Analyst: Merck's Fundamentals Don't Warrant Current Valuation

BMO Capital Markets downgrades the pharmaceutical giant ahead of Q2 earnings as pricing pressure mounts and other potential headwinds begin to emerge.
By Sarah Pringle ,

Investors in Merck (MRK) - Get Report ought to remain cautious ahead of its second quarter earnings results later this month, according to at least one company follower. 

BMOCapitalMarkets' Alex Arfaei wrote Monday that his firm is downgrading Kenilworth, N.J.-based Merck from Outperform to Market Perform as elevated risks outweigh the company's current fundamentals.   

Shares of Merck, listed on the New York Stock Exchange, slid about 1% to $59 a share in Monday morning's trading session. The stock has advanced about 13% this year so far. 

While BMO's Arfaei couldn't immediately be reached on Monday, the analyst wrote in July 18 report that Merck will continue to face pricing pressure in the Hep-C market in the near term and the immune-oncology space in the long-term as options in the sector increase. 

Other risks Arfaei cited include the U.S. presidential election, in which politicians' threats to roll back high drug prices could also to add to biopharma margin pressure; the potential impact of EliLilly's (LLY) - Get Report Jardiance CV label expansion on Merck's Januvia franchise; and the impact of an economic slowdown in the EU following Brexit, given the heavy, 24% exposure to the region of the company's pharma business. 

"Our positive views on Merck's fundamentals have not changed, but the market has mostly caught up," Arfae wrote. "The so called "TINA" (there is no alternative) effect is not enough for us to remain bullish at these levels; the fundamentals have not improved to justify higher valuations."

The possibility of an expensive deal adds to uncertainty, according to Arfaei. The analyst in May said that his firm believes Merck is preparing investors for a mid-size deal that could be as large or larger than its $9.5 billion purchase of antibiotics drugmaker Cubist, which was completed in January 2015. Likely targets for Merck are probably mid-cap biotechs in light of the sector's recent pullback, the analyst said.   

It was only last week that Merck announced plans to build up its Healthcare Services & Solutions subsidiary, purchasing a majority stake in private equity-backed StayWell from Vestar Capital Partners. 

Terms of the transaction weren't disclosed, but Merck will own slightly greater than 50% of Yardley, Pa.-based StayWell, The Deal, a sister publication of TheStreet, previously reported. The acquisition came to fruition after Merck last summer approached Vestar with an interest in the patient-engagement industry, and specifically in Staywell, a source familiar with the deal said. 

The company via its Merck Animal Health unit spent $400 million in a July 1 deal to purchase a majority stake in Brazil-based Vallee SA. The deal made Merck Animal Health the largest animal health company in Brazil and close to the biggest in the world behind Zoetis (ZTS) - Get Report

Merck is scheduled to hold its Q2 earnings conference call on July 29. 

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