MERCK & CO., INC. 
By 
The group is known for the quality of its R&D programs, typically managed internally from start to finish, while its competitors are more likely to favor the acquisition of the most promising biotechs to replenish their pipelines.
This strategic choice is currently paying off and allows Merck to return almost all of its profits to the shareholders; of the $22 billion in free cash flow profits received over the past three years, only $1.5 billion has been spent on acquisitions.
At the same time, $15 billion was distributed in dividends and $13 billion was used for share buybacks, with a significant acceleration of the program in 2018, when $9 billion of shares were repurchased at an average price of $71.
These massive buybacks were largely financed with the liquidation of the Group's bond and money market investment portfolio. The decision makes sense, since the dividend of the Merck share is higher than the majority of AAA returns, with the growth option as a bonus.
Over the next five years, the group’s management expects to generate approximately $60 billion in cash profits. The first half of which will be used for dividends and the second half to finance additional acquisitions and/or share buybacks.
Looking at the period 2016-2023, we can estimate an average cash profit of about $15 billion per year. The company’s current market capitalization ($211 billion) thus represents an a priori very reasonable multiple of 14 times this earnings capacity.
It is true that the major pharmaceutical groups have been facing structural challenges - and as a consequence market mistrust - in recent years. This is undoubtedly what motivated the management's decision to proceed with major share buybacks.
Examples include the creeping inflation of R&D budgets, which, coupled with increased government vigilance over prices, makes the returns on investment uncertain, or the rise of generic treatments that hurts twice after painful patent expiries.
The major groups in question compensate these difficulties with solid competitive advantages: in addition to their cutting-edge expertise in the approval of new treatments and the management of complex R&D programs, their dense and well-structured commercial networks on all continents remain virtually non-reproducible assets.
The overall outlook remains bright, largely due to the growing importance of the Chinese market, where hundreds of millions of patients now enjoy access to healthcare that’s equivalent to that of the Japanese or Westerners. It's worth noting that Merck is growing faster in China than its competitors.
As mentioned above, the group's decision to develop its R&D internally - rather than to buy biotech firms, as Roche did with Genentech, J&J with Actelion, Sanofi with Genzyme, etc. - has so far been very successful.
The main breakthrough was made in immunotherapy - which consists, in short, of mobilizing the patient's immune defenses to fight against their disease rather than replacing them - in the most promising market segment for the coming decades: oncology.
Merck's leading treatment in oncology is called Keytruda. Used in combination with other treatments, it delivers spectacular results (measured in lifetime gains) on a wide range of some of the most common cancers (lungs, liver, kidneys, etc.).
As a result, the group has managed to outperform its main competitors in the race. In particular Bristol-Myers Squibb, AstraZeneca, and Roche in the treatment of lung cancer which is in itself the most common pathology in oncology.
Most observers agree that Keytruda's sales growth is expected to be two to three times higher than for its alternatives. Building on this success, Merck is cementing its leadership and setting the stage with a record number of ongoing R&D programs.
At the same time, thanks to an unparalleled sales force in oncology with nearly 5000 sales representatives worldwide - Merck is a partner of choice for other laboratories. The Japanese company Eisai, for example, has just signed a multi-billion dollar collaboration agreement to combine Lenvima - which reduces tumors by blocking cell reproduction - with Keytruda.
With Lynparzna also in the portfolio, developed in partnership with AstraZeneca, Merck believes it can address more than 50 different oncology diseases; as far as the author knows this kind of diversity is only matched by the Swiss Roche Group.
Merck is also known for the quality of its vaccine portfolio ($7.3 billion in revenue last year), including the famous Gardasil blockbuster ($3 billion in revenue) used to prevent cervical cancer.
Vaccines are difficult treatments to approve. In some cases, once adopted, they are also promoted and subsidized by the government. The barriers to entry are therefore very high, if not impassable.
In its other business activities, Merck remains a world leader in hospital pharmacology, a segment that’s expected to grow significantly in emerging geographies, and animal health.
The animal health business is more difficult - as we discussed in the article on Virbac - but Merck has enough scale to make it through once the industry is more consolidated; otherwise, the group could follow Bayer's example and sell the division to finance other, more profitable projects.
On a financial level, the group’s annualized growth rate (+6% over the last decade) is three times higher than that of Sanofi, and six times higher than that of historical rival Pfizer. The company’s margin profile is in line with industry references such as Roche or J&J, and its profitability is at the top of the range thanks to well-calibrated R&D investments.
Merck’s capitalization is optimal, with almost all the excess cash being returned to the shareholders (as seen above) and without compromising the latitude to finance a large acquisition if necessary, especially if the results projections prove to be accurate.
The strong growth trend continued in the first half of the year, thanks to the Keytruda sales turning out $1 billion higher than expected. In parallel, Merck has just completed the acquisition of Peloton - a biotech company focused on the treatment of liver cancer - for $1.1 billion.
Although promising, this transaction remains disproportionate compared to those carried out by competitors, such as Bristol-Myers Squibb's $90 billion acquisition of Celgene. It seems a kind of all or nothing bet towards which Merck clearly remains poorly committed.
It is to capture this favorable momentum - coupled with a modest valuation - that MarketScreener is integrating the Merck share into its USA portfolio. The share is replacing Exelixis, whose growth rate is slowing down and whose management is continuing to sell its shares at the current price.
(The author is not a shareholder.)
