Being an investment analyst and portfolio manager, I am constantly on the lookout for companies that offer good investment opportunities. In this article, I take a look at Merck (MRK), a pharmaceutical company that may offer investors upside potential that outweighs the risks.
We'll use the management effectiveness ratios, book value-share, price-sales, price-book value, etc., to evaluate Merck.
Additionally, macro-economic indicators are provided at the end of the article. As part of investment analysis, analysts should consider both the company fundamentals and the macro-economic landscape. The macro-economic picture in the U.S. is deteriorating. In Europe, the economy is contracting.
Investment Thesis
Given the current lack of business diversification, and the valuation an equity position in Merck can't be recommended at this time. The loss of patent protection for Singulair further heightens anxiety about the future of the enterprise. Should valuations metrics decline to levels reflective of Merck's future operations, I may recommend the accumulation of common equity shares.
Additionally, credit risk stemming from Europe, and the loss of patent protection for Singulair, may result in Merck reporting a loss from operations.
Rating System
Buy - Be long
Neutral - No position
Sell - Be short
(The ratings, research and analysis in this article should be considered as starting point for further research.)
Merck - Neutral (Exit Long Positions)
Company vs. Industry
- Return on Assets : 6.71 vs. 5.50
- Return on Investment : 8.14 vs. 8.61
- Return on Equity : 12.73 vs. 12.73
Enterprise Operations
More important than earnings is the quality of earnings, and Merck's earnings are high quality. Additionally, the firm generates enough cash from operations to cover its investing and financing activities.
As part of the 2008 global restructuring program, Merck has reduced costs, increased efficiency and enhanced competitiveness. The restructuring program is mostly complete. Additionally, gross margin should expand in the next few years.
Credit Risks
As of March 31, 2012, the enterprise had $1.7B of exposure to Greece, Italy, Ireland, and Portugal through terms of credit extended as part of business operations.
Legal Risks
There is potential liability from court cases involving Vioxx and ENHANCE. Potential losses from Vioxx litigation are currently inestimable, and could materially adversely impact the company's financial position, income and cash flow.
Additionally, Merck faces litigation stemming from other products that may adversely impact the firm's financial position, income and cash flow.
Patent Risks
Between 2012 and 2013 Merck is expected to lose almost all of its revenue from the drug Singulair as the patent expires. Singulair is one of Merck's best selling drugs. Merck stands to lose roughly $4-5B in annual sales.
Competitors
Merck competes with Abbott Labs (ABT), Amgen (AMGN), Astra Zeneca (AZN), Bristol-Myers Squibb (BMY), GlaxoSmithKline (GSK), Johnson & Johnson (JNJ), Novartis (NVS), Pfizer (PFE), and Sanofi-Aventis (SNY).
Valuation
Book value-share declined from Q1 2010 - Q1 2011 and starting rising. Recently, cash and cash equivalents increased as current assets increased compared to the year-ago quarter. However, total assets was relatively flat compared to the year-ago quarter. The firm is carrying roughly $15 billion in long-term debt.
Common equity shares of Merck are rising and may be near a peak.
Price-sales is rising and may be near a peak. Revenue increased in the first quarter of 2012 compared to the year-ago quarter. The firm was able to manage operating costs effectively and operating margin increased. Compared to the year-ago quarter, dividend per share increased to $0.42.
Price-book value is rising and may be near a peak. Book value declined and shares of common equity increased in price.
Macro Environment
ISM non-manufacturing PMI is declining; the index is expected to continue to decline in the coming months.
Non-farm employment change is declining; the pace of job growth is expected to continue to slow.
CB consumer confidence is increasing; the index is expected to decline in the coming months.
European Union flash manufacturing PMI is declining; the index is expected to increase in the coming months.
European Union flash services PMI is declining; the index is expected to increase in the coming months.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bare risk and thus his opinions may not be suitable for all investors.
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