Why Is Merck (MRK) Down 4% Since Last Earnings Report?

It has been about a month since the last earnings report for Merck (MRK). Shares have lost about 4% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Merck due for a breakout? 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 catalysts.

Merck Surpasses Q1 Earnings and Revenue Estimates

Merck reported first-quarter 2020 adjusted earnings of $1.50 per share, which beat the Zacks Consensus Estimate of $1.39. Earnings rose 23% year over year (up 26% excluding the impact of currency).

Including acquisition and divestiture-related costs, restructuring costs and certain other items, earnings per share were $1.26, up 13% year over year.

Revenues rose 11% year over year (13% excluding currency impact) to $12.1 billion, which beat the Zacks Consensus Estimate of $11.81 billion. Impact of COVID-19 on the company’s business as well as production and supply of its drugs and vaccines was immaterial in the first quarter.

During the quarter, sales of its pharmaceutical business were negatively impacted in the Asia-Pacific region, mainly China due to social distancing measures and reduced access to health care providers. Sales in other markets, especially Europe, had a favorable impact due to stockpiling by customers to avoid any supply issues during lockdown.

Merck’s physician-administered products bring almost two-third of the company’s pharmaceutical revenues. Though the impact on COVID-19 on sales of these products was minimal in the first quarter, the company said that in the second quarter, sales of these products are being hurt due to social distancing measures, fewer patient visits and delays in elective surgeries due to COVID-19. As a result, the company is seeing lower administration trends of several of its medicines (including Keytruda) and vaccines.

Quarter in Detail

The Pharmaceutical segment generated revenues of $10.66 billion, up 10% (up 12% excluding Fx impact) year over year driven by higher oncology drugs and vaccines, partially offset by lower sales of several legacy products due to loss of market exclusivity.

Keytruda, the largest product in Merck’s portfolio, generated sales of $3.3 billion in the quarter, up 45% year over year. Keytruda sales are gaining particularly from continued strong momentum in first-line lung cancer indication and continued uptake in newer indications including renal cell carcinoma and adjuvant melanoma.

On the call, the company said that in the United States, Keytruda leads across many indications, including lung, bladder and head and neck cancers. In EU markets, the first-line lung cancer indication (based on KEYNOTE-189 study) drove sales growth. Meanwhile, the company is seeing positive uptake from early launches in the adjuvant melanoma, head and neck and renal cell carcinoma indications.

Alliance revenues from Lynparza and Lenvima also boosted oncology sales in the quarter. Lynparza alliance revenues were $145 million in the quarter compared with $132 million in the previous quarter driven by further uptake in ovarian cancer. Lenvima alliance revenues were $128 million compared with $124 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 $299 million in the quarter, up 17% year over year, driven by strong performance across all major regions. However, the company anticipates decline in sales of this drug in the remaining three quarters of 2020 due to the widespread reduction in elective surgeries amid coronavirus-related lockdowns. Merck also said the decline in elective surgeries will hurt the ongoing launch of Prevymis (letermovir).

Vaccines sales rose 14% in the quarter to $2.2 billion. In vaccines, Gardasil/Gardasil 9 sales surged 31% year over year to $1.1 billion benefiting from favorable timing of shipments in China and public sector purchases in the United States. Higher demand in China and Europe as well as favorable pricing in the U.S. markets boosted sales. However, COVID-19 hurt sales of the vaccine in certain markets, particularly in the United States and Hong Kong.

Proquad, M-M-R II and Varivax vaccines recorded combined sales of $435 million, down 12% year over year. Pneumovax 23 and Rotateq vaccines rose 39% to $256 million and 5% to $222 million, respectively.

Pharmaceutical sales were hurt by loss of U.S. market exclusivity for Remicade, Noxafil, Emend, Cubicin, Nuvaring and Vytorin.

Remicade sales declined 28% year over year to $88 million in the quarter. Zetia/Vytorin sales were $198 million, down 17% from the year-ago quarter due to LOE for both drugs. NuvaRing sales were $63 million, down 71% year over year.

Januvia/Janumet (diabetes) franchise sales declined 6% year over year to $1.28 billion due to continued pricing pressure in the United States. Sales of Isentress declined 4% to $245 million.

Merck’s Animal Health segment generated revenues of $1.2 billion, up 18% (up 21% excluding Fx impact) from the year-ago quarter, driven by higher sales of its livestock products, particularly products added from the acquisition of Antelliq as well as COVID-19-related stockpiling. Sales of livestock products rose 21% in the quarter while those of companion animals rose 15%.

However, the company said that demand for its animal health products could be hurt due to reduced veterinary visits, decreased protein and milk consumption due to restaurant and school closures and lowered incomes which can hurt spending on pets. These factors are expected to hurt its Animal Health segment sales in future quarters.

Margin Discussion

Adjusted gross margin was 75.5%, down 40 basis points from the year-ago quarter due to unfavorable manufacturing variances, inventory write-offs and the negative impact of pricing pressure.

Operating expenses of $4.4 billion were roughly flat year over year. Selling, general and administrative (SG&A) expenses were $2.3 billion in the reported quarter, down 7% 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 rose 10% to $2.2 billion in the quarter due to ongoing clinical studies and cost related to early drug development and higher licensing costs,

Lowers 2020 Outlook

Merck expects the majority of the COVID-19 related negative impact to occur in the second quarter. On the call, Merck said that it has been seeing impact of the COVID-19 related business disruption on its vaccine portfolio, including Gardasil, Pneumovax and pediatric vaccines, fertility and women’s health implantables and on Bridion sales. For oncology drugs, Merck said it is seeing new patient visits decline by approximately 10% to 20%.

However, the company assumes normal business operations to resume in the third quarter and reach normal pre-COVID-19 volume levels by the beginning of the fourth quarter.

Merck lowered its revenue and earnings guidance for the full year to include the impact of COVID-19 and higher currency headwinds.

It expects revenues to be in the range of $46.1 billion – $48.1 billion compared with the guided range of $48.8 billion – $50.3 billion. COVID-19 related business disruptions are expected to hurt Merck’s 2020 revenues by $2.1 billion, comprising approximately $1.7 billion headwind for pharmaceuticals and approximately $400 million for Animal Health.

The new guidance includes a negative currency impact of approximately 2.5%, versus prior expectation of a negative impact of less than 1%.

Adjusted earnings are now expected to be in the range of $5.17–$5.37, compared with $5.62–$5.77 guided previously. This includes a negative currency impact of approximately 3.5%, worse than approximately 1.5% expected previously.

Adjusted gross margin is expected to be around 75% versus 75.5% previously. The company now expects adjusted operating expenses to decrease year over year at low-single digit rate. Previously, it expected the figure to increase year over year at a low-single digit rate. The lower operating cost projections are due to expectation of lower promotion and selling expenses and clinical trial costs.

Adjusted tax rate is expected to be in a range of 17% - 18% versus the previous expectation of 17.5% - 18.5%.

Merck temporarily suspended its share repurchase program.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed a downward trend in estimates revision. The consensus estimate has shifted -18.18% due to these changes.

VGM Scores

At this time, Merck has a subpar Growth Score of D, however its Momentum Score is doing a bit better with a C. Charting a somewhat similar path, the stock was allocated a grade of B on the value side, putting it in the top 40% for this investment strategy.

Overall, the stock has an aggregate VGM Score of C. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. 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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