Throughout the beginning of the Covid-19 pandemic, pharmaceutical companies were mostly focused on the availability and effectiveness of vaccines. However, around December 2021, the focus shifted more to treatments that patients can take after contracting the disease to prevent severe sickness and hospitalization.
Merck & Co. Inc. (MRK, Financial) was the first to apply for emergency use authorization for a Covid pill called molnupiravir under the brand name Lagevrio. Pfizer (PFE, Financial) subsequently applied for approval for a pill-based treatment under brand name Paxlovid.
Merck is one of the largest and oldest pharmaceutical companies in the world. The pharma segment provides drugs in the areas of oncology, hospital acute care, immunology, neuroscience, virology, cardiovascular and diabetes. The company also has an animal health segment which develops and markets veterinary pharmaceuticals, vaccines and other health management solutions and services.
The company was founded in 1891 and currently has a market capitalization of $275 billion, putting it at all-time highs. However, total revenues could approach $59 billion in 2022, and the company's earnings growth means it is trading roughly in line with historical average valuation levels. Thus, could the stock still be fairly valued?
Covid drug operating results
Early reports showed the Merck Covid pill cut the risk of hospitalization and death from Covid by 50% in patients who had mild-to-moderate Covid-19 symtoms, but a final analysis of the trial reported in November, before the FDA and EU authorization, showed a reduction in that benefit to 30%.
Nonethelesss, molnupiravir became a big seller and is expected to bring in between $5.2 billion and $5.4 billion in revenues in 2022. The next year should see a sharp drop-off in molnupiravir sales as more people will have already caught Covid, causing new cases continue to decline. Competition from Pfizers’ Paxlovid also remains a factor.
Financial summary
The company reports financial operating results both including molnupiravir and excluding the drug. Revenues increased 14% when including the Covid-19 treatment drug and increased 10% without it in its most recent quarterly earnings report. The company’s leading anti-cancer drug Keytruda, in comparison, showed a constant-currency sales increase of 26%.
Merck reported GAAP earnings per share of $1.28 for the quarter and non-GAAP earnings per share of $1.85. The non-GAAP EPS was an increase of 7.0% compared to the prior year period on a constant currency basis. Non-GAAP EPS excludes non-recurring charges, primarily in the areas of merger and acquisition charges and restructuring expenses.
The company typically generates very strong levels of free cash flow. For the first nine months of 2022, operating cash flow was $14.7 billion and capital expenditures were $3.2 billion, which created free cash flow of approximately $11.5 billion. During the first period, the company paid down debt in the amount of $2.2 billion and bought back $5.2 billion in common shares.
The company maintains a safe balance sheet with $11.1 billion in cash and $30.4 billion in total debt. With $27 billion in Ebitda, the company’s debt ratings are strongly investment grade.
CEO Robert Davis stated on the recent earnings report:
“We continue to execute on our strategy, invest in leading-edge science and drive innovation as our colleagues deliver meaningful value for patients – which in turn provides value for our shareholders. Our third quarter results demonstrate exceptional revenue and underlying earnings growth and sustained performance across our key growth drivers. Inspired by our purpose of saving and improving lives around the world, I am confident we are well-positioned to continue to deliver strong operational performance.”
Valuation
The company recently raised it full-year 2022 guidance and now expects revenue between $58.5 billion and $59.0 billion, which represents approximately 12% growth excluding molnupiravir. Earnings per share guidance was raised slightly to the range of $7.32 to $7.37 (non-GAAP). Analyst consensus calls for 2022 earnings per share of $7.38, which puts Merck's stock price at 14.7 times this year's earnings estimates. Earnings are expected to increase again in 2023 in the $7.55 to $7.60 range according to analysts. The company's enterprise-value-to-Ebitda ratio is approximately 11 based on 2022 Ebitda estimates.
The GuruFocus discounted cash flow calculator gives a fair value close to the current stock price when using $7.38 as the starting point, a long-term earnings growth rate of 6.0% and a discount rate of 10%.
The company currently pays an annualized dividend of $2.76 which equates to a 2.57% dividend yield. The payout ratio is well below 50% based on current earnings estimates. Merck has been paying dividends for well over 30 years.
Guru trades
Gurus who have purchased Merck stock or added to their positions recently include Ron Baron (Trades, Portfolio) and Private Capital (Trades, Portfolio). Gurus who have reduced their Merck holdings include Dodge & Cox and Ken Fisher (Trades, Portfolio).
Growth drives could disappear
Merck stock is trading near all-highs but still maintains reasonable valuation levels. However, most major long-term catalysts have either occurred or are well known to the investor community.
For long-term investors, it’s important to note that the key growth driver for the company, Keytruda, has a patent expiration in 2028. This cliff will be hard to overcome without a major acquisition, and earnings will likely decline at the point.
Investors should wait for a lower entry point as the stock will likely not continue to make new all-time highs for any extended period going forward.
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