Merck & Company (MRK, Financial) reported first quarter earnings results on April 28. Results for the company have been solid over the past year or so, but the most recent quarter was especially strong.
Quarter highlights
Source: Merck & Company’s First Quarter Earnings Presentation, slide 9
Merck generated revenue of $12.1 billion during the quarer, an 11.5% increase from the previous year. This was $600 million above what the analyst community had expected. Currency was a 2% headwind during the quarter. Adjusted earnings per share (EPS) improved 23% to $1.50. This was $0.16 higher than consensus estimates.
Pharmaceutical sales increased 10% on a reported basis, led once again by Keytruda, which had revenue growth of 45% year-over-year. Keytruda, which treats a variety of cancers including non-small cell lung cancer and melanoma that cannot be removed by surgery, continues to be the key driver for Merck. The increase in revenue for the drug accounted for more than 80% of the revenue increase in the first quarter.
Higher sales for Keytruda were due to an increase in uptake for patients with non-small cell lung cancer as well as other indications. The drug has taken market share in the treatment areas of renal cell carcinoma and adjuvant melanoma. Keytruda sales reached almost $3.3 billion in the quarter, but annual peak profits are expected to be north of $16 billion. Even better, the drug should provide Merck with multiple years of high sales, as it is patent protected in the U.S. until 2028, the European Union until 2030 and Japan until 2032
These dates will allow Merck to see sizeable amounts of revenue from Keytruda over the next eight to 10 years. Keytruda is also in the process of being tested for efficacy as a treatment for a variety of other aliments as well, such as breast cancer, lymphoma and colorectal cancer.
While Keytruda is the big story for Merck, it’s not the only story. The drug accounted for just 27% of total sales in the quarter. Merck’s vaccine segment also showed impressive growth. Gardasil grew 31% to $1.1 billion. This vaccine, which is used to protect against HPV, benefited from the timing of shipments in China as well as purchases made by the Center for Disease Control. This added ~$190 million to the total sales figure. Accounting for this, sales for Gardasil improved more than 8%. The vaccine has seen higher demand in China and Europe in recent quarters.
Pneumovax 23 grew 39% as demand in the U.S. and Europe was especially high due to the Covid-19 pandemic. This vaccine protects against serious infections, such as ear infections, sinus infections, pneumonia and blood infections.
Merck’s Animal Health segment had sales growth of 18% to $1.2 billion, with particularly high growth in the area of Livestock. Much of this is a result of the company’s purchase of Antelliq Corporation, which was completed last April.
Outlook and potential returns
Despite the strong results for the quarter, Merck shares traded down slightly following the earnings release.
Merck anticipates that the Covid-19 pandemic will reduce revenue by approximately $2.1 billion in 2020. The company has thus revised its guidance and now expects revenue in a range of $46.1 billion to $48.8 billion, down from $48.8 billion to $50.3 billion previously. Adjusted EPS is projected in a range of $5.17 to $5.37, down from $5.62 to $5.77 previously. At the midpoint of the revised guidance, revenue would increase 1.4% while adjusted EPS would be higher by 1.5%.
This isn’t the double-digit growth that the company had on the top and bottom lines in 2019 or the high single-digit growth that was expected for the current year at the time of the last earnings release, but this is growth nonetheless. With other companies pulling guidance, at least Merck has some visibility on how its business is expected to perform.
Even with lowered guidance, Merck isn’t overly expensive, in my opinion. Using the most recent closing price of $77.67 and the midpoint for expected adjusted EPS, the stock has a forward price-earnings ratio of 14.7. This compares favorably to the five-year average price-earnings ratio of 16.
Merck’s first quarter showed that its products, especially Keytruda, remain in high demand. Revised guidance has more to do with the ongoing pandemic than product demand. As such, I feel a target price-earnings ratio in a range of 15 to 17 is appropriate for the stock. I predict that buying at the current price could net investors as much as a 15% return at the high end of my valuation range.
This doesn’t include the current dividend yield of 3.1%, which is slightly above the stock’s five-year average yield of 2.9% and which is a full percentage point higher than the average yield of the S&P 500 index. The dividend growth has been well above average over the past two years, with double-digit increases occurring in both years. This follows multiple years of nominal raises. Using the annualized dividend of $2.44 equates to an earnings payout ratio of just 46%, slightly below the average payout ratio over the last half decade.
Conclusion
Merck had a stellar first quarter, with revenue and adjusted EPS improving by double-digits. Key products like Keytruda and Gardasil were once again in high demand. Keytruda will remain especially important to Merck in the coming years as it has a high floor for expected peak sales and doesn’t lose patent protection until at least 2028 in major markets.
While Merck does expect the pandemic to impact revenues by slightly more than $2 billion this year, shares still trade at an attractive valuation in my view.
Author disclosure: The author is not long Merck & Company.
Read more here:
- Let NextEra Energy Power Your Portfolio
- Domino's Pizza Delivers in the First Quarter
- 1st-Quarter Results Reaffirm Lockheed Martin's Status as Top Defense Name
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
