hey YouTube I'm Jimmy in this video I'm gonna walk through my analysis of Merck
ticker symbol MRK this is a 19th video in our series where we're analyzing all
30 stocks in the Dow Jones Industrial Average you can see a link to all those
other videos in the description below well once we're done with our analysis
we're going to take all of that analysis and we're going to try to build three
different portfolios a dividend a value in a growth portfolio so Merck is
the global healthcare company that has prescription medicines vaccines biologic
therapies and animal health care products we're gonna break out their
business into a four main segments we're gonna have human health
vaccines animal health and then alliances this chart breaks out each of
their segments by its contribution to revenue and as we could see human health
is by far the largest segment and that accounts for about 73 percent of revenue
vaccines is the second largest with a bit over 15% animal health is the third
right around ten percent and then alliances is right around two percent
now the Alliance segment is the smallest and that consists of collaborations with
other companies one example of this is back in March of 2018 Merck teamed up
with a company that created some tyrosine kinase kinase kinase inhibitors
and it's supposed to be a really big deal in the potential is something that
could really help the medical industry ultimately if that collaboration ends up
generating revenue this is where it'll fall then we have animal health this
segment discovers develops manufactures and then sells products like vaccines
and other animal health like products they sell them to veterinarians
distributors and animal breeders now the company says that there are many
synergies between the animal health segment and the human health segment and
specifically when it comes to research and development
and if we think about it that makes a lot of sense since I would imagine I
could see how those two research areas could overlap now this is also an
important point from an investing if we're going to value the company from an
investment standpoint because one of the techniques you can use to value a
company it's called sum of the parts where in theory what you do is you say
what does each segment worth if we spun it off in minutes on business that
wouldn't really work in this scenario now that we know that there's so many
synergies between those two because without animal health and human health
sort of collaborating and sharing each other's information and research with
each other then it's likely to slow down both companies so that would make that
type of analysis a bit weaker okay then there's the vaccine segment this segment
is exactly what you might think they make vaccines and they've actually been
a pretty good source of growth for Merck recently but we'll get more to that in a
minute then we have the largest segment that is
human health we can also probably call this pharmaceutical drugs since that's
primarily what they do in fact in the business section of their 10k that's
where I always start whatever I'm tackling a new company well they have
their reportable segments as pharmaceuticals and they include human
health and vaccines in there now for me I combine I separated those two out
instead of combining them because I figured it would give us a better
understanding of what potential growth drivers we have okay so now let's look
at revenue so as we could see revenue declined a bit from 2011 over to 2015
and then had a few small upticks in 2016 and 2017
now analysts estimates there the green bars while analysts are expecting for
revenue to approach the highs of 2011 they expect that to happen in the next
few years now 2018 the estimates for 2018 that's mostly just a fourth quarter
since the first three quarters are already in and Merck has already put up
a bit over 31 billion dollars in revenue through the first three quarters so to
get to the level of estimates here Merck only needs to put up about 11 billion
dollars more in the fourth quarter which is possible especially since fourth
quarter has been a rather strong quarter for them in recent years so now if we
look a bit closer at each of the segments one thing that we can see is
human health when we add that to the chart we could see that that's
consistently been a large driver of overall revenue and we'll look closer at
this segment in a few minutes now I don't have any projections for any of
those segments in order to come up with that we'd have to build essentially a
full model to try to value Merck and try to project what businesses would look
like that would take a ton of time if you're interested in seeing something
like that let me know in the comments below because that might make for an
video I could probably use an old one that I've done and just updated with new
numbers and then walk everybody through how I would build something like that
either way it seems that human health has been about flat recently now when we
add vaccines we could see that vaccines has climbed nicely in recent years now
just so we're all on the same page notice that I added a right-hand access to this
whole chart I did that so we could see the individual lines a bit more clearly
if we kept them on the same axis the chart would look like this and its
really tough to tell whether or not there's anything interesting happening
there so for all the different segments going forward I'm going to use the right
hand axis so don't compare those to the first two company of two the first two
lines in the chart just we're looking more at the trend and if we remember
vaccines the second largest segment they get about 15% of overall revenue so we
can sort of compare them to each other the three that we're about to add now if
we add animal health we could see once again it seems to be grown quite nicely
then if we add the smallest segment alliances we can see that it's a bit
volatile but it only counts about two percent of revenue so I'm not too
concerned about what this segment is doing now jumping back to human health
for a minute because obviously this is one of the key drivers to revenue so
here's a chart for their leading revenue generating prescription drugs going back
to 2010 and as we could see januvia is their largest contributor to revenue
januvia januvia is a diabetes medicine and it's actually januvia and janument
ganument is actually a combination of januvia and something called metformin
so overall these products have been the primary driver of revenue in recent
years so we could see the key true that came to market in 2014 and it's been
growing rapidly ever since in fact if we add in those projections for these drugs
we could see that they expect key keytruda to be one of the primary drivers
of revenue in the future the next few years
keytruda as a cancer drug it's supposed to be quite a quite a promising drug
when it comes to treating lung cancer and a few other cancer types and so that
would be awesome if they could you know figure that thing okay so what do we
think Merck stock is actually worth and should we add it to any of the
portfolio's now I think it's important to remember with pharmaceutical
companies that getting drugs approved is a complex and lengthy process in
often it doesn't go as management or as analysts predict it will and 2019 is is
expected to be a pretty big year for Merck as they have many big developments
in the pipeline this table this is a table from their most recent earnings
presentation and as you can see they have many different things that they're
waiting for in 2019 and some even in 2020 now this is important because any
good or bad news on any of these big developments is likely to really make
the stock move in one direction or another so I think it's something to
consider that we might have to be ready for additional volatility although the
good news is that this type of company tends to be fairly defensive and if the
market continues to struggle it's likely that Merck and its competitors would do
decent since it's often a defensive play and ultimately if a country went into a
recession Merck is likely to be not terribly
affected by that since medicine fairly is tends to be
fairly defensive okay so now let's try to value Merck stock now p/e is tricky
to use here because of the nature of Merck's business so much of the revenue
is often driven in this type of business by a single drug or maybe two or maybe
three it's not as simple as selling something like Cokes or something like
that if Keytruda continues to pick up steam then perhaps Merck should be
trading at a premium compared to its peers but if bad news comes out and a
clinical trial doesn't go as they expect well then Merck might be it might have
to be trading at a discount to its peers so I think it makes more sense for us to
try to use discounted cash flow so when we take analyst estimates for free cash
flow and we go out the next few years we can see if we get a fair value of about
82 dollars per share now the first thing that to me that's interesting is that
this big jump in free cash flow here when I actually saw this I started
questioning analyst projections and I started doing some digging on my own to
see if this was realistic and when I found is that through the first three
quarters of 2018 Merck has already posted up almost six billion dollars in
free cash flow which makes their nine point eight billion much more obtainable
next we use a weighted average cost of capital of about 8.5% and that may seem
a bit high given the stability of Merck's business at least over the long
term but Merck actually very little death they get about thirty
three billion dollars in long-term debt compared to a market cap of near 190
billion it turns out that the valuation we're using is mostly based on the cost
of equity and the cost of equity is higher then we have a perpetual growth
rate of about two point five percent that's been standard for us that's what
we typically use that seems like a reasonable number to use now Merck also
has a pretty good dividend with a dividend yield of about three percent in
October of 2018 marks Board of Directors approved a fifteen percent increase in
their quarterly dividend that's up they've consistently increased it by
about two or three percent every year then they fifteen percent job just
recently they moved it up to fifty five cents from forty eight cents they also
entered an accelerated repurchase program of four five billion dollars
repurchases is the same as a stock buyback so right now Merck is trading at
about seventy two dollars per share our fair value has them up there at about
eighty two dollars per share so that's an upside of bug fourteen percent so
it's a decent one if Merck stock keeps falling it could even become more
appealing from a value perspective so I don't really see them and I don't see
Merck as a fit in our growth portfolio perhaps in the value portfolio
especially if keeps falling the dividend portfolio probably makes some sense
three percent is pretty good could be a good diversifier in that portfolio but
what do you think do you think we should add it to any of the portfolio's is it
strong enough to be in our dividend portfolio at three percent you know I'm
not sure how high we're going to target when we go ahead and build that
portfolio that being said thanks for sticking with me all the way into the
video if you haven't done so already hit the subscribe button let me know any
thoughts or questions or ideas you have in the comments below and thanks a lot
and I'll see in the next video