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Morningstar | MRK Updated Forecasts and Estimates from 29 Oct 2018

Buoyed by robust Keytruda sales, Merck reported solid third-quarter results slightly ahead of both our and consensus expectations, but we don't expect any significant changes to our fair value estimate, based on the minor outperformance. We continue to view Merck as fairly valued with the upside of the company's strong immuno-oncology platform largely in the stock. However, we continue to view the strength of this platform, led by Keytruda, as a major reflection of the strong innovation occurring at Merck that supports its wide moat. Outside of oncology, Merck's innovation in early-stage drugs is improving in virology with HIV drug MK-8591 (Phase II data in 2019) and in vaccines with pneumococcal vaccine V114 (Phase II infant data in 2019).

In the quarter, Keytruda growth of 82% year-over-year helped offset generic competition to older drugs, leading to overall growth of 6%, similar to a 5% top-line growth rate we expect will continue over the next three years. Keytruda is gaining strong market share in several cancer types, including the largest indication of first-line non-small cell lung cancer, or NSCLC, and is on track to post close to $7 billion in sales in 2018. We expect peak sales for the drug of over $15 billion based on continued market penetration in NSCLC as well as smaller cancer indications, including skin, bladder, renal, head and neck cancer. Keytruda's leading efficacy in first-line NSCLC should support gaining almost 50% of the immuno-oncology market by 2022.

Outside of Keytruda, Merck's remaining drugs continue to perform as expected with the exception of human papillomavirus vaccine Gardasil, which posted extra gains partly due to stockpiling. The company's second largest drug Januvia/Janumet was down 1% and we expect minor declines to continue based on weak pricing power in the diabetes market. Also, generic pressure continues to weigh on cardiovascular drugs Zetia and Vytorin as well as immunology drug Remicade.

For a deeper dive into the outlook for Keytruda and competitive immuno oncology drugs, please see our report "Overall Immuno-oncology Market Underappreciated, Supporting Undervalued Wide-Moat Firms Roche, Merck, and Bristol-Myers." Please note Merck's stock price has increased since this report was published and we now view Merck as fairly valued.

Outside of the results, Merck also announced a raise in its dividend by 15% and a new $10 billion share repurchase program. We believe the strong cash flow generation from the firm will easily support these uses of cash.