We're bullish Merck’s immuno-oncology drug Keytruda, but weakness in the remaining parts of the company limit our enthusiasm at the current valuation.
By Damien Conover, CFA | 02-02-17 | 11:00 AM | Email Article

 Merck reported fourth-quarter results and issued 2017 guidance largely in line with both our and consensus expectations, and we don’t expect any major changes to our $65 fair value estimate. We think the stock is fairly valued. We continue to remain very bullish on Merck’s immuno-oncology drug Keytruda, but weakness in the remaining parts of the company limit our enthusiasm at the current valuation. Nevertheless, we continue to view Merck’s moat as wide, with the company doing an excellent job offsetting near-team patent losses with a strong pipeline in immuno-oncology.

Damien Conover, CFA, is director of healthcare equity research and equity strategy for Morningstar.

Generic competition and weakening market positions offset by strong Keytruda gains led to overall flat top-line growth in the fourth quarter, which we expect to continue through 2018. We expect over $5 billion of lost sales (13% of total 2016 sales) to patent expirations over the next five years. Further, increased competitive threats from the SGLT-2 diabetes drugs will likely weigh on Merck’s top drug Januvia. The loss of these well-established drugs will have an amplified impact on the bottom line as these drugs carry high operating margins.

Despite the challenges with older drugs, Merck’s immuno-oncology platform is performing extremely well and is positioned to offset the generic headwinds on other older drugs. Keytruda is poised to take the first-mover advantage in non-small cell lung cancer regardless of PD-L1 status with over a one-year head start. The first-mover advantage is particularly important in cancer, as maturing clinical data and physician acceptance can lock in market share that is hard to displace. The key near-term competitive threat to Merck is Bristol and AstraZeneca’s CTLA4 combination data that is expected as in six to 12 months. However, we expect different patient populations will require different treatments, allowing market share opportunity for all the companies, but Merck’s head start should drive the lion's share of the most important immuno oncology market of NSCLC.

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Damien Conover, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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