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Is Merck a Better Buy After Announcing Spinoff?

By David Jagielski - Feb 22, 2020 at 1:00PM

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Merck announced earlier this month that it would be creating a new company so it can focus on key growth areas.

When companies focus on their strengths and core competencies, it can make them better investments. That's what Merck (MRK 0.40%) is hoping will happen, as the company announced on Feb. 5 that it will be spinning off its women's health business along with legacy brands and biosimilars into a new company as it attempts to focus on "key growth pillars:" oncology, vaccines, animal health, and hospital. 

A leaner business and a greater focus on growth may make the stock a better buy for investors. But it could also leave the company riskier by being less diversified. Let's take a closer look at whether the new Merck will be a good buy or if it will still have the old Merck's problems.

News comes as Merck releases results for 2019 fiscal year

The same day that Merck announced the spinoff, it also released its year-end financials. Revenue of $46.8 billion for 2019 was up 11% over the prior-year tally of $42.3 billion. It's a decent growth rate but the company's financials continue to be weighed down by poorly performing items. Merck's key drug, Keytruda, which treats multiple cancers, made up more than $11 billion in revenue all on its own in 2019 and was up 55% year over year. Now making up about one-quarter of the company's total revenue, it's a big part of Merck's business and it will be responsible for an even bigger piece of the leaner Merck, post-spinoff. 

Pills spilling out of prescription bottle

Image source: Getty Images.

While it's a good opportunity for the company to focus on growing Keytruda, it will also make Merck even more dependent on it. From a risk standpoint, that's not a desirable place for investors to be. The second-best-selling drug was Januvia, which treats type 2 diabetes and generated about half the sales with revenue totaling $5.5 billion in 2019. That was down 7% from 2018. Merck does have products that are growing in double digits, but they're still nowhere near Keytruda's level, and that means the new, more focused Merck is going to be even more dependent on the cancer-fighting drug.

Does spinning off make sense for investors?

In the company's announcement, Merck outlined several advantages the two new companies will have, including "simplified operating models" and "optimized capital structures and resource allocation to pursue their distinct strategic agendas for long-term success." 

The simplification can certainly help build efficiencies and costs, which in turn will produce cost savings. But the main issue that investors are likely concerned about is whether this will lead to more growth from the company's pharmaceutical products. In the company's fourth-quarter results, there were just four drugs with double-digit sales growth from the prior-year. And excluding Keytruda, which grew at a rate of 45% and generated $3.1 billion in revenue, those products made up a combined 6.3% of sales. Keytruda, along with Januvia, which declined 3% in Q4, combined for 38% of Merck's total revenue in Q4.

Merck's been developing products, and while they've been growing, many of them are just nowhere near Keytruda's level of dominance. The move to spin off the business makes sense from an earnings and profitability standpoint, but it's not convincing that it will solve the company's growth problems and dependency on one dominant drug.

Should investors buy the stock?

Overall, the stock still presents an attractive buying opportunity for investors. It's trading at around 21 times earnings, so investors aren't paying a whole lot to own shares of Merck today. While the company will continue to have exposure to Keytruda, that's inevitable when you have a very strong product. And it's a good problem to have, certainly much better than having no product to build around. 

Merck plans to keep its dividend intact, and investors can continue to earn 3% annually, which is still a better return than the 2% that the average S&P 500 stock offers today. That gives investors some incentive to remain patient with Merck. And while the healthcare stock is not without its challenges, the opportunities for Merck to grow and strengthen its financials as a result of the spinoff outweigh the risks and any concerns surrounding a lack of diversification from it.

After all, with Keytruda still showing strong growth, Merck still has time to work on developing its pipeline.

 

David Jagielski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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