Merck Posts Steady Q4; CEO Ken Frazier to Retire

Merck MRK reported fourth-quarter results largely in line with our expectations, and we don’t expect any major changes to our fair value estimate. We continue to view the company as undervalued with the market not fully appreciating the firm’s growth potential, largely driven by cancer drug Keytruda in new indications, which should add high-margin sales and expand profit margins.

In tandem with the earnings release, Merck announced the retirement of Ken Frazier as CEO and the appointment of current CFO Robert Davis to serve as the next CEO, effective July 1. We view the transition in leadership as natural, as Frazier had recently passed Merck’s guidelines on the maximum retirement age. Davis’ strong background in the industry and with Merck is likely to mean a continuity of strategic focus on areas of unmet medical needs.

On the strategic side, Merck is on track to spin off its Organon business (largely women’s health drugs) late in the second quarter. The divestiture represents close to 14% of total Merck sales and should allow the remaining business to grow more quickly after shedding these more mature brands. Also, Merck will receive a $8.5 billion-$9 billion special dividend, which we expect it will use to bolster the pipeline.

In the quarter, total sales increased 5%, led by 27% growth from Keytruda, offsetting declines from mature drugs and pressures from the COVID-19 pandemic. Although it represents over 30% of Merck’s total sales, we still expect significant growth from the drug based on increasing penetration in currently approved indications and the likely approval in earlier lines of therapy. We expect Merck will redeploy these growing cash flows to develop the next generation of drugs, critical to the firm’s wide moat. With Keytruda’s patent protection likely through 2028 (and longer in some geographies), we believe the firm has plenty of time to develop new innovative drugs.

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