Merck & Co, Inc.: Big Pharma Checkup for 2014

It's been tough sledding for Merck (NYSE: MRK  ) since it lost patent protection for its high profile $5 billion a year blockbuster drug Singulair in 2012. The lost sales have forced major restructuring that's included asset sales, lay-offs, and a laser focus on the company's pipeline.

However, Merck may be turning the corner. Investors thinking the worst may be behind the drug giant have helped lift shares in the past year. 

MRK Chart

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The enthusiasm may not be misplaced.
Merck has a potential blockbuster cancer drug working its way through trials. MK-3475 is one of a new class of promising drugs, and it's currently in phase 3 clinical trials for advanced melanoma. Merck hopes to file for FDA approval this year. 

Patients treated with MK-3475 saw a marked 81% improvement in overall survival and 41% of patients in the trial saw their tumor shrink.

If those results hold up and the drug gets the go-ahead from the FDA, it will compete against Bristol-Myers Squibb's (NYSE: BMY  ) successful cancer drug Yervoy, which is on pace to post more than $1 billion in sales.

The market for melanoma treatment is $2.4 billion in the United States and is expected to grow to as much as $4.5 billion by 2020 as new, more pricey treatments like MK-3475 win approval. Nearly 1 million people in the United States are diagnosed with melanoma, and nearly 77,000 new cases are diagnosed each year, according to the National Cancer Institute.

Cutting to the bone
Offsetting sales lost to patent expirations means, at least in the near-term, cutting down on costs. That includes plans announced in October to cut 20% of its workforce in a bid to shave $2.5 billion in expenses. Merck expects $1 billion of those savings will show up in 2014.

The company also sold its RNAi assets to Alnylam Pharmaceuticals (NASDAQ: ALNY  ) this month, putting an end to investor uncertainty regarding patents that were acquired in a $1 billion purchase of Sirna Therapeutics in 2006.   

As it struggled to monetize the acquisition, Merck shuttered Sirna in 2011.  Investors my be unhappy with the $175 million sales price.  However, despite Alnylam getting what may turn out to be a bargain, Merck does walk away with $25 million in cash, $150 million in Alnylam stock, more than $100 million in potential milestones, and the chance for royalties if Alnylam is able to commercialize any drugs using Sirna's patents.

Merck is also considering other big changes, including whether to jettison its consumer health care business. That business includes everything from Claritin to Coppertone sun protection and had sales of $443 million in Q3.

Rumors have popped up recently suggesting Merck may be discussing an asset swap with Novartis (NYSE: NVS  ) that would include Novartis taking over Merck's OTC portfolio in exchange for Novartis' animal health and vaccines product lines. Sales of Novartis' animal health business total roughly $1 billion a year and sales of Novartis vaccines reached $594 million in the third quarter.

But the changes have so far done little to encourage analysts who have cut their earnings outlook for Merck from $3.56 to $3.48 over the past 90 days. That drop-off is likely due to worries over the loss of patent protection for Merck's cancer drug Temodar, which had $900 million in sales last year. 

Focusing investors on the areas for growth
During Merck's presentation at the recent JP Morgan Healthcare Conference in January, a lot of attention focused on growing areas of Merck's business, including vaccines, immunology, emerging markets, and diabetes.

The fastest growing of those four has been vaccines, with sales growing 15% year-to-date through September from 2012. That lift has come in large part thanks to higher sales of Gardasil, which produced revenue of $1.4 billion in the first three quarters of 2013, up from $1.2 billion a year ago.

Immunology has also been a strong performer, with sales up 12% during the same period thanks to Remicade. Remicade's sales totaled $1.6 billion in the first nine months of 2013, up from $1.5 billion in the comparable period of 2012.

MK-5172/MK-8742, a two drug combo treatment for hepatitis C that is in phase 2b, and MK-8931 in phase 3 trials for Alzheimer's disease potentially support future growth.

Fool-worthy final thoughts
Bristol charges $110,000 for Yervoy That suggests MK-3475, which Merck is studying in 10 trials across 10 different cancers, could be priced similarly. But Bristol isn't going to just hand over its market share for the indication. It's advancing its own PD-1 drug, nivolumab, through more than 25 studies too.

However, given Merck is trading at just 15 times forward earnings estimates -- below where shares have been valued over the past five years and less than Bristol's valuation -- there may be an opportunity in Merck for investors, particularly if the company can over-execute on its plans this year.

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