The Dow's Best Health Care Stock: Merck

Investing in the health care sector isn't easy. Where do you start out? From medical device companies to big pharma to small biotech firms bristling with boom-or-bust prospects, it's tough for investors new to this sector to understand the intricacies unique to health care. Fortunately, there's an easy place to look for blue-chip, tried-and-true stocks: the Dow Jones Industrial Average (DJINDICES: ^DJI  ) .

Four big-time health care stocks call the Dow home, but which one is the best pick for your money? In this five-part series, we'll take an in-depth look into why each health care stock on the Dow is worth investing in -- and in the final installment, we'll select a winner. Yesterday we took a look at the present and future of big pharma giant Pfizer; today, let's check out one of its biggest rivals: Merck (NYSE: MRK  ) .

An income investor's delight
Merck's recent gains aren't enough to raise eyebrows, but the stock's still pleased investors lately. In the past 52 weeks, shares of the big pharma have gained more than 15%. However, things haven't been so easy in the shorter term: The last three months have seen Merck lose 2.8% as the company struggles with patent expirations and their hit on revenue.

For income investors, however, Merck's at the top of its game. The company offers a 4% dividend yield, tops among the health care stocks of the Dow and one of the highest-yielding stocks on the index overall. A payout ratio of 78% makes that high yield a pricey endeavor, however.

Growth investors will need to see more, however -- particularly as Merck struggles to combat falling sales due to the patent cliff.

The present state of Merck's drug portfolio
The loss of patent exclusivity on top-selling allergy and asthma blockbuster Singulair has undoubtedly hurt Merck's pharmaceutical revenue. The drug's still the company's second-best-selling therapy, but sales plummeted 30% in 2012 due to generic competition. Merck's going to have to kick its other medications into high gear in order to make up the more than $1.6 billion in lost sales.

Fortunately, some of Merck's others therapies are picking up the slack. HPV vaccine Gardasil has come on strong in recent years, posting a nearly 35% gain in 2012 after hitting blockbuster status a year earlier. With Gardasil's patent exclusivity lasting way down the road until 2028 -- and an increasing public awareness about the dangers of HPV recently -- count on this vaccine to remain a staple of Merck's pharmaceutical revenue for years to come.

Merck's already-on-the-market drug of the future, however, is the Januvia and Janumet family of diabetes therapies. These drugs are already a foundation of Merck's success, with a combined $5.7 billion in 2012 sales; however, there's room for even more growth. Don't expect the diabetes market to slow down any time soon with obesity rates rising across the world. The drug family saw much of its 23% growth last year in the U.S. and Japan, and if Merck can expand that success elsewhere -- particularly in emerging markets, no stranger to climbing obesity rates -- Januvia and Janumet could make investors forget all about Singulair.

Other companies haven't missed the diabetes market, however, and investors need to be wary of competition. AstraZeneca (NYSE: AZN  ) and Bristol-Myers Squibb's (NYSE: BMY  ) recently approved Forxiga -- a new, revolutionary type of diabetes treatment -- could be one of the bigger threats to Merck abroad. While Forxiga couldn't win FDA approval, it received European clearance in November and very well could cut into Januvia and Janumet's sales across the Atlantic. Furthermore, Johnson & Johnson (NYSE: JNJ  ) presents another challenge for Merck's top drug line with developmental drug Invokana, a therapy that proved more effective than Januvia in head-to-head clinical trials. Invokana's PDUFA date of March 31 could signal the arrival of a major threat to Januvia and Janumet.

Furthermore, Merck's drugs haven't been free of controversy: A recent study linked Januvia to increasing risk of pancreatic inflammation and kidney failure. It's not a deal-breaker for the drugs and not likely to slow down Merck's sales, but the reported dangers are worth keeping tabs on. The company can't afford to have safety trouble trip up its best seller.

Questionable growth ahead
Merck's looking good in the here-and-now, but the future holds some concern for investors.

With the company delaying the FDA filing of promising osteoporosis candidate odanacatib  until 2014, Merck investors will have to wait on the fate of one of the company's potential stars of the future. The company has other pipeline hopefuls that should shore things up, however: Promising insomnia drug suvorexant, which could hit up to $1 billion in peak sales, should help ease the pain of patent-related losses.

The patent cliff isn't over for Merck, however, as Nasonex, Zetia, and Vytorin -- all blockbuster drugs -- face patent expirations by 2017. Those three drugs alone put more than $5 billion in 2012 sales at risk, raising questions about the company's future growth. Generic drugmakers have also pushed lawsuits against Merck recently, hoping to invalidate patents on several key drugs; if any of those are successful, investors could see sales falling sooner than expected.

Merck also sports some non-pharmaceutical divisions, such as consumer care and animal health, but don't expect chart-topping growth from these. Other segments made up just around 11% of total sales in 2012 and saw a slight decline from 2011's numbers. If Merck's going to grow, it'll have to find answers from pharmaceuticals.

In all, Merck's future looks shaky. While Januvia and Janumet along with potential pipeline blockbusters like suvorexant and odanacatib could fuel years of strong sales, continued losses from Singulair -- something that company leadership already predicted will hamper 2013 results -- and patent expirations on other top sellers threaten Merck's future. Are these problems enough to threaten Merck's contention for the top health care stock in the Dow? They could be -- keep reading the series to find out.

Can Merck beat the patent cliff?
This titan of the pharmaceutical industry stumbled into 2013 and continues to battle patent expirations and pipeline problems. Is Merck still a solid dividend play, or should investors be looking elsewhere? In a new premium research report on Merck, The Fool tackles all of the company's moving parts, its major market opportunities, and reasons to both buy and sell. To find out more click here to claim your copy today.


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