Merck Earnings: Solid Results Led by Keytruda; Firm Working to Mitigate Eventual Biosimilar Pressure

We are maintaining our $103 fair value estimate for Merck MRK after third-quarter results that were slightly higher than we projected, but some of the outperformance was due to robust international sales of COVID-19 treatment Lagevrio that seem unlikely to continue. The underlying core business looks solid, with operational sales growth of 8% (excluding Lagevrio), led by cancer drug Keytruda (up 17%). Merck’s steady pipeline innovation, especially the movement of Keytruda into earlier lines of lung cancer, should enable a 5% annual compound growth rate over the next five years. Further, Merck’s earnings should grow faster as royalty payments on human papillomavirus vaccine Gardasil and Keytruda fall in 2024.

The solid outlook for Merck should continue until the 2028 patent loss on Keytruda (close to 40% of sales). Merck’s progress on its pipeline increases our confidence in the firm’s ability to support its wide moat and mitigate the eventual Keytruda biosimilar pressures. We are increasingly optimistic that a subcutaneous version of Keytruda will work based on recent data released for similar drugs. With close to 50% of Keytruda sales likely a target for the subcutaneous version and patent protection out to 2039, this new formulation could significantly reduce biosimilar pressure. We expect subcutaneous Keytruda data over the next 12 months. Also, new drug combinations (CTLA4, LAG3, TIGIT) with Keytruda could provide additional ways to slow the eventual Keytruda erosion curve.

Beyond Keytruda, Merck’s pipeline is advancing well. We remain most bullish on pulmonary arterial hypertension drug sotatercept and cancer drug V940. We expect U.S. Food and Drug Administration approval for sotatercept in the first quarter of 2024, followed by a strong launch based on excellent clinical efficacy. We expect V940 to begin a phase 3 non-small cell lung cancer study, which if as successful as the midstage melanoma study, could create a major new blockbuster for the firm.