In the next few days,
will make two separate presentations to analysts that could be titled "Short-Term Pain!" and "Long-Term Gain?"
The pain presentation deserves an exclamation point because it's clear that on Dec. 8 the company will present the emphatically grim news of a post-Vioxx world. Merck will offer financial guidance for next year, the first long-term prediction since it withdrew its arthritis drug from the market on Sept. 30.
The gain presentation requires a question mark because Merck's Dec. 14 meeting will focus on the prospects in its research pipeline. So far, Merck's research efforts haven't done much to offset Wall Street's gloomy view about the next few years, which will be filled with patent expirations on big products, Vioxx lawsuits and speculation about Merck's strategic direction as CEO Raymond V. Gilmartin heads toward retirement -- sooner than planned.
Merck already has said that fourth-quarter 2004 earnings per share will be in the range of 48 cents to 53 cents. Analysts polled by Thomson First Call predict an average of 50 cents. The company's full-year prediction for EPS is in the range of $2.59 to $2.64; the consensus is $2.61.
The Thomson First Call consensus for Merck's 2005 EPS is $2.57, with estimates as high as $2.80 and as low as $2.40. The consensus for the first quarter is 57 cents, the midpoint of a range of 54 cents to 60 cents.
At the Dec. 8 meeting, analysts will likely focus on when Merck will establish a reserve for the ever-growing number of product liability lawsuits and securities issue-related lawsuits stemming from Vioxx. The company declined to set up a reserve when it made its Oct. 21 announcement on the projected financial damage in 2004 due to the Vioxx withdrawal.
At the time, Merck said it wasn't establishing a reserve due to the uncertainty over litigation. In its latest update, the company said it knows of 375 lawsuits as of Oct. 31. On Wednesday, analysts will no doubt ask about the financial impact of other matters -- Vioxx-related investigations by the
Securities and Exchange
and the Justice Department, as well as the downgrades by three credit-rating firms.
Merck's stock is "trading in line with
during the height of the diet drug litigation, with the expectation that Merck will be required to take large Vioxx-related reserves," said Mara Goldstein, of CIBC World Markets, in a recent report to clients. She was referring to lawsuits filed against Wyeth for its now-withdrawn diet drug combination nicknamed fen-phen. Litigation and settlement discussions continue; Wyeth has taken $16 billion in reserves, she said.
Even though Merck's shares are cheap, Goldstein said investors should "exercise patience" because the stock will remain under pressure for the rest of the year due to tax-loss selling and the upcoming revelations about 2005 guidance and future products. Goldstein has a sector perform rating on the stock. (She owns shares; her firm doesn't have an investment banking relationship.)
Goldstein predicts Merck will maintain its dividend, which, at a yield of 5.7% in mid-November, is the Big Pharma leader by a wide margin. The average yield for Big Pharma companies is 3%; the second-highest yield belongs to
Keeping the dividend "will be attractive to dividend investors, but this transition may take a while," she added. "We believe that investor sentiment has to capitulate ... before the dividend takes over as a key investment feature. But where could that point be?"
Like other analysts, Goldstein offers up a guess on Vioxx liability ranging from $4 billion to $15 billion. "Litigation that results in a $10 billion outlay could thus lower EPS by up to 50 cents pre-tax," she said.
Her estimate is dwarfed by the prediction from Sanford Bernstein & Co. that Vioxx lawsuits could cost Merck $38 billion. And if plaintiffs could prove negligence, the damage could go as high as $55 billion.
"We emphasize that it's as yet unclear whether plaintiffs have adequate leverage to win any verdicts or gain any settlements," said Richard T. Evans, in a Dec. 3 report to clients that outlined his worst-case scenario. "Assuming such leverage exists, total liability is likely to well exceed our original $12 billion estimate."
Evans has a market perform rating on the stock, but he just cut his price target by 10% to $30. "We wouldn't buy Merck regardless of Vioxx liability," he said. His $2.46 EPS prediction is 11 cents below the Thomson First Call consensus. (He doesn't own shares; his firm doesn't have an investment banking relationship.)
Bear Stearns analyst Joseph P. Riccardo has a much lower view of Vioxx's legal impact -- he estimates $16 billion -- as well as a much lesser view of Merck's management.
"Management succession is the primary risk to Merck shares in our opinion -- not Vioxx," he said in a research report last month. "
It's unclear to us ... who would take this job, nor do we have much confidence in the board."
Riccardo, who has a peer perform rating on the stock, said the best news for the stock would be an accelerated CEO hunt complete with an early departure by Gilmartin and "turnover on the board." Under the company's mandatory retirement policy, Gilmartin must leave by early 2006 and an executive search -- both inside and outside of the firm -- is already under way.
Riccardo said "a good CEO might be able to turn the company around." Without knowing who the next boss will be, "there is no way to analyze the fundamentals of this company." (He doesn't own shares; his firm has a non-investment banking relationship with Merck.)