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In August of last year I concluded that Merck (NYSE:MRK) showed a “murky non-Keytruda” performance. Despite non-Keytruda sales being not that inspiring, I believed that overall valuations and expectations were low, making me hold a position in shares with great conviction.
Since this period of time, shares have risen some 30% which in itself is impressive enough, but it’s certainly a big result if we factor in the disappointing performance of the market at large since this period of time.
Former Take
Ahead of the pandemic, Merck was a business which generated nearly $47 billion in sales in 2019 on which it earned $5.19 per share. Being an $80 stock, valuations were not too demanding at just 15-16 times earnings, certainly as the company guided for 2020 sales to rise to roughly $49 billion, with earnings seen around $5.70 per share. The reason for the non-demanding multiples was the fact and curse that Merck has Keytruda in its product line, a hugely successful drug, with investors clearly worried about its growing reliance as well.
The pandemic held the company back in a minor extent. In the end, sales were up 2% to $48 billion, albeit that reliance on Keytruda rose as its sales rose 30% to $14.4 billion that year. Comforting was the 2021 guidance, calling for sales to rise to nearly $53 billion with earnings seen in excess of $6.50 per share. With shares trading in the seventies, the overall valuation was very low, certainly as we found ourselves in a low interest rate environment at the time, making me compelled to shares in the seventies, as I kept adding to my stake.
The company updated the guidance throughout the year, seeing sales at $47 billion if we strip out the $6 billion revenue contribution from Organon (OGN) which was spun off, as earnings were seen down to $5.50 per share. The deal furthermore allowed Merck to cut net debt to $18 billion, resulting in a very modest leverage number. The only downfall is that the reliance on Keytruda kept rising, creeping up to mid-thirties percentages.
Despite this reliance, and non-inspiring growth outside Keytruda, I was appealed to Merck given the strong balance sheet, full pipeline and non-demanding valuation.
Moving Up
With shares range bound around the $80 mark since August of last year, shares have recently seen quite momentum, trading up to $100 right now, as shares are finally breaking through their highs set around the 2000s.
Earlier this year the company posted a very strong $48.7 billion in annual revenue number (essentially $55 billion including Organon), up 17% on the year before. Keytruda sales were up 20% to $17.2 billion, increasing its share to 35% of sales. Non-GAAP earnings came in at $6.02 per share, coming in ahead of the guidance by a comfortable margin.
The company furthermore guided for a very strong 2022 with sales seen at a midpoint of $56.8 billion and earnings seen around $7.20 per share (on an adjusted basis).
The company started the year in a spectacular fashion with first quarter sales up 50% to $15.9 billion, as the company hiked the full-year midpoint of the guidance to $57.5 billion in sales. The $4.8 billion quarterly revenue contribution from Keytruda was a huge driver behind this growth, up 23% on the year before. The real contribution came from LAGEVRIO. This anti COVID-19 treatment drug generated $3.2 billion in sales in the quarter.
Second quarter sales rose 28% to $14.6 billion, including a much more modest $1.2 billion LAGEVRIO revenue contribution. The midpoint of the full year revenue guidance was hiked to $58 billion, despite intensifying headwinds from a strong dollar.
Third quarter sales were up 14% to $15.0 billion, with LAGEVRIO sales down to just $436 million. Excluding this revenue contribution, revenue growth came in at 10%, but this included a 4% headwind from the strong dollar. Comforting is that growth outside Keytruda has accelerated to high single digits, comforting as a $5.4 billion revenue contribution of Keytruda (at $22 billion a year here) increases the reliance on this drug further, driven by wider adoption and approvals, it must be said.
Full-year sales are now seen between $58.5 and $59 billion. This suggests fourth quarter revenues between $13.1 and $13.6 billion which feels a bit light. This is seen in the earnings guidance as well, as a non-GAAP earnings number of $5.86 per share so far this year is set only to rise to $7.35 per share for the year.
No 10-Q filling was filed so far for the third quarter, as net debt stood at $21 billion and change through the second quarter of the year.
Concluding Remark
The reality is that the market shift from growth to value has resulted in a re-rating of Merck’s valuation, aided by solid growth so far this year. A 12-13 times multiple based on $6 per share earnings power last year has expanded to about 14 times earnings of just over $7 per share here. Hence, growth is driven by a higher valuation multiple and earnings growth, driven by the superior performance of the business. Of course this is still largely driven by Keytruda, yet non-Keytruda sales are starting to increase again, albeit that the reliance on Keytruda keep increasing following rapid growth in sales of this particular product.
Right now the situation is quite stable and upbeat around Merck here, as the company is in full execution mode. The goal is to simply execute here, deleverage and perhaps pursue bolt-on dealmaking. Of course, we have seen rumors about a Seattle Genetics (SGEN) deal this past summer, a potential massive deal in which the target could be valued at $40 billion. This is of course an astonishing amount, although Merck’s valuation has risen to $270 billion.
Right now, given the outperformance and slightly higher multiple in a rapidly raising interest rate, I see no reason to add to my position here, yet find it too early to go profit taking, leaving me cautiously sitting on my position which carries very decent gains.
