The conclusion of Merck & Co., Inc.’s (NYSE:MRK) recent $10.8 billion acquisition of Prometheus Biosciences was not well received by investors of the leading biopharmaceutical company. Due to the fact that its premium valuation needs to be carefully evaluated, Merck stock price has remained very close to where it was in June.
At the forthcoming results announcement for the second quarter, which will take place on August 1, the business plans to analyze the near-term impact on its earnings drivers and provide a more thorough view. The preliminary report provided by the company states that it is “expected to negatively impact earnings per share by approximately $0.25 in the first 12 months following the transaction’s close.”
In light of this, I am of the opinion that the impact is not going to be all that large, given that Merck is anticipated to announce an adjusted EPS of $7 based on the revised consensus projections. Even if this represents a 6.5% decrease year over year, it is highly unlikely that this will have a structural impact on Merck’s earnings growth. As a result, it is anticipated that Merck’s adjusted earnings per share would see a positive growth rate in FY24, amounting to a 21.8% gain.
Merck does not have an imminent patent cliff looming over its well-diversified portfolio; hence, Merck Bulls may claim that this justifies MRK’s premium price. In addition, Merck has a strong balance sheet, which boasts a net debt/forward EBITDA ratio of just 0.32x for FY23. This provides the company with a great amount of flexibility to capitalize on business growth possibilities to extend its pipeline.
Merck’s business strategy is built on the success it has had with Keytruda; however, the company also has a robust vaccine portfolio, which helps it maintain its position as a leader in the industry. Merck is anticipated to continue producing significant profitability and operating leverage as a result of the industry-leading production scale it possesses.
Not the Best Time to Buy Merck Stock
Nevertheless, it is essential to analyze if the current price of MRK supports the growth inflection that experts estimate will occur next year. I came to the conclusion that investors were not overly concerned despite the fact that the company’s recent purchase had a negative influence on the earnings that will be reported for this year.
Despite this, MRK traded at a forward EBITDA multiple of about 12x during its most recent trade, which is much higher than its 10-year average of 10.6x. According to the data provided by S&P Cap IQ, MRK has a forward adjusted P/E of 15.8x, which is significantly higher than the 11.5x median that is held by its Pharma competitors. This indicates that there has been no valuation dislocation despite the current sell-off.
As a result, I arrived at the conclusion that unless you have a high level of belief in MRK’s thesis, the current opportunity does not strike me as very appealing from the point of view of risk and return.
The latest fall in MRK’s price signals that the stock is getting ready to retest the lows it reached in June. However, the most important support zone to monitor is still MRK’s $100 level, which was strengthened by purchasers of dips in January and March.
The fact that holders weren’t willing to back a definitive breakout into higher levels when MRK took out its all-time highs is particularly concerning to me in regard to MRK’s highs in the month of May, which indicates that level. As a consequence of this, the lack of clear breakout buying momentum implies that perhaps the market was concerned about MRK’s relatively costly valuation.
Keeping this in mind, I strongly advise investors to give some thought to the possibility of delaying the addition of new positions at the current levels, as the ratio of risk to reward is pretty well-balanced, and there are no convincing technical buy triggers.
But if Merck stock could retrograde further toward the $100 region and hold its support zone robustly, it might open up another opportunity for dip buyers to add with more confidence considering an enhanced risk/reward profile. This would be the case if MRK was able to retrace further toward the $100 region.
Featured Image: Megapixl
