Can Merck Find a Cure for Depressed Sales?

A healthy pipeline and strong patent protection are vital to the success of pharmaceutical companies. Drug giant Merck (NYSE:MRK), has faced both patent expirations and a weak pipeline in the past year. Still, the stock is up almost 10 percent in the last 12 months. Will Merck's share price continue to rise in the second half of 2013? Let's use our CHEAT SHEET investing framework to decide whether Merck is an OUTPERFORM, WAIT AND SEE, or STAY AWAY.

C = Catalysts for the Stock's Movement

Investors and analysts have critizized the lack of attractive late-stage drugs in Merck’s pipeline. An acquisition of drug maker Schering-Plough in 2009 has drastically increased the amount of these late-stage drugs Merck has in its inventory. Schering-Plough also provides synergies to Merck's business operations and will cut down on expenses in the coming years.

Merck suffered a blow on Wednesday as the Food and Drug Administration cancelled a meeting to determine the approval of reverse-anesthesia drug sugammadex. The surgery drug is already experiencing success overseas — marketed under the name Bridion — but with the FDA denying approval back in 2008, it has a long way to go before it can be sold in the U.S. This setback comes after the FDA denied approval for insomnia drug suvorexant earlier this month.

Merck, however, was granted “breakthrough” status for cancer drug lambrolizumab. Earning breakthrough status is important to pharmaceutical companies because it allows them to commercialize drugs faster, something Merck desperately needs. If lambrolizumab gains approval from the FDA, it would be a big win for Merck, as skin cancer is the most commonly diagnosed form of cancer in the U.S.

E = Earnings are Mostly Decreasing Year-over-Year

While Merck's first-quarter earnings surpassed analysts' estimates, these earnings were inflated due to the inclusion of a one-time tax break. The real disappointment was Merck's revenue growth, which declined 9 percent from the previous year's quarter. A big hit to the company was the expiration of the patent for allergy drug Singular, one of Merck's biggest sellers. Sales declined around 75 percent after cheaper generics came onto the market in mid-2012.

Additionally, sales of Merck's popular diabetes drug, Januvia, were almost 20 percent below analyst expectations. Januvia, which contributes 12 percent to Merck's top line, will continue to face difficulties. Rival Johnson & Johnson (NYSE:JNJ) was recently granted FDA approval for its new diabetes drug, Invokana, which should intensify competition in the diabetes drug space.

On a more positive note, Merck recently announced a program to buy back $5 billion of its outstanding shares from Goldman Sachs (NYSE:GS). This makes up part of a $15-billion share repurchase program — $7.5 billion of which Merck will buy back in the next 12 months. This will certainly help the stock price, which has struggled since the lackluster earnings announcement.

	2013 Q1	2012 Q4	2012 Q3	2012 Q2	2012 Q1
Qtrly. EPS	$0.52	$0.30	$0.56	$0.58	0.56%
EPS Growth YoY	-7.14%	-40.07%	-1.82%	-10.77%	64.71%
Qtrly. Revenue	$10.67B	$11.74B	$11.49B	$12.31B	$11.73B
Revenue Growth YoY	-9.04%	-4.53%	-4.44%	1.32%	1.30%

*Data sourced from YCharts

T = Technicals on the Stock Chart are Mixed

Merck is currently trading at around $45.50. The stock is trading above its 200-day moving average of $45.10, implying that it is experiencing a longer-term uptrend, but trading slightly below its 50-day moving average of $47.54, suggesting that the stock has experienced sideways price movement in the near term. Merck experienced a “golden cross” in late April — when the 50-day moving average surpasses the 200-day moving average — implying that investor sentiment has been positive as of late. Merck is trading 5.6 percent below its 52-week high of $50.16 that it set on June 4.

Conclusion 

In a surprising move earlier this year, Merck rehired Ron Perlmutter to take over its research and development division. After leaving Merck, Perlmutter successfully rebuilt Amgen's (NASDAQ:AMGN) pipeline during an 11-year run. While he has not formally stated his plans for Merck's pipeline, Perlmutter's proven track record could help revitalize it. Merck is relatively cheap compared with the market as a whole, trading at a forward price-to-equity ratio of 12.72. However, the pharmaceutical giant needs to prove it can grow earnings without relying on dated drugs Singular and Januvia. With Merck's second-quarter earnings announcement scheduled for July 30, investors should WAIT AND SEE how Merck performs.

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