Inside Wall Street: Even After Health Care Reform, Merck Is Looking Hale

Gene Marcial's Inside Wall Street Merck
Gene Marcial's Inside Wall Street Merck

Big Pharmas have been busy figuring out how much the newly enacted health care reform law will cost. That means lowering their projected sales and earnings for 2010 and 2011. For Merck (MRK), however, the bad news is turning out to be not so bad after all, so most analysts have reiterated their bullish stance on the company -- one of the world's largest drugmakers.

Of the 25 analysts who follow Merck, 18 still recommend buying the stock, including those at JPMorganChase, Sanford C. Bernstein and Credit Suisse. None recommend selling this big-cap stock (nearly $40 billion), and the seven others peg it a hold.

Merck estimates that health care reform will lower revenues by $170 million in 2010 and $300 million to $350 million in 2011, or less than 1% of most analysts' sales projections for each of those years. The drops are below comparable shortfalls that some analysts estimate for Eli Lilly (LLY) and Bristol-Myers Squibb (BMY). For Lilly and Bristol-Myers, the hit will be about a 1.6% revenue drop in 2010 and 3% for 2011, figures Herman Saftlas, health care analyst at Standard & Poor's.

"The relatively better showing for Merck reflects its more diversified product and geographic base," says Saftlas. He reiterated his buy recommendation on the stock, now trading at $34 a share, with a 12-month price target of $48. Merck's stock bumped up on April 23, when it made public its estimates on health reform's impact. It rose 5%, or $1.69 to $35.46 a share. It closed on Apr. 29 at $35.25 .

Dissipated Worries

The stock has been under pressure since Jan. 21, 2010, when it traded at a 52-week high of $41.56. It has since sloped down to as low as $34 on Apr. 21, partly because of concern over the revenue depression from health care reform. After Merck came out with its own estimates, the worries dissipated.

Despite the projected revenue decline, Merck says it's still aiming to generate a compound annual growth rate in the high single digits through 2013, compared with its 2009 results.

What's the reform law's impact on earnings? C. Anthony Butler, health care analyst at Barclays Capital, figures Merck's 2010 earnings could be approximately 1.4% lower, or 4 cent to 6 cents a share, and in 2011, 5% lower, or 8 cents to 11 cents a share (assuming no changes in drug pricing). This would imply less exposure than Lilly and Abbot Laboratories (ABT), he says. (Barclays has done banking for Merck).

The earnings impact on Merck isn't as harsh as for the other companies because of its less-than-average exposure to the U.S. market, says Butler. He cites its November 2009 acquisition of Schering-Plough, which will diversify Merck's revenue base. Foreign operations accounted for 47% of pharmaceutical and vaccine sales in 2009. Merck also has less exposure to patients on Medicaid in the U.S., he adds.

Butler made no changes his 2010 earnings estimate of $3.40 a share, nor in his 2011 estimate of $3.92 a share. One important factor in the bullish case, says Butler, is that management didn't change its long-term earnings growth guidance.

Putting More in the Pipeline

The Schering-Plough deal gives Merck another advantage. "This acquisition has significantly expanded and diversified Merck's revenue base ahead of impending patent expirations on Cozaar/Hyzaar and Singular," says S&P analyst Saftlas. Singular, a treatment for asthma and seasonal allergic rhinitis, is Merck's largest-selling product, generating 2009 sales of $4.7 billion. Cozaar/Hyzaar treats high blood pressure and congestive heart failure, and is Merck's second-largest product, producing sales of $3.6 billion.

The Schering-Plough purchase will also beef up Merck's research and development pipeline, which now consists of some 20 projects in late-stage development. One of Schering-Plough's top products is Zetia, which blocks cholesterol absorption in the intestines. It brought in sales of $1.8 billion in 2009. Right behind that is Vytorin, a cholesterol-lowering drug, which had sales of $1.7 billion in 2009.

In all, Schering-Plough is projected to boost Merck's sales and earnings results over the long term. With Merck's huge resources and strong balance sheet, analysts expect Schering-Plough, which earned $2.5 billion from operations in the first three quarters of 2009, on sales of $13.5 billion, to significantly widen Merck's global reach.

Despite the waning importance of Big Pharma in many investment portfolios, Merck remains a favorite among deep-pocket investors. The drugmaker's large institutional shareholders continued to add to their holdings as of Mar. 31, 2010, including No. 1 holder Capital World Investors, which owns a 5.40% stake; Capital Research Global, with 4.98%; and Wellington Management with 4.19%.

For the individual investors scouting for a hale and hearty player among big-cap pharmaceuticals, Merck looks like one healthy bet.