Merck Stock Down, Could Have Been Worse


Merck's stock was down almost 3% on Wednesday after the company released first quarter earnings.

Revenue dropped, but that was to be expected, with asthma-drug Singulair seeing generic competition. Every investor knew it was going to happen.

The problem was the other drugs didn't make up nearly enough of the Singulair loss. In the fourth quarter -- the first full quarter with generic competition -- overall revenue fell only 4.5%, as Januvia and Gardasil closed some of the gap.

In the first quarter, revenue was down 9%. Changing currencies had a negative two percentage point affect on revenue, but even a 7% decline is still quite a fall. Investors were right to send Merck stock down.

Unlike the fourth quarter, Januvia, the company's multi-billion diabetes drug franchise, not only didn't help sales, but it actually contributed to the problem. Sales were down 1% in the first quarter. Merck blamed changing currencies for a two percentage point drop. It also blamed reduced inventories held by wholesalers in the U.S. According to Merck, if wholesalers had kept product at the same level, it would have seen a 5% increase in U.S. sales instead of a 5% decline.

The question then becomes: Why did wholesalers reduce their inventory? Are they worried about competition from Bristol-Myers Squibb and AstraZeneca's Onglyza, which is in the same DPP-4 class as Januvia? Or perhaps they think Johnson & Johnson's newly approved diabetes drug Invokana, which is in a new class called SGLT2 inhibitors, will take away sales? Or maybe wholesalers are worried about recently reported side effects?

A lot of questions with few answers.

Management was adamant that they see SGLT2 inhibitors as a second-line treatment after DPP-4 drugs. That can't give Pfizer, which just struck a deal with Merck for its SGLT2 inhibitor, a warm and fuzzy feeling. But if Pfizer's management was being honest, they'd probably agree. DPP-4 drugs have become the first-line branded treatment because of their high tolerability; SGLT2 drugs have a ways to go before doctors are comfortable prescribing them.

When pressed for more information about the inventory changes, Merck's management basically blamed the decrease on a slowdown in growth of prescriptions, which are only growing at 4%. A year ago, Merck was still benefiting from safety concerns over Takeda's Actos and GlaxoSmithKline's Avandia. With sales not accelerating, wholesalers can cut back on the inventory they hold.

I'm not sure that I fully buy that argument; U.S. sales of Onglyza were up 17% year over year in the first quarter, which wholesalers must be taking into consideration. But we'll know in a quarter or two if sales slow down further.

So what's holding up the price of Merck Stock
With such a disastrous quarter, and an uncertain future for its lead product, why did Merck stock only fall 3%? My guess is the new $15 billion share repurchase program announced Wednesday. That's more than 10% of Merck's current market cap!

When Merck stock is repurchased, it artificially increases demand for the shares, driving Merck stock higher. And once the shares are retired, earnings per share increases because there are less shares in the denominator of the calculation, making the company more valuable.

Even if Merck wasn't buying its stock yesterday, investors know it'll be buying in the future -- $7.5 billion over the next 12 months -- which should help hold up Merck stock or, perhaps, even increase the price.

Can Merck beat the patent cliff?
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