Several big pharma stocks delivered market-beating returns during the last bull market. An innovation boom in biologic therapies, an aging global population, and favorable reimbursement terms in the U.S. fueled this near industrywide upswing.
The titans of pharma may have a tougher go of it in the next bull market, however. Scores of top-selling biologic therapies are poised to lose market exclusivity during the current decade, and drug prices in the U.S. have become a central topic of debate in the political realm.
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Merck (MRK 0.37%) is a prime example of this conundrum facing pharma investors. The drugmaker's stock is currently on a five-year winning streak, relative to standard benchmarks like the S&P 500.
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Merck's market-beating performance has been fueled by the meteoric sales growth of Keytruda, a top-selling immuno-oncology medication. However, this key growth driver is slated to face biosimilar competition from generic biologics in the U.S. in 2028. Is Merck stock still a buy with this pivotal headwind looming? Let's dig deeper to find out.
A developing story
The importance of Keytruda to Merck's growth story can't be overstated. In 2022, this single drug accounted for roughly 35% of the big pharma's annual revenue.
Merck has thus been investing heavily in internal and external pipeline development in anticipation of the drug's eventual decline. Earlier this year, the drugmaker dove headfirst into immunology with the $11 billion acquisition of Prometheus Biosciences, and its novel ulcerative colitis candidate, PRA023. Merck has also significantly broadened its oncology footprint through business development (BD). This effort is expected to culminate in the advancement of four late-stage programs later this year.
Another green shoot is Merck's cardiovascular-care franchise. The drugmaker's $11.5 billion deal for Acceleron Pharma appears on track to produce a blockbuster-level product, known as sotatercept, in pulmonary arterial hypertension. Several analysts covering the stock expect sotatercept to evolve into a major growth driver for the company.
Despite this flurry of BD activity, the company still doesn't have a rock-solid growth strategy in place post-2028. Broadening its oncology platform, bolstering its cardiovascular pipeline, and branching out into immunology are solid steps, to be sure. But more BD appears to be a near certainty at this point.
Capital allocation priorities
In addition to its rising share price, Keytruda has also had a profound impact on management's capital allocation strategy in recent years. Specifically, Merck has become decidedly more aggressive about raising its dividend of late. Turning to the details, the drugmaker boosted its dividend yield by 32.7% over the past five years. In the 23 years before Keytruda's growth spurt, however, Merck raised its dividend by only 83.3%.
What's in store for the dividend? As Merck moves closer to Keytruda's commercial decline, BD is probably going to constrain management's ability to continually boost the dividend by 6% or more every year. Investors, in turn, should probably brace for annual dividend increases to return to historical norms -- 3.6% on average -- as this seminal event draws near.
Bottom line: Merck probably won't be a top dividend growth stock over the balance of the current decade. Instead, the company will likely be a big player on the merger and acquisition scene as it braces for Keytruda's patent expiration.
Verdict
Merck has arguably earned a leap of faith from shareholders. The company has a proven ability to identify next-generation drugs and subsequently bring them to market in a timely manner. Still, the fact remains that Merck has more work to do to maintain a reasonable growth trajectory in the next decade and beyond. Hence, this blue-chip pharma stock doesn't stand out as a top buy for the buy-and-hold crowd right now.
