Merck Reports Mixed Quarter; Stock Looks Undervalued

Merck MRK reported mixed first-quarter results with strong reported sales, but it also lowered full-year earnings guidance by 7% at the midpoint of the new range. We don’t expect any major changes to our fair value estimate, as we believe the weaker 2020 outlook will reverse in 2021 when hospital-administered drugs return to more normal utilization following better controls around the coronavirus. Merck’s reduction in guidance is notable, as most drug companies haven’t lowered 2020 guidance. However, the virus is likely more disruptive to Merck, as the firm generates close to two thirds of its human health business from physician-administered products. Also, Merck is one of the few drug companies with an animal health business (10% of total sales), which is more vulnerable to reduced veterinary and consumption demands because of coronavirus concerns. Despite these headwinds, we continue to view Merck as undervalued, with the market not fully appreciating the firm’s strong immuno-oncology positioning, which also supports its wide moat.

In the quarter, strong sales of cancer drug Keytruda (up 46%) helped lift overall sales by 13%, but we expect an overall slowing in sales for 2020, as coronavirus concerns crowd out doctor-administered treatments, followed by a growth rebound in 2021. Given the severity of underlying diseases such as cancer and the strong benefits of vaccines, we expect a strong rebound for physician-administered drugs for Merck in 2021. In particular, 2021 Keytruda sales in Europe should accelerate based on recent reimbursement approvals in the large indication of first-line non-small-cell lung cancer. The recent Keytruda submission for six-week dosing should help with patients wanting to avoid doctors’ offices and further differentiate the drug from four-week dosing by competing drugs. Also, we expect important Keytruda data from an adjuvant (earlier stage) lung cancer study in 2021 that could expand the market potential by close to 25%.

Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.