Can Merck's Breadth Beat AbbVie's and Pfizer's Focus?

Merck (NYSE: MRK  ) will release its quarterly report on Monday, and investors are expecting a continuing pullback in earnings that shows the difficulty the pharmaceutical giant has had in navigating its patent cliff. One big strategic question that shareholders will want answered is whether Merck expects eventually to follow moves by Pfizer (NYSE: PFE  ) and AbbVie (NYSE: ABBV  )  to try to unlock shareholder value through separating parts of their respective businesses and focusing on pharma.

This quarter, Merck will finally stop seeing the huge revenue hits that the loss of patent protection on Singulair has wrought throughout the past year. Yet that doesn't make it any less important for Merck to keep looking for prospective blockbuster treatments to replace that lost revenue. At the same time, though, Merck is also still looking to other markets like animal health and over-the-counter consumer health products to bolster sales, choosing not to follow Pfizer's and AbbVie's lead in splitting off similar businesses to focus exclusively on pharmaceuticals. Let's take an early look at what's been happening with Merck over the past quarter and what we're likely to see in its report.

Stats on Merck

Analyst EPS Estimate

$0.88

Change From Year-Ago EPS

(7.4%)

Revenue Estimate

$11.12 billion

Change From Year-Ago Revenue

(3.2%)

Earnings Beats in Past 4 Quarters

4

Source: Yahoo! Finance.

When will Merck earnings grow again?
In recent months, analysts have cut their views on Merck earnings, reducing third-quarter estimates by $0.02 per share and pushing down their full-year 2014 projections by $0.15 per share. The stock has also moved down slightly, falling 2% since late July.

Merck's second-quarter earnings announcement in July showed the successes and challenges that the pharma giant has faced recently. The company managed to beat earnings estimates by a penny per share, but double-digit sales declines led to generally accepted accounting principles earnings getting cut almost in half. Asthma drug Singulair was responsible for just about all of those declines, with Merck's stable of other approved drugs failing to pick up the slack. Moreover, just as AbbVie must face the coming loss of patent protection for its key drug Humira, Merck has to deal with patents on major drugs Zetia, Vytorin, and Nasonex all expiring within the next three to four years, opening up more generic competition down the road.

As a result, Merck has scurried to get replacement drugs into its pipeline. Yet pipeline efforts have led to increased research and development expenses, raising Merck's total costs well above those of Pfizer and other industry rivals like Johnson & Johnson and GlaxoSmithKline. High expenses have led Merck to announce massive layoffs, but some question whether a smaller workforce can pull the company back to health.

Strategic partnerships could help Merck move forward with its pipeline development. Last month, Merck added to its ongoing relationship with AstraZeneca to develop Merck's MK-1775 experimental cancer drug. The move should allow Merck to focus on more promising cancer treatments, such as its vintafolide ovarian-cancer treatment in phase 3 studies in the U.S., as well as its MK-3475 drug for metastatic melanoma.

The larger question is whether Merck could better focus on its pharma opportunities without the distraction of its other businesses. Animal health is a substantial contributor to overall sales, with Merck controlling more than 15% of the $100 billion global market, second only to Pfizer spinoff Zoetis, and it offers huge growth potential as the world moves toward higher-protein diets. Yet the consumer-care division saw double-digit percentage sales declines in the second quarter, suggesting that Merck isn't doing that business any favors by keeping it under its broader umbrella rather than following the AbbVie and Pfizer model of focusing solely on pharma.

In the Merck earnings report, watch to see how the company responds to its massive challenges. A spinoff wouldn't solve its problems automatically, but it might make it easier for Merck to find solutions to resolve them in the long run.

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