Citi: MRK: Solid Januvia Data at the ADA
HOLD (2)
Medium Risk (M)
Mkt Cap: $73,684 mil.
June 14, 2006 SUMMARY
* On June 13, data on Januvia & Galvus was presented at an ADA late-breaker.
* A 52 wk study vs. glipizide established non-inferiority of Januvia & also demonstrated a more favorable safety profile on weight loss & hypoglycemia.
* The safety & efficacy of 100mg Galvus once-daily was also demonstrated in another study that evaluated the agent as an add-on therapy to pioglitazone.
* Januvia & Galvus appear to be broadly comparable products. The PDUFA date for Januvia is expected in mid-October & Galvus about one month later.
* DPP-IV inhibitors appear to be attractive agents (used as early as second-line therapy) by virtue of their weight neutrality, clean safety profile, and satisfactory anti-glycemic activity.
* We continue to stay on the sidelines w/ MRK given val. (~10% prem. to drug P/E), restructuring execution risk & our expectation of modest LT EPS growth, but would become opportunistic on Vioxx litigation related pullbacks.
FUNDAMENTALS
P/E (12/06E) 14.2x
P/E (12/07E) 14.7x
TEV/EBITDA (12/06E) 10.9x
TEV/EBITDA (12/07E) 12.4x
Book Value/Share (12/06E) $8.63
Price/Book Value 3.9x
Revenue (12/06E) $21,390.0 mil.
Proj. Long-Term EPS Growth 0%
ROE (12/06E) 28.1%
Long-Term Debt to Capital(a) 18.6%
MRK is in the S&P 500(R) Index.
(a) Data as of most recent quarter
SHARE DATA . RECOMMENDATION
Price (6/13/06) $33.37
Rating (Cur/Prev) 2M/2M
52-Week Range $36.23-$25.85
Target Price (Cur/Prev) $37.00/$37.00
Shares Outstanding(a) 2,208.1 mil.
Expected Share Price Return 10.9%
Div(E) (Cur/Prev) $1.52/$1.52
Expected Dividend Yield 4.6%
Expected Total Return 15.4%
OPINION
The DPP-IV class of drugs has been a focus at the 2006 ADA. On June 13, at the
late breaking session of the ADA, MRK presented additional data for Januvia
that further supports its clinical profile for the treatment of type II
diabetes.
Januvia and Galvus appear to be largely comparable products with convenient
oral dosing, satisfactory glycemic control, weight neutrality, and clean safety
profiles. Both drugs have shown the potential to positively influence beta cell
function. Importantly, Novartis presented data that Galvus 100mg is an
effective once-daily drug with efficacy comparable to Galvus 50mg twice-daily
(Januvia is dosed 100mg once-daily). According to Novartis, 73% of patients
take metformin twice daily, diminishing the importance of a once-daily dose.
We note Januvia has more specificity than Galvus for DPP-4 (versus DPP-8 or
DPP-9, which are associated with side effects); however, the side effect
profiles presented thus far appear to be clean and broadly similar.
We note that MRK has a potential slight lead in time to market (NDAs for both
drug were filed in early 2006). Additionally, MRK recently announced it now
plans on filing the NDA for a Januvia/metformin fixed pill in 2006 (versus 2007
previously as expected); Novartis has not announced a filing timeline for their
fixed metformin combo pill. We continue to forecast worldwide Januvia sales of
approximately $1 billion by 2010, which implies a 65% rampup of Avandia (the
DPP-IV market may be slightly more crowded with potential entrants from BMY,
GSK, etc. over the next few years).
MRK will likely experience a plethora of meaningful datapoints for key pipeline
compounds in the coming months, including the launches of Gardasil and Januvia,
which both appear to be significant commercial opportunities. We note the ACIP
will convene June 29-30 to decide whether to endorse routine vaccination with
Gardasil; the PDUFA date for Januvia is mid-October, and Phase II data for MK-
0524 will likely be presented at the AHA meeting in November. That said, we
continue to stay on the sidelines with MRK given valuation (~10% premium to
drug P/E), restructuring execution risk and our expectation of modest long-term
EPS growth, but would become opportunistic on Vioxx litigation related
pullbacks.
STUDY DEMONSTRATES NON-INFERIORITY OF JANUVIA TO GLIPIZIDE
Study Methodology: The data presented at the late breaker on Januvia included
results of a large, multi-center, double-blind study. In this study, after a
two week run-in period with metformin monotherapy (>1500 mg/day), 1,172
patients were randomized to receive either 5-20 mg/ day of glipizide (n=584) or
100 mg once-daily of Januvia (n= 588). Patients were then followed up for 52
weeks. The mean duration of type II diabetes was six years and mean HBA1c was
7.5%.
Efficacy Results: The results established Januvia's non-inferiority to
glipizide, with patients on Januvia experiencing HBA1c reductions in the range
of 0.26-1.68% (depending on the baseline HBA1c level). This was comparable to
the 0.14-1.76% reductions seen in the glipizide arm. Please refer to Table 1
for a breakup in HBA1c reduction by patient segment.
Table 1: Segmental breakup of reduction in HBA1c from ADA late breaking study
Safety Results: Januvia fared better than glipizide on two parameters - total
weight loss and incidence of hypoglycemia. While the glipizide arm witnessed a
net weight gain of 1.2 kg, the Januvia arm actually witnessed a weight loss of
1.3 kg (p<0.001). Similarly, the incidence of hypoglycemia at 4.9% was much
lower in the Januvia arm as compared to the glipizide arm, which was at 32%
(p<0.001). Overall, Januvia was well tolerated without any significant side
effects or discontinuations. Please refer to Table 2 for the safety results
from the late-breaker study.
Table 2: Safety results from ADA late breaking study
VALIDITY OF ONCE A DAY DOSE OF GALVUS ESTABLISHED
The late breaking session also included a presentation of results from a 24
week study that compared Galvus with pioglitazone. Patients taking Galvus (100
mg/day) had a reduction of -1.1% in HBA1c levels. Further, patients taking
Galvus as an add-on to pioglitazone saw average reduction of 1.9%. This study
demonstrated the safety and efficacy of Galvus, when administered as a single
100 mg dose. Other studies presented at the ADA evaluated Galvus 50 mg twice
daily.
VALUATION
Our $37 target price for Merck is based on the average of two valuation
methodologies: 1) relative price/earnings (P/E) ratios compared to the U.S.
large-cap drug industry and 2) a residual earnings model.
Our relative P/E value of $35 assumes Merck will trade at a 5%--10% premium to
the 2007E drug multiple of 13.8x on our 2007 EPS estimate. We note this trading
range is higher than Merck's historical mean of an ~10% discount to the drug
multiple over the past decade (range of a 25% discount to a 15% premium).
However, we believe a premium to the 2007E drug multiple for Merck shares is
appropriate, given its increasingly promising pipeline, and encouraging
restructuring program ($4.5--$5 billion in savings expected from 2005--2010).
Applying our residual earnings model to Merck, we calculate a value of $39.
Our residual earnings model incorporates the company's current book value and
present values of the company's future residual earnings. We use our earnings
and dividend expectations through 2009 to estimate future residual earnings,
and discount our 2010 estimate to perpetuity. We assume a constant growth rate
of 4.25%, a required return of 8.4%, which assumes a beta of 1.10, and a market
risk premium of 3.9%. While Merck has a three-year beta of 0.52 (according to
Bloomberg), we note that it has increased significantly in recent months as a
result of the ongoing Vioxx litigation. Following the first Vioxx ruling (Ernst
versus Merck, August 19, 2005), we observe a Merck beta of 1.62 (according to
Bloomberg), significantly higher than the company's historical beta. Based on
this recently observed increased volatility (associated with the Vioxx
litigation), we believe it is intuitively reasonable to assign Merck a beta of
1.10 (higher than its historical average) to better capture the company's
present risk profile and expected volatility going forward.
RISKS
We rate Merck Medium Risk because of its strong balance sheet and cash-
generating ability. However, we note that Merck is exposed to a fair amount of
generic risk, with 31% of its 2005 sales exposed to generic cannibalization
over the 2005--2010 time frame; this is largely due to the Zocor (June 2006)
and Fosamax (February 2008) patent expirations, which could result in greater-
than-expected margin erosion. With respect to the Vioxx withdrawal, Merck faces
approximately 11,500 product liability cases, which include roughly 23,350
plaintiff groups. We expect the company's caseload will continue to grow in the
future. Additionally, we note Merck's restructuring program includes a fair
amount of execution risk. Mitigating the above concerns are Merck's significant
financial flexibility and resources. If Merck's Vioxx product liability were
diminished further, the stock could appreciate above our target price.
Investment risks related to the pharmaceutical industry include ongoing
political, product development, and regulatory risks, as well as various
pricing pressures.
If the impact on the company from any of these factors proves to be
greater/less than we anticipate, it may prevent the stock from achieving our
target price or could cause our target price to be materially outperformed.
INVESTMENT THESIS
We rate the shares of Merck Hold / Medium Risk (2M). Merck's earnings growth is
largely driven by four key franchises: its cholesterol franchise (Zocor, and
the Schering-Plough joint venture products, Zetia and Vytorin), Fosamax for
osteoporosis, Cozaar/Hyzaar for hypertension, and Singulair for asthma/allergic
rhinitis.
However, Merck's long-term EPS growth is largely pressured by rolling patent
expirations for Zocor in non-U.S. markets (2005 non-US sales of $1.2 billion),
which began in 2Q03; U.S. Zocor (2005 U.S. sales of $3.1 billion) losing
exclusivity in June 2006; and Fosamax losing exclusivity in February 2008.
Mitigating these challenges is improving visibility of the company's pipeline
and a major restructuring program, which is expected to yield $4.5--$5 billion
in savings from 2005--2010. Merck is expected to launch three vaccines in 2006
--- Gardasil (for cervical cancer), Zostavax (for shingles), and Rotateq (for
rotavirus). The company's next wave of product launches includes Januvia for
Type-II diabetes and MK-0524 for cholesterol reduction. All considered, we
expect Merck will return to earnings growth in 2008 and estimate the company's
2005--2010E EPS CAGR to be ~3%. Potential product liability charges from the
global withdrawal of Vioxx, due to cardiovascular safety risks, will also
create stock volatility. Despite these challenges, we believe downside should
be limited given Merck's ~4% dividend yield. Accordingly, we rate Merck Hold.
I, George Grofik, research analyst and the author of this report, hereby certify .... |
