Summary
- MRK has gone into a tailspin since its Q4 conference call.
- It reported a fair but not great Q4, and surprised and disappointed the Street with a spinoff that will hurt MRK EPS for a while.
- I, however, like the spinoff and think that MRK is unduly cheap to the market, with bright prospects indefinitely.
- I'm willing to emulate Warren Buffett with MRK and just enjoy high and rising dividends while traders satisfy themselves that MRK is the real deal (which it is).
Introduction - how a growing mega-cap becomes a relative value play
Merck (MRK) reported Q4 and full-year earnings recently, and guided for 2020. Q4 sales were marginally below consensus, and guidance was probably cautious. The stock has gotten hammered since then. My guess is that there are a few reasons for this, including:
- relative undervaluation of large stable drug names
- increased worries about MRK's pipeline
- the spinoff.
I will discuss these points in order, with the third point the crux of the article. After these sections, I will comment on Q4 and the year ahead.
Large pharma/biotechs may simply be out of favor and thus undervalued
Rather than regurgitate P/Es, profit margins, political threats to drug prices, etc., I'd like to bring in an independent analytic house, Morningstar, and provide some info from a Feb. 12 commentary, 5 Cheap Stocks With Growing Dividends. The company discussed its criteria for dividend growth stocks and out of the 50 most heavily weighted stocks, only 5 were judged to be undervalued. The 5 were, with the ratio of the stock price to fair value shown:
- Chevron (CVX): 0.80
- Gilead Sciences (GILD): 0.82
- Merck (MRK): 0.83
- Pfizer (PFE): 0.83
- Wells Fargo (WFC): 0.85.
What is striking is that 3/5 of these names are large drug stocks. I wonder how many times that has happened before. Of these three names, both GILD and PFE are in some degree of turnarounds, with recent changes at the CEO level and with each new CEO pledging to improve performance. In contrast, MRK is sailing along with growing sales, cash flows, and EPS. Its growth has actually been mildly constrained by the need to construct additional manufacturing facilities for its blockbuster Gardasil vaccine.
It is a surprise to see three major drug companies in this grouping along with troubled WFC and an inherently-troubled oil major. It is especially strange to me to see a healthy MRK on this list.
Moving to the second bullet point:
