5 Things Merck Wants You to Know

Source: Merck.

Two weeks ago global pharmaceutical behemoth Merck reported its second-quarter results, and, while rough around the edges, they surpassed Wall Street's expectations.

As a refresher for those who may have missed it, Merck generated $9.79 billion in revenue in Q2, a 10.5% drop from the year-ago period due in part to a 7% decline from foreign currency translation. Looking at its bottom line, Merck's adjusted net income fell 2% to $2.44 billion, but share repurchasing activity helped boost its adjusted EPS by $0.01 to $0.86 from the prior-year quarter. Comparatively speaking, Merck's revenue was in-line with the Street's expectations, but its profit per share soared past expectations by $0.05.

On the surface, Merck's results look OK compared to Wall Street's forecasts -- but they actually tell us very little about the health of the current business or Merck's pipeline. In order to get the full story we need to be willing to dig below the surface and analyze what its management team had to say during its conference call with analysts.

With this in mind, here are five of the most important things that Merck's management wants you to know following its Q2 earnings release. Quotes are courtesy of S&P Capital IQ.

Source: Merck.

Regardless of its label, Keytruda is well-established

Arguably no drug is more important to Merck's future than its cancer immunotherapy product Keytruda. At the moment there are a lot of questions left to be answered about Merck's future blockbuster drug, such as what its label might look like as a second-line treatment for non-small cell lung cancer (NSCLC) and whether or not it'll only be indicated for PD-L1-positive patients in future approvals. But what Merck's management can tell you is that it's absolutely kicking butt and taking names in the early going in advanced melanoma.

According to Adam Schechter, Keytruda is already boasting 35% market share in melanoma -- no small feat considering how crowded the treatment field is becoming -- with Schechter later noting that his company believes 85% of its current use is being directed toward melanoma. The inference here is that regardless of labeling Keytruda is already building a strong case for itself among physicians. Because of this, and the 45% response rate in advanced NSCLC for patients expressing PD-L1, Merck feels very strongly that it'll be competitive against rival Opdivo in an eventual second-line NSCLC launch.

We could repatriate a lot of cash under the right conditions

According to one analyst estimate, Merck has $29 billion in cash and cash equivalents, with up to 90% of that sitting in overseas markets. If Merck repatriated this cash it could be required to pay a hefty tax bill. In response to queries on whether or not the company would consider repatriating its cash in the future, and what it would do with its cash if it did, Robert Davis gave the answer above.

The two key points to Davis' answer are that Merck would continue to support steady dividend growth over time after its internal programs are fully funded, and two, that it would support bringing back its cash if Congress considers serious tax reforms for corporations. Keep in mind that Merck hasn't been shy about its bolt-on strategy of acquiring small- and mid-cap companies that help augment its research. Repatriated cash could go a long way to furthering Merck's bolt-on strategy, so consider this all the more reason to keep your eyes on the 2016 elections and potential tax reforms.

Source: Merck.

Animal Health is an important puzzle piece to our growth

Although Merck has beendivesting non-core assets, one asset it has no intentions of getting rid of despite some of its peers doing the opposite is its Animal Health operations. Despite a top-line 4% decline in year-over-year revenue, Animal Health operational growth actually jumped 10% year-over-year on an apples-to-apples basis.

According to Merck CEO Ken Frazier, the company's long-term plans very much rely on its Animal Health segment's growth. Frazier's commentary suggests that its business development plans could involve its Animal Health segment, implying that acquisitions to bolster its pipeline may not be out of the question. With the global population on the rise and companion pets becoming more and more a part of the family, Merck has two major avenues to grow its Animal Health business over the years to come.

We're not cutting costs in these two areas

Merck, like many of its Big Pharma peers, has been watching its revenue shrink as it deals with the loss of exclusivity on select drugs. One of the easiest ways for Merck to counteract these losses is by cutting its expenses. Pulling a few levers on the expense front can help it maintain its margins and profitability even as its revenue falls.

However, during its conference call Merck made it clear that best-selling diabetes drug Januvia (known as Janumet overseas) and its oncology product pipeline are two areas where cost reductions don't apply.

Januvia/Janumet accounts for around a sixth of Merck's pharmaceutical product revenue, so it's not surprising that Merck has been freely spending on marketing in order to maintain or gain market share in the highly-competitive diabetes segment. Likewise, with oncology spending expected to grow feverishly over the next decade, Merck views Keytruda and other oncology drug hopefuls as a means to quickly move the needle.

Source: Merck.

The hepatitis C market is still a big opportunity

Lastly, when Merck's management team was questioned about a possible slowdown in hepatitis C market sales, Merck simply used the question to reinforce its belief that its experimental HCV combo therapy, grazoprevir and elbasvir, has a genuine opportunity to excel.

Keep in mind that while the U.S. market could be one of the first to dramatically reduce the instances of HCV, there are some 180 million people worldwide wide this disease, per the World Health Organization. HCV is the type of indication that could support a half-dozen players with ease for a decade or longer around the globe. While Merck may not be first to market, it still could see its HCV combo therapy turn into a blockbuster.

Can Merck head higher? The big question investors have to ask now is whether or not Merck's Q2 report and management commentary should excite you to buy its stock.

While it has finally turned the corner on its revenue decline, if you look at things from an apples-to-apples basis and remove currency fluctuations, divestments, and acquisitions, Merck is still a ways off from really seeing substantial benefits from Keytruda and its HCV combo. A forward P/E of 15 is technically "value" territory, but Merck is still dealing with the negative repercussions associated with patent losses. This trade-off, I suspect, is going to keep Merck's stock range-bound for some time to come. I would personally keep Merck as a fixture on my watchlist, but I see no reason to rush in and buy its stock here.

The article 5 Things Merck Wants You to Know originally appeared on Fool.com.

Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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