Strong Keytruda outlook helps mitigate upcoming patent losses.
reported third-quarter results slightly above both our and consensus expectations, but we don’t plan to increase our $65 fair value based on the minor outperformance and we continue to view Merck as modestly undervalued largely due to an underappreciated pipeline. Further, as shown by the strong strides made in the quarter in advancing innovative drugs, we continue to view Merck’s moat as wide.
Damien Conover, CFA, is director of healthcare equity research and equity strategy for Morningstar.
In the quarter, total sales increased 6% operationally year over year, driven by expected strong growth with cancer drug Keytruda and unexpected demand from vaccine sales due to the opaque buying patterns of public sector purchases. While the robust growth in vaccines should dissipate (as the Gardasil vaccine regimen declines to two doses from three), we continue to expect solid growth from Keytruda. Aided by the recent approval in first-line non-small cell lung cancer, Keytruda holds a first-mover advantage in this critically important cancer indication. While we expect studies with combination immuno-oncology drug therapy from Bristol, Roche and AstraZeneca will report out in 2017 in lung cancer and eventually take share from Merck, Keytruda should have close to a year to establish itself in first-line lung cancer (limited to high expressers of PD-L1 of greater than 50%, or approximately 25%-30% of lung cancer patients).
Despite the strong positioning with Keytruda, the firm lacks other pillars of growth and derives a significant amount of sales from mature products and off-patent drugs, creating headwinds to growth and likely pressuring the firm to make acquisitions. On the patent side, while Remicade’s biologic structure will slow the sales decline, the remaining near-term patent losses are small molecules (Zetia, Vytorin, and Cubicin, totaling 12% of total sales), which face likely rapid sales declines. However, Merck’s strong position in immuno-oncology, diverse portfolio, and cost-cutting ability should mitigate the generic headwinds.
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