It has been about a month since the last earnings report for Merck (MRK). Shares have added about 8.4% in that time frame, outperforming the S&P 500.
Will the recent positive trend continue leading up to its next earnings release, or is Merck due for a pullback? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important drivers.
Merck Beats on Q2 Earnings, Misses Sales, Ups View
Merck reported second-quarter 2020 adjusted earnings of $1.37 per share, which beat the Zacks Consensus Estimate of $1.14. Earnings rose 6% year over year (up 9% excluding the impact of currency) helped by lower costs and higher other income as revenues declined in the quarter.
Including acquisition and divestiture-related costs, restructuring costs and certain other items, earnings per share were $1.18, up 15% year over year.
Revenues declined 8% year over year (down 5% excluding currency impact) to $10.87 billion. Sales also missed the Zacks Consensus Estimate of $10.92 billion. Sales of several of Merck’s medicines were hurt due to social distancing measures, fewer patient visits and delays in elective surgeries due to COVID-19.
COVID-19 related business disruptions hurt Merck’s second-quarter revenues by $1.6 billion, comprising approximately $1.5 billion headwind for pharmaceuticals and approximately $100 million for Animal Health. Mainly COVID-19 hurt sales of Bridion and Merck’s vaccines, including Gardasil. However, blockbuster cancer drug, Keytruda continued to do well and provided top-line support.
Merck said that the majority of the COVID-19 related negative impact occurred in the second quarter with a gradual recovery beginning toward the end of the quarter. Merck expects normal business operations to resume in the fourth quarter.
Quarter in Detail
The Pharmaceutical segment generated revenues of $9.68 billion, down 7% (down 6% excluding Fx impact) year over year due to negative impact of the COVID-19 pandemic on vaccines and hospital acute care products and lower sales of several legacy products due to loss of market exclusivity. However, oncology products, including Keytruda, did well in the quarter.
Keytruda, the largest product in Merck’s portfolio, generated sales of $3.39 billion in the quarter, up 29% year over year. Keytruda sales have been gaining particularly from continued strong momentum in first-line lung cancer indication and continued uptake in newer indications.
In the quarter, Merck witnessed COVID-19 related impact on Keytruda’s sales in April and May across all tumor types which eased in June mainly in the United States and Europe. The recovery has continued in the third quarter per the company.
Alliance revenues from Lynparza and Lenvima also boosted oncology sales in the quarter, reflecting continued uptake in approved indications in the United States, Europe and China.
Lynparza alliance revenues were $178 million in the quarter compared with $145 million in the previous quarter, driven by further uptake in ovarian cancer and approvals for new indications. Lenvima alliance revenues were $151 million compared with $128 million in the previous quarter, driven by continued strong demand in first-line hepatocellular carcinoma. Lenvima sales also benefited from the launch of the endometrial carcinoma indication in combination with Keytruda.
In the hospital specialty portfolio, Bridion Injection generated sales of $224 million in the quarter, down 19% year over year, due to widespread reduction in elective surgeries amid coronavirus-related mobility restrictions.
In vaccines, Gardasil/Gardasil 9 sales declined 26% year over year to $656 million as COVID-19 hurt sales of the vaccine, particularly in the United States and Hong Kong. Higher demand in China provided some top-line support. Merck witnessed significant increase in wellness visits beginning in late April for children and in late June for adults in the United States and expects its vaccines business to recover in the second half of 2020.
Proquad, M-M-R II and Varivax vaccines recorded combined sales of $378 million, down 44% year over year due to lower demand. Rotateq vaccine sales declined 2% to $168 million.
Pharmaceutical sales were hurt by loss of U.S. market exclusivity for Remicade, Noxafil, Emend, Cubicin, Nuvaring and Vytorin.
Remicade sales declined 26% year over year to $73 million in the quarter. Zetia/Vytorin sales were $175 million, down 24% from the year-ago quarter due to loss of exclusivity for both drugs. NuvaRing sales were $63 million, down 74% year over year.
Januvia/Janumet (diabetes) franchise sales declined 7% year over year to $1.34 billion due to continued pricing pressure in the United States and lower demand in some markets due to COVID-19. Sales of Isentress declined 21% to $196 million.
Merck’s Animal Health segment generated revenues of $1.1 billion, down 2% from the year-ago quarter. However, excluding the impact of currency, sales rose 3%, helped by an additional month of sales related to the acquisition of Antelliq. Sales of livestock products declined 3% due to reduced veterinary visits and decreased protein and milk consumption due to restaurant and school closures. Sales of companion animals were flat as higher demand for BRAVECTO parasite control products was offset by lower demand for companion animal vaccines due to COVID-19 related reduced veterinary access. However, the impact of COVID-19 on the Animal Health unit in the quarter was less than anticipated as veterinarian offices opened earlier than initially expected and stay-at-home restrictions were lifted sooner than anticipated.
Adjusted gross margin was 73.8%, down 160 basis points from the year-ago quarter due to unfavorable manufacturing variances and higher amortization of intangible assets, which were partially offset by favorable product mix.
Operating expenses decreased 9% year over year to $4.4 billion. Selling, general and administrative (SG&A) expenses were $2.2 billion in the reported quarter, down 16% year over year driven by lower selling and administrative costs due in part to the COVID-19 pandemic and currency tailwinds. Research and development (R&D) spend declined 1% to $2.2 billion.
Lifts 2020 Outlook
Merck raised its sales and earnings guidance for 2020 to reflect lower-than-previously-expected impact of COVID-19 and currency and the continued underlying strength of its business.
Although sales of pharmaceuticals products were hurt significantly, demand trends improved in May and June. The company expects improved business conditions coupled with its digital and other transformation efforts to result in stronger-than-expected second-half growth.
It expects revenues to be in the range of $47.2 billion – $48.7 billion, higher than the earlier guided range of $46.1 billion – $48.1 billion. COVID-19 related business disruptions are expected to hurt Merck’s 2020 revenues by $1.95 billion (previously $2.1 billion), comprising approximately $1.8 billion headwind for pharmaceuticals and approximately $150 million for Animal Health.
The new guidance includes a negative currency impact of approximately 2% compared with the prior expectation of a negative impact of approximately 2.5%.
Adjusted earnings are now expected to be in the range of $5.63–$5.78 compared with $5.17–$5.37 guided previously. This includes a negative currency impact of approximately 3%, compared with approximately 3.5% expected previously.
Adjusted gross margin is expected to be around 75%. The company now expects adjusted operating expenses to be flat year over year. Previously, it expected the figure to decline year over year at a low-single digit rate. The higher operating cost projections are due to expectation of higher R&D costs related to its COVID-19 program. Operating margins are expected to rise approximately 100 basis points year over year.
Adjusted tax rate is expected to be in the range of 16%-16.5% versus the previous expectation of 17%- 18%.
Coronavirus Related Research Efforts
Merck announced three deals in the quarter to find new antivirals and vaccines to help combat COVID-19. First, Merck acquired Austrian private biotech, Themis, in June. Themis has a COVID-19 vaccine candidate, V591, in preclinical development with clinical studies expected to start in the third quarter. Themis developed the candidate using its measles virus vector platform. Second, Merck is co-developing private biotech, Ridgeback Biotherapeutics’ oral antiviral candidate, MK-4482 (previously EIDD-2801), which is being evaluated in phase II studies for the treatment of COVID-19. Third, Merck in collaboration with a non-profit research organization, IAVI, is co-developing, V590, a vaccine to prevent COVID-19 using its rVSV platform, which was used to make its Ebola vaccine. V590 is in pre-clinical development with clinical studies expected to start this year.
How Have Estimates Been Moving Since Then?
It turns out, estimates revision have trended upward during the past month.
Currently, Merck has a nice Growth Score of B, though it is lagging a lot on the Momentum Score front with an F. However, the stock was allocated a grade of B on the value side, putting it in the second quintile for this investment strategy.
Overall, the stock has an aggregate VGM Score of B. If you aren't focused on one strategy, this score is the one you should be interested in.
Estimates have been broadly trending upward for the stock, and the magnitude of these revisions looks promising. Notably, Merck has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.
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