Merck: Your Opportunity Is Knocking (NYSE:MRK)

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Merck (MRK) has mostly been a value investor’s dream over the past 12 months, proving plenty of meaningful dips over this timeframe for investors to layer in capital at attractive prices. It appears that another opportunity is upon us with the latest material drop. In this article, I highlight what makes MRK a solid candidate at present for potentially strong capital appreciation and growing income.

MRK: Your Opportunity Is Knocking

Merck is one of the largest global pharmaceutical companies, with specialty drugs in the fields of oncology, cardiometabolic disease and infections. MRK also has a substantial vaccine business that treats HPV, Shingles, Hepatitis B, and pediatric diseases. It’s been in existence for 130+ years, generating about half of its revenues in the U.S. and the rest internationally.

Starting with the stock’s technical indicators, MRK has sold off since the start of February, declining from the $82-level to $76.64 at present. It now trades below its 50-day moving average of $77.55 and close to its 200-day moving average of $76.48. As shown below, MRK now carries an RSI score of 37, indicating that it’s approaching oversold territory.

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MRK Stock Technicals (StockCharts)

Meanwhile, MRK demonstrated strong Q4’21 results, with adjusted EPS of $1.80, beating analyst expectations by a respectable $0.28. In addition, revenue grew rather robustly by an impressive 23% YoY (on a constant currency basis) to $13.5B for the fourth quarter. This was driven in part by $952M of Molnupiravir sales (Merck’s COVID treatment)

Notably, MRK also had a strong full-year 2021, with sales growing by 16% YoY on a CC basis. This was driven by its blockbuster cancer drug, Keytruda, which saw sales growth of 18% YoY to $17.2B. Also encouraging, Gardasil saw sales growth of 39% YoY to $5.7B and Animal Health sales grew by 16% YoY to $5.6B, driven a dramatic increase in pet ownership over the course of the pandemic.

MRK also maintains strong profitability due to its focus on specialty drugs. As shown below, it scores an A+ grade for profitability, with sector leading Gross and EBITDA margins of 73% and 40%, respectively.

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MRK Profitability (Seeking Alpha)

Looking forward, I see continued reasons to be optimistic, as management is guiding for full-year 2022 sales between $56.1B and $57.6B. This equates to 17% sales growth over 2021 (based on the midpoint of guidance). Management expects to generate very strong cash flow this year, which it intends to deploy into value-enhancing pipeline opportunities, inclusive of vaccines, cardiometabolic, neuroscience and other diseases.

Notably, Morningstar maintains its $94 fair value estimate on MRK and expects to see margin expansion. This is supported by the following comments in its post-Q4 analyst report:

We don’t expect a long duration of molnupiravir sales since other COVID treatments look better positioned and the rate of COVID infections should decline with increased vaccine utilization. Nevertheless, we believe the core underlying business for Merck remains solid and underappreciated. We view the stock as undervalued, with the market not fully recognizing the firm’s growth potential driven by the leading immuno-oncology franchise, entrenched vaccine portfolio, and strong animal health business, all of which also support a wide moat

We expect immuno-oncology drug Keytruda (up 16% in the quarter) will continue to drive sales growth supported by new indications in earlier-line (adjuvant) therapy in renal, skin, lung, and other cancers. Human papillomavirus vaccine Gardasil (up 50%) continues to be well positioned with almost a monopolistic position.

Merck’s guidance of doubling Gardasil sales by 2030 is slightly higher than our estimate but looking increasingly likely, especially with the company’s heavy vaccine manufacturing investment to meet the robust global demand. As these key franchises continue to scale, we expect further margin expansion.

Risks to MRK include geopolitical tensions in Europe, which could trigger a recession, and it seems that the recent price action reflects some of this concern. Plus, MRK faces competition for its molnupiravir from other COVID treatments, and it must content with patent expirations and innovations in the oncology space, which could disrupt its blockbuster Keytruda drug.

Meanwhile, MRK maintains a strong A+ rated balance sheet with $10B in cash on hand, representing one of the highest balances over the past 5 years. It also carries very low leverage as reflected by its net debt to EBITDA ratio of 0.78x.

The recent price weakness has also pushed up MRK’s dividend yield to 3.6%, and it’s supported by a reasonably low 46% payout ratio (based on 2021 adjusted EPS of $6.02). It also comes with a 5-year dividend CAGR of 8.2%.

MRK appears to be undervalued at the current price of $76.64 with a forward PE of just 10.5. sitting well below its normal PE of 14.9 over the past decade. Sell side analysts have a consensus Buy rating with an average price target of $92, implying a potential one-year 24% total return including dividends.

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MRK Valuation (FAST Graphs)

Investor Takeaway

Merck has demonstrated strong Q4 and full-year 2021 results, with growth in its key segments, and it maintains strong margins. Looking forward, management has guided for continued double-digit revenue growth and has strong cash flow to support its pipeline. Meanwhile, it maintains a very strong balance sheet and pays a well-covered and growing dividend. I view the latest share price weakness as presenting a buying opportunity.

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