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Is Merck's New Strategy a Winning One?

By Peter Stephens – Mar 2, 2014 at 2:30PM

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Can changes at Merck (NYSE: MRK) make it a winning stock in 2014?

After a challenging 2013, Merck (MRK -1.31%) is pushing ahead with a new strategy to try to reinvigorate its top- and bottom-line growth prospects over the next few years.

The company's fourth-quarter results highlighted the need for a shift in strategy, with Merck reporting a drop in net profit of 14% in the fourth quarter of 2013, as generic competition continued to cut into the sales of multiple key blockbuster drugs.

Furthermore, shares had a tough 2013 and underperformed the S&P 500, with Merck delivering capital gains of 23% while the wider index posted gains of 32%. However, can Merck's new strategy help to turn things around in 2014 and make it a year where the company outperforms the S&P 500?

A new focus
An important aspect of Merck's turnaround plan is to focus to a far greater degree on therapeutic areas where it feels it is strongest, such as drugs for cancer and diabetes, as well as vaccines. Therefore, a new head of research and development has been appointed, Roger Perlmutter, who will restructure the company's laboratories and attempt to stimulate drug development.

Allied to this shift in strategy change is a slimming down of the company's workforce, with up to 20% of total staff numbers being reduced. This should help to reduce costs, and although it will do little to aid in the development of new treatments to counter the threat from generic competition, it could provide the company with some breathing space (in terms of a reduction in costs as well as revenue) in the meantime.

Consumer business
A key part of the strategy change is the possible sale of Merck's consumer businesses, which includes brands such as Claritin allergy tablets, Dr. Scholl's foot-care products, and Coppertone sunscreen. The sale of the various brands could generate as much as $10 billion, which would probably be used to stimulate the company's research and development function.

This move follows a similar shift at sector peer GlaxoSmithKline (GSK 0.17%). Although it has been far less affected than Merck by the impact of generic competition (and has a very attractive pipeline of drugs), it sold off its Ribena soft-drinks and Lucozade energy-drinks businesses in September to Japanese firm Suntory for $2.2 billion. As with Merck, the proceeds from the deal are likely to be invested within the research and development function of the company, as GlaxoSmithKline also seeks a stronger and more robust pipeline.

Meanwhile, another pharmaceutical company with a consumer arm (which accounts for around 40% of revenue) is effecting its own strategy shift, but in a different direction from Merck and GlaxoSmithKline. Johnson & Johnson (JNJ -0.96%) is moving away from business units that it feels are unlikely to contribute above-average growth rates in future, in favor of faster-growth areas. As such, it agreed to sell its blood-testing unit to Carlyle Group for $4.1 billion in January, as it seeks to reinvigorate a top-line that has only grown by 2.2% per annum over the last five years.

Looking ahead
Merck's strategy to combine cost-cutting with a renewed focus on key therapeutic areas looks to be a sensible one. Although its consumer business is clearly a valuable asset, Merck needs to address the problems it's facing that have been brought on by patent expiry and subsequent generic competition. With shares making a strong start to 2014 (up 13% while the S&P 500 is flat), it looks as though the market could be warming to Merck's new strategy. Indeed, 2014 could prove to be a strong year for the share price, both on a standalone basis and when compared with the S&P 500.

Peter Stephens owns shares of GlaxoSmithKline. The Motley Fool recommends and owns shares of Johnson & Johnson. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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