On Tuesday, pharmaceutical giant Merck (NYSE:MRK) reported its first-quarter earnings results, topping Wall Street's estimates handily and rocketing higher by $2.88, or 5%, to close at $59.98.
Merck's results, by the numbers
For the first quarter, Merck reported total sales of $9.43 billion, an 8% decline from the $10.26 billion it reported in the year-ago quarter. However, five percentage points of this decline was a result of negative foreign currency translation. Since a sizable chunk of Merck's business is derived from overseas markets, and the U.S. dollar has been strengthening against foreign currencies, Merck is losing some percentage of its revenue when converting its foreign currencies back into U.S. dollars. Thus, Merck's top-line figure on a comparable basis showed a 3% sales decline.
On an adjusted EPS basis, Merck delivered $0.85, down modestly from the $0.88 in EPS it recorded in Q1 2014. However, on a comparable basis, Merck's first-quarter EPS topped Wall Street's expectations by $0.10, and its $9.43 billion in sales surpassed the Street's consensus by $370 million. Combine these market-topping results with Merck's full-year forecast of $38.3 billion to $39.8 billion in sales and $3.35 to $3.48 in EPS, both in line with estimates on the Street, and you have a perfect recipe for a strong rally.
But, if you solely focused on just a few of Merck's headlines, you likely missed a handful of important points within its quarterly report. Here are three big surprises you won't be reading in any headlines.
No. 1: Throw those Januvia worries out the window
For the past two years, Merck shareholders have been concerned about the growth prospects for Januvia/Janumet, the company's leading pharmaceutical product that produced $6 billion in annual sales last year and is designed to treat type 2 diabetes. Janumet is its name in overseas markets.
In 2013, a study noted that Januvia taken by itself could increase the risk a diabetes patient has of developing pancreatitis. Other studies pointed to Januvia as a possible risk factor for heart failure in diabetes patients. Between these reports and added competition from SGLT2 inhibitors -- a new class of type 2 diabetes drugs that works by blocking glucose absorption in the kidneys and allows patients to excrete that excess glucose through their urine -- concerns persisted that the drug responsible for 14% of Merck's total revenue may see sales declines.
After two years, we can safely put that rumor to rest. On Monday, Merck reported that Januvia met its primary endpoint in TECOS, a cardiovascular outcomes study that demonstrated the drug was safe and didn't lead to an increase in hospitalization rates for heart failure.
During the first quarter, Januvia sales rose 4% to $1.39 billion, but on an apples-to-apples basis, when foreign currency translation is stripped out, Januvia delivered 10% year-over-year growth. This is incredible growth, and it demonstrates that not only is demand for Januvia likely growing, but also that Merck's pricing power on the drug remains strong. Additionally, I'd suggest Januvia's solid results imply that the diabetes market is expanding to support new therapies, such as SGLT2 inhibitors, rather than squeezing older therapies out of the picture.
All in all, the immediate future looks bright for Merck's leading diabetes therapy.
No. 2: Animal health could be a monster for Merck
It's an often overlooked business for Merck since it makes up roughly 9% of its total sales, but animal health is turning into a growth monster.
In the first quarter, animal health produced $829 million in revenue, up 2% from the year-ago period. Sounds unimpressive, doesn't it? But, back out the negative 11% effect from foreign currency translation, and we have 13% year-over-year, apples-to-apples growth. Specifically, Merck cited strength in companion animal products as the primary growth driver, with solid gains coming from Bravecto, a recently launched chewable tablet for dogs that kills fleas and ticks for up to 12 weeks.
According to the latest National Pet Owners Survey from the American Pet Products Association, 65% of U.S. households owned a pet, up from 56% in 1988, when the survey was first conducted. With pet owners expected to spend $60.6 billion on companion pets in 2015, including $15.7 billion on veterinary care, and more pet owners considering their pets as part of the family, the prospects for Merck's animal health division looks bright.
No. 3: Keytruda trounced Opdivo, for now
Finally, Merck spent a lot of time highlighting the clinical advancements of Keytruda, its PD-1 inhibitor focused on fighting a number of cancer types, but the real show-stopper was the early outperformance of Keytruda when compared to PD-1 inhibitor Opdivo from Bristol-Myers Squibb (NYSE:BMY).
Both Keytruda and Opdivo are approved as late-stage therapies for select types of melanoma, although each drug is being studied in dozens of additional indications. In the latest quarter, Opdivo generated sales of $40 million per Bristol-Myers' press release, while Keytruda delivered $83 million in sales. In all fairness, Keytruda was approved three-and-a-half months before Opdivo, so it's arguably had a bit of a head start. But, what I find interesting is that Keytruda is about 5% more expensive annually than Opdivo, and Opdivo delivered arguably better response rates in clinical trials that led to their approval, at least in melanoma.
We're very early in the sales process for both drugs, so reading too much into it may not be a good idea. However, the initial takeaway is that Keytruda has the early lead among PD-1 inhibitors, and that both remain on track to eventually hit blockbuster status, which is good news for Merck and Bristol-Myers Squibb.
A good quarter, but lacking the "wow" factor
Overall, this was a solid quarter for Merck, but the grim reality is that its sales still fell 3% year over year, even including the addition of Cubist Pharmaceuticals' acute hospital care products to the fold.
While Merck will continue to generate substantial cash flow and return healthy amounts to shareholders in the form of a dividend or share buybacks, it's forward P/E of 16 isn't encouraging when minimal growth is expected over the coming three years. Keytruda is likely going to be Merck's saving grace by the early 2020s, but it'll take time for sales to ramp up, and for Merck to settle down after losing exclusivity on key drugs.
I'd continue to wait for a substantial pullback in Merck's shares before considering a position, or I'd hold off on buying into Merck until its sales show significant strength.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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