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MERCK: A SLEEPER AMONG THE DRUG STOCKS?Viagra is proving to be a blessing for Pfizer's stockholders as well as for men suffering from impotence. In the days following Viagra's early April launch, Pfizer (PFE) shot up about 20%, although it has since fallen back from its Apr. 24 high of 118 to close at 113 13/16 on Apr. 30. While some analysts think it still has plenty of room to rise, others say the stock is just too high. Indeed, on Apr. 30, CS First Boston analyst James Kelly dropped Pfizer from a "buy" to a "hold" because he thinks Viagra's impact has already been priced into the shares. Case closed for drug stocks? Hardly. If you're looking for a cheaper drug play with some hidden potential, Merck & Co. (MRK), while not a sure-shot, could prove a better bet. Although it's also a pharmaceutical giant, Merck's shares are much cheaper than many of its competitors right now. Merck is trading at a current price-earnings ratio of 31, while Pfizer's multiple is 64. That means investors are currently willing to pay about twice as much for Pfizer, as well as for shares of some other high-priced drug stocks like Warner-Lambert (WLA) and Eli Lilly (LLY), than they are for Merck. But analysts tracked by First Call actually have the same average rating for Merck as for Pfizer (1.8 out of a range of 1 to 5 from best to worst). "I love Merck," says David Saks, a Gruntal & Co. analyst who rates it a "strong buy" based on its low valuations, promising drug lineup, and record of long-term earnings growth. "It is one of the bluest of the blue chips," he says. "People are in a buying panic for drug stocks. They see Merck is at the low end of the range, so even if they don't have the intuitive knowledge to differentiate among drug stocks, they are buying it." Merck, which released positive test results for its upcoming migraine treatment on Apr. 30, gained 4 1/2 points to close at 120 1/2 on that day. GENERIC TROUBLE? Frank Sustersic, a health-care analyst and portfolio manager at Turner Investment Partners, recommends taking some profits in Pfizer now and adding to Merck. "The only stock that is cheaper based on '98 earnings is Pharmacia & Upjohn [PNU]," says Sustersic, "which really has a lot of problems." To be sure, Merck has problems of its own. Its stock price lagged behind its drug-company cohorts in 1996 and 1997 as investors became increasingly nervous that many of its best-selling drugs were coming off patent, which opens them up to competition from cheaper generic products. While Saks is enthusiastic, other analysts still think Merck's pipeline looks rather dry. Also, some of Merck's star drugs have been clobbered by rivals who've come out with superior products. For example, Eli Lilly's Evista, an osteoporosis treatment that may also lower cholesterol and fight breast cancer, took the wind out of the sails of Merck's Fosomax, which also treats osteoporosis. One of Merck's best-selling drugs, Zocor, which reduces cholesterol, seems to be losing out to Warner-Lambert's Lipitor. Merck's stock did get a boost in January, 1998, with the launch of Propecia, a treatment for male pattern baldness. Although it's superior to Rogaine as a preventative, it is far from a cure, and the drug's sales have disappointed some analysts thus far. PENNY SHY. Merck's earnings have also been a bit of a letdown to some analysts recently. Its shares fell 5 points, to 118, on Apr. 16 when it reported first-quarter earnings that were a penny shy of Wall Street consensus estimates. The stronger dollar combined with less-than-expected sales abroad, especially in Japan, dampened sales growth, which was up only 9% over the prior year's quarter. Still, Merck reported quarterly sales of $6.1 billion and net income of $1.16 billion, or earnings of 95 cents a share, a 16% increase over the first quarter of 1997. Merck expects to deliver "double-digit" EPS growth in 1998, Chairman Raymond V. Gilmartin told the company's annual meeting on Apr. 28. And analysts predict long-term earnings growth of 14% a year. Analysts say all that news, both good and bad, has been priced into the current stock price -- if not excessively. "I think the Merck pipeline is probably a lot stronger than people give it credit for," says Sustersic. He points to some promising nonsteroidal anti-inflammatory drugs for arthritis that are in development and should have sales in the billions. Merck also has drugs for glaucoma, angina, and migraines pending Food & Drug Administration clearance. A study presented on Apr. 30 at the American Academy of Neurology showed that Merck's Maxalt relieved migraine pain and symptoms faster than the leading oral treatment for migraines. Merck is also investigating a new class of drugs that could be used to treat depression and schizophrenia. It has strong sellers in Crixivan, a protease inhibitor; Zocor, which lowers cholesterol; and new asthma medications. "Singulair, for asthma, is off to a quick start and is our favorite product in the Merck lineup," Merrill Lynch analysts wrote in an Apr. 17 report. Sustersic also thinks Propecia could prove a stronger seller than expected, now that Merck has begun a new direct-to-consumer marketing campaign. CAGEY COMPETITOR. A titan in research, Merck may well prove to have a stronger pipeline than most analysts suspect. While other companies will promote drugs in earlier stages of development, Merck "won't show everything in their stable," says Sustersic. Plus, he thinks Merck may be able to ward off competition from the generic-drug companies longer than expected. "In the past, Abbott Laboratories, Schering-Plough (SGP), American Home Products (AHP), have been able to fight off generic competition through various means," he says. "I think Merck, while not public about it, will be able to use some tactics also." The biggest boost to Merck's shares, however, would come if it were to use its tremendous financial strength to acquire another drug company. Although rumors have it that Chairman Gilmartin against such a move, some analysts think he may be pressured to do so by his board. Merck clearly faces challenges. "This all adds up to a lot less maneuvering room for Merck than perhaps it is traditionally used to -- and [it must] execute flawlessly," Merrill Lynch analysts wrote in their recent report, which rated Merck only "neutral" in the intermediate-term and "accumulate" in the long-term. But, if Gruntal's Saks is right and Merck is really the "bluest of blue chips" it will come through this rough patch hale and hearty. With Merck's star currently dimmed a bit dimmed, this may prove a good time to add it to your portfolio -- and wait for it to brighten again.
By Amey Stone, Associate Editor, Business Week Online, with Amy Barrett in Philadelphia and Joseph Weber in Toronto RELATED ITEMS
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Updated Apr. 30, 1998 by bwwebmaster
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