Shares of pharmaceutical giant Merck
For starters, Merck has two key issues surrounding it: patent expirations and litigation. The first one is the most significant. Merck is facing the loss of about half of its sales over the next five years with its patents set to expire. Blockbuster cholesterol-fighting drug Zocor was its top seller last year, with $4.4 billion in sales. It lost patent protection in June. Its second-highest seller, osteoporosis treatment Fosamax, at $3.2 billion, will lose protection in 2008. Next up is anti-hypertension blockbuster Cozaar, with 2005 sales of $3 billion, set for a 2010 date with generic destiny. There are others, too, so even with an amazing pipeline, the next decade will be an uphill battle from a top-line perspective.
Additionally, Merck is facing years of defending itself against lawsuits stemming from the September 2004 withdrawal of arthritis treatment Vioxx. It took a $726.2 million charge shortly after pulling Vioxx from the market and another $295 million late last year, as it expects hundreds of millions in annual legal defense costs. Defense costs totaled $285 million for all of last year, and investors will soon know the total for 2006. Merck is seeing favorable rulings in most cases, but that is little consolation, since investors can count on many more years of Vioxx-related legal fees that will drain capital that could be used for dividends or research-and-development efforts.
Sure, these risks are well known to investors keeping tabs on Merck, and the company does have a strong drug pipeline and free cash flow that should be able to keep it afloat over the next several years. But the important questions to ask are whether these matters are priced into the shares and whether there are better health care opportunities out there. We can attempt to answer that by checking out the competition.
|
Company |
Trailing P/E |
Forward P/E |
Yield |
|---|---|---|---|
|
Pfizer |
14.9 |
11.8 |
3.7% |
|
Ely Lilly |
18.3 |
16.4 |
2.9% |
|
Novartis |
24.1 |
16.8 |
1.5% |
|
Johnson & Johnson |
17.5 |
16.5 |
2.3% |
|
GlaxoSmithKline |
21.5 |
13.3 |
3.5% |
|
Bristol-Myers Squibb |
22.9 |
21.4 |
4.4% |
|
Schering-Plough |
36.7 |
23.1 |
0.9% |
|
Merck |
19.0 |
17.0 |
3.5% |
|
Average |
21.9 |
17.0 |
2.8% |
I would rule out Schering-Plough because of its low dividend and weaker pipeline. Bristol-Myers is facing a number of patent expirations as well and is going through some management turmoil, but it does pay an above-average dividend yield.
The best plays may be the European pharma companies. Novartis is seen as having among the strongest pipelines and is a big player in the generic-drug space, and GlaxoSmithKline has a strong pipeline, a diversified revenue stream, a decent dividend, and a low P/E. Johnson & Johnson is also worth a look for its stellar track record, exposure to faster-growing medical devices, and stable consumer brands.
So, overall, on an individual basis, I can find health-care peers with higher dividend yields, more stability from a patent-expiration perspective, and just-as-compelling pipelines. And none of the above companies faces the product-liability worries that Merck does because of Vioxx. Overall, Glaxo may be the pick of the litter, with honorable mention to J&J.
There's also Pfizer to consider, which is where my money has been, though with mixed results. It is also facing a number of significant patent expirations, but its dividend yield is as high as Merck's, and it also has a decent pipeline. The kicker is that it's trading at a much lower P/E, providing downside protection should the pipeline not turn out according to plan -- something we just saw with the removal of torcetrapib from late-stage clinical trials.
I was seriously considering Merck when it traded below $30 after the Vioxx debacle began. But because of its recent run-up, I no longer find the risk/reward tradeoff very compelling and believe there are safer, more lucrative ways to invest in the space.
- Read the bull argument
- Read the bullish rebuttal
- Read the bearish rebuttal
- Sound off in Motley Fool CAPS
- Vote for the winner
Johnson & Johnson, GlaxoSmithKline, and Eli Lilly are Income Investor selections. Pfizer is an Inside Value pick. Merck is a former Income Investor pick. Check out either service free for 30 days.
Fool contributor Ryan Fuhrmann is long shares of Pfizer but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.
