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This Stock is a Standout in the Rapidly Consolidating Pharma Industry

For the next five years, experts predict that global pharmaceutical sales will expand by more than 5% annually, reaching a trillion dollars by 2020. Specialty and biologic drugs will account for more than 50% of those revenues. Oncology remedies will be the market leader, with growth expected to surpass 10% annually.

Biologics are manufactured in a living system such as a microorganism, or plant or animal cell, and make up the majority of the $60 billion+ that pharmas spend on research and development annually. That research continues to ramp up as demand increases globally for late-stage development drugs to treat new and emerging threats to global health.

And that’s where my recommendation today comes in. Recently recommended by our contributor Benjamin Shepherd of Global Income Edge, pharma giant Merck (MRK) is placing priority on drugs for unmet medical needs, including Ebola, for which the company has created a drug that is 100% effective in preventing infections.

Value, Growth and Innovation

Here’s what Mr. Shepherd had to say:

“The booming biotechnology sector has stolen the thunder from the big pharmaceutical companies in the last year, leaving the steady dividend payers among the Big Pharma group reasonably priced.

Merck & Co. (MRK) is particularly attractive now, because its shares are well off their 52-week high of $63. A big reason for that is Merck hadn’t had any drug breakthroughs in several years, but had focused on selling just a few major drugs rather than casting a wide drug development net. But a recent management shakeup has increased the company’s commitment to new drug discovery, particularly for diseases with few, or even any, effective treatments.

Another major plus is that Merck only faces a handful of patent losses over the next few years. However, most of the losses on expirations are being offset by its other major sellers and Merck’s strong pipeline of new drugs. Showing blockbuster potential are its recently launched Januvia for treating diabetes, Keytruda for melanoma, Isentress for HIV and its Gardasil vaccine used to prevent human papillomavirus.

Its Ebola vaccine, which was developed with NewLink Genetics and still needs to be approved, has been shown to be 100% effective in preventing Ebola infections, an impressive feat. Its work on the Ebola virus is also representative of Merck’s renewed focus on unmet medical needs. That’s not a novel approach, but the early 2000s were marked by major pharmaceutical companies competing head-to-head to treat the same basic diseases. There’s now more differentiation between the major pharmaceuticals, as Merck focuses on Ebola and the others work on other, less common, diseases. That parting of the ways actually makes it easier to pick out the best pharmaceutical companies.

Merck financials are strong, with just over $40 billion in revenue last year, and free cash flow over the trailing twelve months amounted to an impressive 14% of total sales. That helps to support more than $6 billion in annual research and development spending, a driving force behind Merck’s success in launching new drugs. The company also carries very little debt, with a debt-to-equity ratio of just 0.38.

Despite its strong financial position and its pipeline of 38 drugs in late-stage development, Merck is undervalued relative to its peers. It trades at just 14.5 times trailing twelve months earnings, versus the industry average of 17.6 and its own five-year average of 30.3. And while earnings are expected to be relatively flat this year versus last year ($3.50 this year versus $3.49 in 2014), it is expected that they will hit $3.79 next year and $4.41 by 2018.

Part of the reason why Merck is undervalued relative to its peers is its earnings are expected to take a few years to ramp up after its recent new launches. But that also means this is a good time to pick up shares on the cheap, especially since that earnings ramp up means dividend growth down the line is a strong possibility. That’s particularly true since Merck pays out more of its earnings in the form of dividends then its major competitors, even while keeping debt low and funding a large R&D program.

Large investors seem to be recognizing Merck’s long-term potential though, with data from Morningstar showing that buying activity from institutional investors and mutual funds is picking up. With a dividend that has room for growth, a full pipeline and potential blockbuster drugs in the works, Merck is a buy up to $65.”

merck chart

A Top 10 R&D Spender

Merck has new management, and has returned to its successful track record of aggressively developing new drugs, and now boasts a very healthy pipeline. As such, the company is listed as one of the top 10 spenders on R&D—expending some 17% of its annual revenues on new drug research.

And investors should be happy to note that its top R&D investment priorities are oncology, infectious diseases, vaccines and diabetes—some of the fastest-growing healthcare challenges. Merck is currently engaged in160 clinical trials for more than 30 tumor types in 25 registrational trials.

That’s a lot of money invested in the future, and presents Merck with a tremendous opportunity to continue growing its market share. In terms of sales, Merck is number five globally, after Novartis, Pfizer, Roche and Sanofi—giving the company plenty of incentive to continue organic and acquisitive expansion.

During the first six months of 2015, global M&A deals reached an estimated $221 billion—three times the deals booked during the first half of 2014. And Merck is a keen participant. This past January, Merck acquired antibiotics specialist Cubist Pharmaceuticals for $8.3 billion, and paid $3.9 billion in 2014 for Idenix Pharmaceuticals, developer of a hepatitis C drug.

Recently, Merck CEO Kenneth C. Frazier said, “Merck remains on the hunt for acquisitions and drug-licensing deals that could bolster the company’s drug development.”

Ripe for Appreciation

With big pharma companies cash-rich and biotechs often cash-poor, it’s no surprise that M&A is so robust in the industry. Mr. Shepherd also mentioned that “There’s now more differentiation between the major pharmaceuticals,” and that is also true with smaller biotechs who are driving innovation via unique, clinically differentiated assets.

That sounds like a great marriage opportunity between emerging biotechs and the big pharma who are focusing on similar drug discovery paths, doesn’t it?

And Merck, emerging from a five-year period of so-so earnings, is looking to shine. Last quarter, the company beat analysts’ estimates by four cents, and recently, the shares were recommended by Todd Campbell on Motley Fool, who commented, that “If the FDA approves Merck & Co.'s new hepatitis C therapy on its expected Jan. 28 decision date, then Merck & Co. could take away billions in hepatitis C drug sales from competitors Gilead Sciences, and that makes it one of my top stocks to buy this month”.

Undervalued, and ripe for appreciation, the shares also pay a healthy dividend of $1.84 per share, annually—a dividend that has been increased every year since 2010.

Growth and income—maybe a pretty good bet for what is setting up to be another volatile year in the markets.

Happy investing,


Nancy Zambell
Editor, Wall Street’s Best Investments and Wall Street’s Best Dividend Stocks

Nancy Zambell has spent 30 years educating and helping individual investors navigate the minefields of the financial industry. She has created and/or written numerous investment publications, including UnDiscovered Stocks, UnTapped Opportunities, and Nancy Zambell’s Buried Treasures under $10. Nancy has worked with MoneyShow.com for many years as an editor and interviewer for their on-site video studios.