Merck

You can buy it here!

Last time I covered Merck here MRK, I warned about buying the stock. This was a prescient call, since February the stock has been down 15%. Now, it is worth revisiting, to see whether the risk/reward has changed in the buyer's favor.

Risks

The risk remains the same as before, Merck has two blockbuster drugs, Keytruda and Gardasil, which go off-patent in 2028. The patent issue is accentuated by the fact that Keytruda and Gardasil represent about half the business measured in revenues. 

The big question also remains the same, has Merck any blockbuster candidates in the pipeline that can mitigate future sales impairments coming from the patent cliff in 2028? 

Here is a presentation of some drugs with good potential in the pipeline, but first a few words about a recently approved drug with promising projections. 

Winrevair  

Winrevair got FDA approval in March and EU approval in August. The approval gives better treatment for everybody living with pulmonary arterial hypertension (PAH).  PAH is a potentially life-threatening disease that can lead to right-side heart failure if left untreated. The disease manifests itself as breathing difficulties, fatigue, and other symptoms that can significantly impact a person's quality of life. 

In short, Winrevair improves blood flow and reduces strain on the heart. Clinical trials showed that patients could do more tasks before feeling fatigued, and even more significantly, an 84% reduction in the occurrence of death or clinical worsening events related to PAH. Rightfully so, Merck calls Winrevair for a game changer.

There are around 40.000 patients diagnosed with PAH in the US. Winrevair has a peak revenue potential of $8B according to analysts. However, this figure rests upon Winrevair having efficacy in additional forms of pulmonary hypertensions. 

Blockbuster candidates in the pipeline

Restoret is an investigational drug aimed at treating eye diseases as a consequence of diabetes and aging, such as diabetic macular edema (DME) and neovascular age-related macular degeneration (NVAMD). DME affects nearly 7% of everyone who is inflicted by diabetes, while there are 1,5M that are diagnosed by NVAMD in the US. So, the market size is significant, analysts think that the total addressable market (TAM) for these two eye diseases alone could be around $15B. Early clinical trials suggest that Restoret may offer meaningful visual and anatomical improvements for patients, while also demonstrating a strong safety profile. Restore moves into late-stage trials in a few days from now.

Trophoblast Cell-Surface Antigen 2 (TROP2) is a glycoprotein that plays a significant role in various cancers, being overexpressed in many solid tumors, including breast, pancreatic, and ovarian cancers. Speaking in layman's terms, TROP2 is associated with skin cancers (carcinoma), and the fact of the matter is that around 80% of all cancers stem from degeneration in carcinoma cells, and these cells cover not only the whole body but also internal organs.

Merck is targeting TROP2 in various clinical trials through antibody-drug conjugates (ADCs). The treatment of metastatic triple-negative breast cancer (TNBC) has moved into phase III. Investigations into small-cell lung cancer and advanced solid tumors are currently in phase II. There are also several early clinical trials going on.

Merck is developing TROP2 drugs alongside its partner Daiichi Sankyo. The TROP2 inhibitor market is expected to grow significantly within the next decade. However, Merck has not made any revenue projections

Epidermal Growth Factor Receptor 3 (HER3) is a member of the human epidermal growth factor receptor (HER) family. Receptors, in simple terms, are like "mailboxes" on the surface of cells that receive signals from outside. These signals can come in the form of hormones, nutrients, or growth factors, and they help the cell understand what to do—such as grow, divide, or even die. Merck is targeting HER2 to stop it from being overactive, and promote tumor growth, diming its reception if you like. 

HER3 signaling is present in various types of breast and lung cancers. Merck's HER3 program is advancing through critical phases of clinical development.  A Phase 3 trial concerning small-cell lung cancer has shown promising results, meeting its primary endpoint by demonstrating significant improvement in progression-free survival (PFS) compared to chemotherapy in patients. 

If approved, the drugs produced as a result of this trial would be the first HER3-directed therapy available, particularly targeting patients who have limited options after multiple prior treatments. Merck expects that its HER3 program would generate around $20B in revenue by 2035.

Valuation

Yes, there are patent risks present in this name. However, we should not exaggerate the risks. Merck is a company with a long history and is used to navigate patent losses, continuously replacing old winners with new winners in its portfolio. The innovation culture should not be underestimated.

I feel Merck is undervalued here. My fair value estimate is $125 for the share price. Looking at jewels hidden in the pipeline, it looks to me that Wall Street underestimates how fast Merkc will bounce back to growth after the patent cliff in 2028.

Final considerations

The market is going to stay volatile until the American election is over. Right now, the bond market is about to bake in a Republican sweep, which is believed to be inflationary and lead to higher financial costs. If the Republicans carry out a sweep, there is a danger that the bond vigilantes come out to play and that the 10-year government rate will go to 5%. This will be detrimental to stock prices. so the end of the year can turn out to be negative rather than positive as everyone believes today. 

I would be careful with putting new money to work here. Wait a few weeks and see how the market behaves after the election.

Having said all this, Merck is undervalued here in fundamental terms. It pays out a dividend of around 3%, the revenue growth is above 10% in constant currency terms, and is cheap on most metrics like price/free cash flow and price/earnings.

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