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Morningstar | Merck Posts Strong 1Q, Supported by Robust Keytruda Growth and Fading Generic Pressures

Merck reported first-quarter results slightly ahead of our expectations, but we don't expect any changes to our fair value estimate based on the minor outperformance. We continue to see the company as largely fairly valued with the strong outlook for Merck's immuno oncology platform largely factored into the stock. We believe this strong cancer platform, combined with a solid portfolio of branded products, support Merck's wide moat.

In the quarter, total sales increased 11% operationally, buoyed by 60% growth from cancer drug Keytruda offsetting decelerating generic competition to cardiovascular drugs Zetia and Vytorin as well a slight decline from diabetes drugs Januvia and Janumet. While we expect Keytruda gains to slow as the key U.S. market in non-small cell lung cancer (NSCLC) is becoming more saturated with Keytruda use close to 70% in the PDL1 positive patient group, we continue to expect peak annual Keytruda sales of over $18 billion, supported by significantly more usage in NSCLC outside the U.S. as well new indications in renal, small cell lung, and triple negative breast cancer in the near term. Also, beyond Keytruda, we expect additional growth from human papillomavirus vaccine Gardasil that posted 31% growth in the quarter, buoyed by growth in China. These growth drivers should continue to drive solid overall top-line growth as Merck faces less patent losses in the near term.

On top of the solid top-line growth, Merck is posting improving operating margins that we expect will continue, partly driven by the high-margin contribution of Keytruda gains. With pricing close to $150,000 per annual course of treatment and relatively lower marketing costs, Keytruda should help drive expanding margins over the next several years. We project operating margins will expand by over 300 basis points over the next three years.

On the pipeline front, Merck is making strides, but we believe the breadth of its late-stage pipeline needs to expand beyond new indications expected for Keytruda. We remain skeptical that Merck's next generation pneumococcal vaccine V114 will be able to gain share from Pfizer's entrenched position. However, the early-stage data on HIV drug MK-8591 looks promising, and we believe the drug represents one of the more important drugs in the firm's pipeline.