Merck's Growth Potential Remains Underappreciated

Undervalued Merck MRK reported third-quarter results that were ahead of our expectations, but we don't expect any significant changes to our fair value estimate, as some of the outperformance was driven by irregular vaccine orders. Nevertheless, the strong quarter (sales up 19%) reflects our view that the market underappreciates Merck's position in immuno-oncology and vaccines. Continued performance in these areas should drive investments to improve the firm's late-stage pipeline, a key pillar for its wide moat. Strong growth in human papillomavirus vaccine Gardasil (up 63%, partly due to tenders) and immuno-oncology drug Keytruda (up 21%) buoyed overall growth, and we expect continued robust sales for these leading drugs that represent close to half of total sales. With less than 10% of the eligible cohort taking Gardasil and new supply coming on line in 2023, we expect sales to almost double over the next decade, especially given very limited competition. New indications for Keytruda in earlier lines of therapy, including the likely positive adjuvant lung data in early 2022, should help contribute to our $10 billion in incremental Keytruda sales forecast over the next five years. We expect the strong core business to support investments in an underappreciated pipeline that needs more late-stage assets. We believe the recent positive data for oral COVID-19 treatment molnupiravir will lead to sales of close to $7 billion through 2022 (in line with management guidance) and shows the resilience of Merck's research and development. While we are less bullish than management on pipeline asset Vaxneuvance (pneumococcal vaccine) because of a competitive vaccine from Pfizer, novel drugs used with Keytruda look promising to offer improved efficacy and longer combination patents for Keytruda. We also expect continued pipeline-focused acquisitions like the recent purchase of Acceleron, which looks like a prudent use of capital to expand the firm's late-stage pipeline.

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