Drug Firm Merck Is a Safe Haven

03/01/2007 12:00 am EST

Focus:

Jon Markman

Editor, Trader's Advantage

Defensive stocks like Merck held up well in Tuesday’s sell off, says Jon Markman of Markman Capital Insight, but the drug maker has a lot going for it—a good pipeline, hefty profit margins and a fat dividend.

Pharmaceutical stocks did better than most of their peers [in Tuesday’s market] plunge. The one I’d like you to focus on for the moment is Merck (MRK).

Some of its good karma may be a result of its recent good deeds in emerging markets. The company announced that it would sell its HIV drug, Atripla, in developing counties at $1.68 a shot, rather than the $40 per shot it earns in the West. The drug was developed by Merck scientists, but it is actually made by Gilead Sciences (GILD) and distributed under license by Bristol-Myers Squibb (BMY).

Merck sold $22.6 billion worth of its therapies at a staggering profit margin of 25% last year, so it can afford to be a good guy. Merck's include cholesterol-lowering Zetia, Zocor, and Vytorin, and anti-allergy medication, Singulair.

The company has to keep pushing into new territories, however, and right now the market is excited about the prospects for a new treatment for Type-2 diabetes called Januvia, as well as a skin cancer therapy called Zolinza.

To put it in perspective, Goldman Sachs analysts expect Zolinza sales to grow by 206% and Januvia by 123%, by 2011. Januvia is the first DPP-4 inhibitor, a new generation drug for diabetes treatment, and archrival Novartis is in hot pursuit of the same market with a drug called Galvus.

Fortunately, for Merck shareholders, the US Food and Drug Administration announced this week that it wants to see more clinical work done on [competing] Galvus, as it may not be completely safe for patients with kidney problems. This gives Merck access to a virtually competition-free market, where sales are limited only by demand.

Analysts at Leerink Swann believe that this development gives Merck time to develop and market Janumet, which is a combination of Januvia and metformin. It’s basically an oral diabetes medicine that physicians appear to prefer.

Looking a little further forward, an exciting new project for Merck is an HIV treatment called Sustiva, or MK-0518, which prevents the human immunodeficiency virus from taking over a cell’s DNA. The program is currently in Phase III trials and has reportedly had great success so far with patients. (On Wednesday the company reported strong sales and raised earnings guidance for 2007—Editor.)

In sum, Merck is a fundamentally strong and underappreciated company with substantial profit margins that will probably outperform the market in weak periods. Currently trading at around $44, my early 2008 target is $53, which represents a 19x multiple on my 2008 earnings estimate. Don’t forget a $1.52 dividend, an additional 3% gain.

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