Merck & Co. Inc.: The Bear Case from a Bull

A pessimistic look at Merck from an optimist.

Keith Speights
Keith Speights
Jun 29, 2017 at 9:03AM
Health Care

Merck (NYSE:MRK) lays claim to one of the hottest cancer drugs on the market, with Keytruda. The big pharma company also just announced positive results for its experimental cholesterol drug anacetrapib, with significantly reduced cardiovascular risk.

Perhaps not surprisingly, Merck stock is up 17% over the past 12 months. There are plenty of reasons to be bullish about Merck -- and I am. However, not all is rosy with the major drugmaker. Here's the bear care against Merck from this bull. 

A toy bear and bull stand face to face on a stock chart.

Image source: Getty Images.

Most drugs not named Keytruda are in trouble

Merck provided detail for 33 current drugs on its last quarterly filing to the SEC. Twenty of them experienced year-over-year sales declines. Keytruda was the company's biggest winner, with revenue more than doubling from the prior-year period. But decreased sales for just one of Merck's other drugs, cholesterol drug Zetia, wiped out all of the gains from Keytruda and then some.

Yes, Merck still managed to generate overall sales growth. But that growth amounted to less than 1% year over year. Granted, Merck beat expectations and raised its 2017 guidance, but 1% growth isn't very exciting.

Between 2017 and the end of 2020, Merck faces the loss of key U.S. patents for a dozen drugs. Most of those drugs will also have key patents expire in Europe. The stark reality is that Merck's current product lineup, with a few exceptions, sucha s Keytruda and human papillomavirus vaccine Gardasil, appears to be pretty weak. 

Questionable pipeline candidates  

In a case like Merck's, where many current drugs aren't performing well, the obvious place to look for help is the pipeline. Merck does have nine programs in regulatory review and 19 late-stage programs. That's promising, right?

A closer look, though, reveals that those nine programs in review stem from two drugs -- Keytruda, and diabetes drug ertugliflozin as a monotherapy and in combination with other drugs. There's no question that Keytruda will become a megablockbuster. Ertugliflozin will also probably be a solid success, but Merck must share 40% of all sales (assuming approval) with its partner Pfizer (NYSE:PFE).

Keytruda also accounts for eight of Merck's 19 late-stage programs. The prospects for at least two of the other drugs in phase 3 testing appear to be questionable.

Merck has already stopped one late-stage study for experimental Alzheimer's disease drug verubecestat because of lack of efficacy. Another is continuing with evaluating the drug in treating patients with early-onset Alzheimer's disease, but I wouldn't hold my breath for positive results after the first failure.

Then there's experimental heart-failure drug vericiguat. The drug didn't meet its primary endpoint in a phase 2 test, but Merck and partner Bayer opted to move ahead with late-stage testing anyway.  

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Other gripes

Investors can certainly find other things to dislike about Merck. The stock is more expensive than several of its peers. Pfizer, for example, trades at 12 times expected earnings, compared with a forward earnings multiple of 17. Even factoring in growth prospects, Merck stock is still priced at a premium to Pfizer.

While Merck's dividend yield of 2.84% isn't bad, it's still less than that of many of the company's peers. Pfizer's yield of 3.75% blows Merck away. Also, Merck is using well more than it's earning to fund the dividend program. I'm not concerned that the dividend is in jeopardy, but the high payout ratio could limit the drugmaker from increasing its dividend enough to catch up with some of the other large pharmaceutical companies.

Bull to bear?

Are Merck's weak current lineup, iffy pipeline candidates, and valuation enough to flip this bull to a bear? Nope. I think the prospects for Keytruda are so strong that it makes up for a lot of negatives facing the company. 

To be clear, I think there are stronger stocks to buy. However, my view is that Merck should continue to be a solid pick for investors despite some weaknesses.