MRK Summary: Cutting Costs to Spur Growth

For Gilmartin's preview heading into the Merck conference call, please click here.

Merck (MRK - commentary - Cramer's Take) reported third-quarter 2008 earnings before the bell this morning, printing operating earnings of 80 cents a share and $5.944 billion in revenue, for year-over-year growth of 7% and unchanged, respectively. Merck guided 2008 EPS to $3.28 to $3.32, vs. a consensus estimate of $3.28 prior to the call.

Mean analyst estimates coming into the call were looking for 79 cents in EPS and $5.977 billion in revenue.

While revenue remains the biggest challenge for Merck given the Gardasil and Singulair pressure, the most striking news from the press release and the conference call was that a 2008 "global restructuring effort" was being launched that would eliminate 12% of jobs by 2010 and generate cumulative savings of $3.8 billion to $4.2 billion from 2000 to 2013.

As of this writing, I'm unsure what this will do to the current '09 and '10 EPS consensus of $3.54 and $3.74, which is calling for expected EPS growth of 7% in 2009 and 6% in 2010, but since Merck management is trying to generate double-digit earnings growth from cost-cutting, assume the '09 and '10 estimates will be revised higher.

Merck is doing what it can to generate returns for shareholders while faced with a pipeline of drugs facing stiff challenges and the prospects of a stronger dollar in '09 and '10.

One unqualified strength to Merck's fundamentals is the balance sheet and substantial cash flow: Cost-cutting should only boost cash flow. $2.6 billion remains under the company's share repurchase plan, according to the press release. Management might be hesitant to dramatically boost the dividend given the current 5% yield. Looking at a couple of cash-flow models, if Merck can generate $9 billion to $10 billion in cash flow per year, with $1.5 billion dedicated to capex and $3.5 billion dedicated to the dividend, Merck will turn half its cash flow into free cash flow, which will provide a nice safety net for the stock.

No positions.

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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.