MRK Preview: What Is the Catalyst?

Merck (MRK - commentary - Cramer's Take) reports Monday morning before the bell, and analysts expect the company to post earnings of 83 cents per share on $6.04 billion in revenue, for year-over-year growth of 1% in EPS and a 1.5% decline in revenue.

The weekly chart tells the whole story within large-cap pharma, with the stock down more than 50% from its late 2000 high near $90 per share. And to top it all off, even with health care starting to outperform, Merck is still down 35% year-to-date, even worse than most of the large-cap financials.

MRK Weekly Merck

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Source: Worden.com

The macro issues impacting large-cap pharma have been well-documented, thus we'll focus on Merck and what this earnings report might hold.

All one has to do is look at the trends in Merck's earnings and revenue estimates for clues to the stock's direction:.

At $36 per share, Merck is trading at 11 times and 10 times 2008 and 2009 EPS estimates, respectively, for expected growth of 10% for 2009, thus the stock is hardly expensive. (The remarkable thing about large-cap pharma stocks is that R&D is expensed, not capitalized. Thus, if we added back R&D to large-cap pharma's earnings, the stocks would look even cheaper.) Merck continues to get buffeted, however, by both the FDA - the company's key cholesterol drug, Cordaptive, was issued a "non-approvable" letter -- and the pending litigation over the Vioxx scandal. (The company made a $5 billion offer to settle the case, even though two appellate cases found favorably for Merck.) Right around the same time Merck got the non-approvable letter on Cordaptive, a non-approvable letter was received on the Claritin/Singlair tablets, thus analyst cut estimates for 2008 and 2009.

Looking at cash flow, with a $75 billion market cap, Merck is trading at about 10 times price-to-cash from operations (about $7.5 billion per year), and, as you would expect, free cash flow generation is sizable, north of $5 billion per year. The dividend is currently consuming about half of cash flow.

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At the time of publication, Gilmartin had no positions in the stocks mentioned, although positions may change at any time.

Brian Gilmartin, CFA, founded Trinity Asset Management (TAM) in 1995, where he is currently a portfolio manager. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gilmartin appreciates your feedback; click here to send him an email.