights (Source: Company Reports)
 
Going forward, the company’s latest products like cancer drug Keytruda and Bridion injection are expected to drive its top-line growth supported by strong demand for the drugs. Further, the animal health franchise is expected to be a potential tailwind for the company, driven by elevated sales of its companion animal and livestock products. Further, positive innovations stemming in new drug approvals, vital advances in clinical studies, tactical partnerships and frequent M&A activity have provided an edge over its competitors.
 
1QFY20 Key Financial Highlights: During the quarter, the company reported adjusted earnings of $1.50 per share, which increased a whopping 23% from the prior corresponding period. The company reported revenues of $12.1 billion, which increased 11% year over year and 13% excluding currency impact. Notably, MRK stated that COVID-19 impact was immaterial on its first-quarter business. Revenues from the Pharmaceutical segment went up 10% year over year and came in at $10.66 billion. Excluding foreign exchange impact, segmental revenues went up 12% led by robust oncology drugs and vaccines. Keytruda sales during the quarter stood at $3.3 billion, skyrocketing 45% on pcp. The increase was on the back of robust impetus in first-line lung cancer indication along with higher renal cell carcinoma and adjuvant melanoma-related symptoms. Moreover, oncology sales were boosted by higher revenues from Lynparza and Lenvima. Revenues from Animal Health segment came in at $1.2 billion, an increase of 18% year over year, driven by higher sales of its livestock products, especially from products added from the Antelliq acquisition as well as COVID-19-related stockpiling.
 

 
Other Key Highlights: In 1QFY20, social distancing methods and decreased access to health care providers, led a negative impact on the company’s human health business in Asia-Pacific region. Stockpiling by customers to avoid any supply concerns, led to higher sales in other markets, particularly in Europe. In the hospital specialty portfolio, Bridion (sugammadex) Injection sales went up 17% on pcp and came in at $299 million. In vaccines, Gardasil/Gardasil 9 sales came in at $1.1 billion, up 31% year over year, aiding from timings of a shipment and public sector purchases in China and the United States, respectively. Robust order in China and Europe along with promising pricing in the United States markets were key positives. Proquad, M-M-R II and Varivax vaccines recorded decline of 12% year over year, whereas, Pneumovax 23 and Rotateq vaccines increased 39% and 5%, respectively, year over year. Sales from Remicade declined 28% year over year, whereas revenue from Vytorin went down 45% from the year-ago quarter. Janumet franchise sales stood at $1.28 billion, down 6% year over year.
 

Segmental Highlight (Source: Company Reports)
 
Operating Highlight: During the quarter, non-GAAP gross margin stood at 75.5%, which contracted 440 basis points year over year, owing to unfavorable manufacturing modifications and pricing pressure. Research and development (R&D) came in at $2.2 billion, up 10% from the prior corresponding period due to continuing clinical studies and cost associated with early drug advancement.
 
Latest Important Developments:

(a) In February 2020, the company had stated that it plans to spin off products from its Women’s Health unit, legacy drugs and biosimilar products into a new openly traded company called Organon & Co. The spin-off is likely to be completed by the 1HFY21.

(b) In a recent update, the company announced a collaborative agreement with Ridgeback Biotherapeutics LP, to advance oral antiviral medicine called EIDD-2801, for the treatment of patients with COVID-19 infection. In another update, the company stated that it has also entered into a collaborative agreement within IAVI, to develop a new vaccine against SARS-CoV-2 to be used for the impediment of COVID-19 virus.

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 27.68% of the total shareholding. The Vanguard Group, Inc. and BlackRock Institutional Trust Company, N.A. hold the maximum interests in the company at 8.6% and 5.18%, respectively.

 
Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)
 
Key Metrics: The Company reported Apr’20 gross margin at 73.1%, higher than the industry median of 71.7%. EBITDA margin, during the same time span stood in at 45.6%, higher than the industry median of 14%. Operating margin stood at 32.4%, as compared to the industry negative operating margin of 5.1%. Net margin, in the same time span, stood at 26.7%, as compared to the industry negative net margin of 7.5%
 
 
Key Metrics (Source: Refinitiv, Thomson Reuters)
 
Risk Analysis: It is to be noted that MRK’s biggest strength lies in Keytruda, but it can also be said that Merck is extremely dependent on the drug and should look for ways to expand its product line-up. Further, the loss of uniqueness for some products including NuvaRing, biosimilar competition for Remicade in Merck’s marketing territories, competitive pressure on the diabetes franchise along with currency headwinds, are the potential threats to the company. Further, supply chain disruptions, caused by the outbreak adds to the woes.
 
Future Expectation: The company provided the latest outlook for 2020 earnings and sales, which incorporates the impact of COVID-19. It opines that the impact of the outbreak will be reflected in the coming quarter. However, the company assumes that the business will start resuming to normality in the third quarter and will enter the fourth quarter with a positive note. For FY20, the company expects revenues to be lower by $2.1 billion from the earlier guided range, which comprises ~$1.7 billion for pharmaceuticals and ~$400 million for Animal Health.
 
Notably, the company expects FY20 revenues to be between $46.1 billion – $48.1 billion down from $48.8 billion – $50.3 billion guided previously. This reflects a negative currency impact of ~2.5%. Non-GAAP earnings are likely to be between $4.12–$4.32, lower than the prior outlook of $5.62–$5.77 per share. The company expects Non-GAAP operating expenses for FY20  to decline year over year at a low single-digit rate. 
 

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)
 
Valuation Methodologies:
 
Method 1: P/CF Multiple Based Relative Valuation (Illustrative)
 

P/CF Based Valuation (Source: Refinitiv, Thomson Reuters)
 
Method 2: EV/Sales Multiple Based Relative Valuation (Illustrative)
 

EV/Sales Based Valuation (Source: Refinitiv, Thomson Reuters)
 
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months
 
Stock Recommendation: The stock of MRK closed at $82.06 with a market capitalization of ~$207.1 billion. The stock made a 52-week low and high of $65.25 and $92.64, respectively, and is currently trading above the average of its 52-week trading range. At the closing price of $82.06, current yield for the stock stands at 3.07%. The stock has given positive returns of ~4.63% and 2.06% in the last one month and one year, respectively. Strong demand for KEYTRUDA & GARDASIL and other products, monopoly of PROQUAD vaccine, acquisition to strengthen its animal health revenue segment along with good fundamentals augur well for the prospects of the business. Considering the above factors, we have valued the stock using P/CF multiple and EV/Sales multiple two multiple based illustrative relative valuation and arrived at a target price with an upside of lower double-digit (in % terms). For the purpose, we have taken peers like Abbvie Inc (NYSE: ABBV), Pfizer Inc (NYSE: PFE), Eli Lilly and Co (NYSE: LLY), to name few. Hence, we recommend a “Buy” rating on the stock at the closing price of $82.06, up 1.51% on 03 June 2020. 
 
 
MRK Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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