Merck Biding Its Time

By Ryan C. Fuhrmann | May 04, 2012 AAA

Pharma giant Merck (NYSE:MRK) isn't a standout in the industry, but is biding its time by holding profits steady while it works through a steady wave of patent expirations. Its first quarter results reflected this predicament, though investors are getting paid to wait for an improvement down the road.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

First Quarter Recap
Sales grew modestly, rising 1% to $11.7 billion. Pharmaceutical sales rose 3% to $10.1 billion to account for the vast majority of the top line at approximately 86.3%. Despite a continued wave of patent expirations, Merck still boasts nearly a dozen blockbuster drugs including Singulair (first quarter sales grew 1% to $1.3 billion), Januvia (jumped 24% to $919 million) and Zetia (up 6% to $614 million). However, Singulair is set to see generic competition as soon as August, and this is expected to pressure sales going forward. The other two segments include Animal Health and Consumer Care, which reported sales growth of 8 and 7% to $821 million and $554 million, respectively.

A 14% drop in research and development (R&D) costs and a 77% drop in other expenses contributed in sending pre-tax income up 45% to $2.5 billion. Moderate income tax expense growth helped send net income up 67% to $1.7 billion, or 56 cents per diluted share. Management backed out $1.3 billion in net acquisition restructuring charges to report its estimate of recurring earnings of $3 billion, or 99 cents per share.

SEE: Analyzing An Acquisition Announcement

Outlook and Valuation
Analysts project a full year sales decline of nearly 2% and total sales of $47.2 billion. The consensus earnings projection currently stands at $3.81 per share, which is within Merck's guided range of $3.75 to $3.85 per share. The reported GAAP result will likely be in the neighborhood of $2.04 to $2.30 per share. Based off the recurring figure, the forward P/E is currently 10.6. But based on the reported figures, it is right around 17.

The Bottom Line
Investors have been somewhat lenient in considering Merck's own estimates of recurring earnings, versus the ones it is reporting on its financial statements. The same can be said for archrival Pfizer (NYSE:PFE). In Merck's case, it currently has the cash flow production to back up these more generous measures of profits. Last year, it reported free cash flow of $10.7 billion, or about $3.44 per share.

Investors are probably also forgiving because Merck currently sports a dividend yield of 4.4%. This is right within the industry average and rivals have similar yields. Pfizer is currently at 3.8% while Bristol-Myers Squibb (NYSE:BMY) is at 4.1%, Eli Lilly (NYSE:LLY) has a current yield of 4.7% and Novartis (NYSE:NVS) is at 4.5%.

SEE: 5 Must-Have Metrics For Value Investors

Right now, most are in the same boat in that patent expirations are offsetting the introduction of any new drugs. But they are also able to cut costs to sustain profitability, though cutting R&D could hurt future drug pipelines. The dividend yields offer the opportunity for investors to get paid to wait until top-line trends improve, though this could still be a few years off.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

comments powered by Disqus
Related Analysis
  1. MedTech Defies Sequestration, M&As Steal the Show - Industry Outlook
    Stock Analysis

    MedTech Defies Sequestration, M&As Steal the Show - Industry Outlook

  2. Unconventional Drilling Still Has Room To Boom
    Stock Analysis

    Unconventional Drilling Still Has Room To Boom

  3. Finding An Alternative With Currency ETFs
    Stock Analysis

    Finding An Alternative With Currency ETFs

  4. Commodities: Has Their Time Come Again?
    Stock Analysis

    Commodities: Has Their Time Come Again?

  5. An Investing Legend Predicts A Major M&A Boom -- Here's How To Profit
    Stock Analysis

    An Investing Legend Predicts A Major M&A Boom -- Here's How To Profit

Trading Center