Despite Losses, Investors Should Love Merck's 2012

2012's been a big year for big pharma. Between preparing for the major changes ahead with the Affordable Care Act to dealing with the patent cliff, health care's biggest businesses have made many substantial changes to deal with an ever-changing sector landscape. Merck (NYSE: MRK  ) hasn't heeded the call, however: Despite its rivals spinning off businesses and more, Merck has stayed the course amid the storm and pushed on despite confronting a major patent cliff-related loss of its own.

How has 2012 repaid this top dividend stock? Rather than dwindle, shares of Merck have instead jumped more than 13% for the year. While there's still plenty to be concerned about, Merck has had a year for investors to be proud of.

Singulair, the FDA, and more pitfalls of 2012
Let's get the biggest stumbling block out of the way first: The loss of patent protection on Singulair, Merck's best-selling drug, has hurt badly. After racking up more than 11% of Merck's total revenue in 2011, Singulair's sales plummeted more than 50% in the third quarter of 2012. Total sales are roughly flat through nine months for the year, weighed down heavily by Singulair's losses as generics from Mylan (NASDAQ: MYL  ) and other companies flood the market.

Merck's been undergoing restructuring for a while that have staved off hits to its profit margin -- indeed, the company's profit is up this year, largely because of improved efficiencies, lower costs of goods sold, and third-quarter tax gains. Still, the company will need to make some real progress on its top line if it expects to continue that trend in the future.

The company has run into some regulatory stonewalling in 2012, as well. The Food and Drug Administration dropped the hammer on Merck and Araid Pharmaceuticals' (NASDAQ: ARIA  ) sarcoma drug Taltorvic in July, rejecting it and asking for further trials. While the two companies plan to continue making progress on Taltorvic and the rejection didn't seriously cripple either, it's still bad news for investors that sent both stocks lower at the time. The FDA advisory panel also split over Merck's bladder patch Oxytrol, which the agency will rule in January whether the company can sell without a prescription. While Oxytrol has a huge market, the advisory panel raised concerns over women self-selecting the patch for over-the-counter purchases.

Even lawsuits haven't been much fun for Merck in 2012, with several generic-drug makers -- Teva Pharmaceuticals (NYSE: TEVA  ) and Impax Laboratories (NASDAQ: IPXL  ) among them -- suing Merck over its patents earlier this year on strong-selling drugs Vytorin and Zetia. Over the first nine months of 2012, Vytorin and Zetia have been the company's fifth- and third-best-selling drugs, respectively. Any legal victory by the plaintiffs could seriously hurt Merck's sales going forward.

But get ready for all the good news from 2012 -- the news that's pushed this stock up and set Merck's course for a brighter future.

Tomorrow's winners today
Despite Singulair's sales collapse, Merck hasn't stood idly by. In to the rescue come Januvia and Janumet, Merck's diabetes drugs of the future that have grown sales through the first nine months of 2012 by 25% and 24%, respectively, to become the company's second- and sixth-best-selling drugs. With patent protection lasting until 2022 for each and a huge, growing diabetes market, Merck has its hands firmly on the blockbusters of tomorrow.

Those certainly aren't the only ones; Merck's also had its share of FDA victories in 2012. The FDA sent Merck's shares up 4% in one day after recommending that phase 3 trials of osteoporosis drug odanacatib be halted early. It seems that the agency was on to something, however: Odanacatib might not be enough to replace Singulair, but it's been predicted to pull in $1 billion in sales by 2017. That's nothing to sniff at with JP Morgan (NYSE: JPM  ) expecting approval in 2014.

Insomnia drug suvorexant has also had a good 2012, with positive data and a new drug application submitted to the FDA. Despite facing generic versions of Sanofi's (NYSE: SNY  ) Ambien across the insomnia market, suvorexant's steps toward approval in 2012 put one more future cash cow in Merck's corner.

Merck also paid biotech Endocyte (NASDAQ: ECYT  ) a substantial sum up front this year in betting on the company's cancer drug vintafolide, used to treat a type of ovarian cancer. The European Marketing Authorization accepted vintafolide for review in November, the first step for this drug in an ovarian cancer market projected to exceed $2 billion in 2012.

Finally, it's what Merck didn't do in 2012 that also made waves. While big pharma rival Pfizer (NYSE: PFE  ) has cast off its nutrition business and aims to do the same with its animal health segment, and Abbott Labs (NYSE: ABT  ) is spinning off its pharmaceutical business into separate company, AbbVie, Merck has kept its separate divisions together. Although investors might panic at Merck not following the crowd, the company has good reason not to. Merck's consumer care and animal health businesses may lack the star power of pharmaceuticals, but both are up 5% through the first nine months in 2012.

Setting course for the future
While Singulair has hurt Merck's top line, the company has built up a powerful base of established and developing drugs for the future. Keeping the animal health and consumer care businesses provides Merck with low-margin but growing segments to add to its balance sheet, while the likes of odanacatib and Januvia and Janumet should provide blockbusters for many years to come. I'm confident enough in Merck's moves to give the company a thumbs-up over the long-term on CAPS, and investors giving Merck the thumbs-up in their portfolios have plenty of reasons for optimism after 2012's successes.


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