Will Generics Sink Merck’s Fleet of Flagship Drugs?

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Merck & Co. (NYSE:MRK) woke up on the wrong side of the bed on Monday. Shares fell as much as 2.2 percent in early trading after the pharmaceutical company reported third-quarter financial results that fell short of expectations. Total sales fell nearly 5 percent to about $11 billion, missing the mean analyst estimate of $11.12 billion (a 3.2 percent contraction on the year). Adjusted earnings did come in ahead of expectations at 92 cents per share, down from 95 cents per share in the year-ago period, but un-adjusted (GAAP) net income fell 35 percent to just 38 cents per share, down from 56 cents per share on the year, largely thanks to competition from generic drugs as patents expired.

Merck reports that unfavorable foreign exchange accounted for a 2 percent decline in worldwide sales — the rest of the damage can pretty much be explained away as the expiration of patents on flagship drugs. Sales of Singulair, a drug used for the treatment of asthma and allergies, fell 53 percent to just $280 million in the third quarter, a far cry from the $5.5 billion or so the drug was bringing in every year up until August 2012, when the patent expired.

Meanwhile, sales of Vytorin, a drug used to treat dyslipidemia, fell 6 percent, and sales of Januvia, an antidiabetic drug, fell 4 percent. Merck’s pharmaceutical division accounts for about 86 percent of total sales.  Januvia accounts for about 10 percent of pharmaceutical sales.

One of the timeless challenges facing all pharmaceutical companies is how to deal with the issue of patent expiration. Generally, the winning strategy is to keep refreshing the fleet of flagship drugs, but Merck has had a hard time boosting sales of its other drugs recently. This struggle has made itself evident in the stock’s sideways movement over the past several months. Shares have pretty much gone nowhere since June, and have spent most of October sliding.

Reduced guidance appeared to be the nail in the coffin. Merck narrowed its full-year adjusted earnings target to between $3.48 and $3.52 per share (un-adjusted to between $1.61 and $1.79). The firm expects full-year sales to fell between 5 and 6 percent, with a 2.5 percent negative impact from foreign exchange.

Pfizer (NYSE:PFE), another major pharmaceutical company, will report earnings on October 29. Analysts are expecting the firm to report a 9.1 percent decline in revenue to $12.7 billion, but a slight gain in earnings to 56 cents per share, up from 53 cents per share in the year-ago period. Pfizer stock has spent most of August rallying, and is up about 6 percent of the past 30-day period. With 18 percent year-to-date gains, Pfizer has outperformed Merck this year to date.

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