Last year, Merck (NYSE:MRK) was a wonderful medicine for the portfolio because of its steady growth, even after deducting the “contribution” from the epidemic.

Growth has increased the valuation multiple while rising interest rates have put pressure on market multiples. 

The Show Is Driven By Keytruda

Merck was a company that generated $47 billion in sales in 2019, with earnings of $5.19 per share. At the time, an $80 stock demanded a 15-16 times earnings multiple, as the firm forecasted modest revenue growth in 2020.

Revenues climbed only 2% to $48 billion in 2020, hampered by the pandemic, as sales of the main medicine Keytruda rose 30% to $14.4 billion, with non-Keytruda revenues declining somewhat and reliance on the top-selling drug only rising as a result of its success.

With the company forecasting sales of $53 billion in 2021 and earnings of more than $6.50 a share, a $70 price seemed appealing. That was overly simplified because the business broke off Organon (NYSE:OGN) during the year, resulting in pro forma sales of $47 billion and earnings of $5.50 per share. Nevertheless, the measure merely increased dependency on Keytruda, despite the fact that net debt would decline to $18 billion.

Notwithstanding the Organon spin-off, the market has grown more fond of the company, with 2021 sales rising to $48.7 billion and earnings of $6.02 per share reported. Keytruda sales increased 20%, slightly surpassing organic sales growth of 17%, boosting Keytruda’s revenue share to 35% of total sales. With the firm predicting 2022 sales of about $57 billion and earnings of more than $7 per share, the stock has a great path to $100 by October.

After reporting third-quarter results, the company raised its full-year outlook to $58.5-$59.0 billion, including a $5 billion sales contribution from Covid-19 medication LAGEVRIO in the first three quarters of the year, with full-year earnings expected to be approximately $7.35 per share. Net debt was $21 billion as of the second quarter reports, as the third quarter 10-Q report had not yet been completed.

Given the growth, the ensuing 14 times multiple was appropriate, albeit Keytruda’s dependency is a little issue. The company was just executing and was announcing bolt-on dealmaking at the time, despite rumors that it was making a $40 billion approach for Seattle Genetics (NASDAQ:SGEN) last summer, a potentially massive deal in relation to a $270 billion valuation at the time. All of this left me sitting on pretty solid gains with no cause to change my long position.

Performing Well

Merck’s stock price has increased another 10% since October, presently trading above $110 per share, which is impressive given that several big pharma brands have lately had a dip in this area.

Merck announced a $1.35 billion deal to acquire Imago BioSciences (NASDAQ:IMGO) for $36 per share in cash shortly after the third quarter results were released in October. With the acquisition of this clinical-stage biopharmaceutical business, the company hopes to increase its footprint in hematology. The company was confident in its long-term prospects, announcing a quarterly dividend of $0.73 per share, for a substantial payout of nearly $3 per share.

Merck released its full-year results in early February. Sales increased by only 2% to $1.38 billion in the fourth quarter, with a strong dollar reducing sales growth by six points. Non-GAAP earnings declined 10% to $1.62 per share, but total earnings increased 10% to $7.48 per share. LAGEVRIO sales increased from the third quarter to $852 million in the fourth quarter. Notwithstanding the accidental impact of LAGEVRIO, Keytruda sales increased 19% to $5.5 billion for the quarter, raising its dependency to 39%. The faster increase in reliance is due in part to Merck facing competition for JANUMET, their diabetes medicine, which saw fourth-quarter sales drop by a third to less than a billion dollars.

Despite the greater contribution of LAGEVRIO, which thrived on the pandemic, full-year sales came in at $59.3 billion, with the business expecting some form of stabilization, with revenues expected to be around $58 billion in 2023. Adjusted earnings are expected to dip slightly to $6.80-$6.95 per share. With LAGEVRIO sales only at a billion, compared to $5.7 billion in 2022, it is apparent that revenue growth is moderate outside of this boom. By the conclusion of the third quarter, net debt had dropped to a very low $18 billion.

What Happens Next?

To be honest, 2023 is a bit of a bridge year, as reported statistics will most certainly be negative due to the drop in LAGEVRIO sales. This will make it difficult to observe growth because Keytruda’s dependency is increasing, and hence bolt-on deals like Imago are critical to lowering this reliance over time.

Based on the adjusted profits ratio witnessed this year, the earnings multiple has climbed 16 times to $110 per share. As a result, the earnings multiple has risen, despite market valuation multiples being pushed by increasing interest rates, as the setup is less convincing than it was previously.

Given all of this, I believe it is best to avoid Merck stock for the moment and shift to other large pharmaceutical companies that have recently had setbacks.

Featured Image: Megapixl @ Michaelvi

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