Battle Royale: Merck & Co. vs. Pfizer

By George

Source: Pixabay.

The Big Pharma landscape has been forever altered by the so-called patent cliff as generic drugs erode an expected $65 billion in branded drug sales by 2019. Most major pharmas have invested heavily in M&A activity, as well as their own clinical pipelines, over the last few years to replenish their falling revenue streams.

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So, with the smoke starting to clear across the embattled pharmaceutical industry, I think it's high time to consider which companies are in the best position to generate long-term growth for investors. Keeping with this theme, let's compare Merck & Co. andPfizer-- two of the biggest names in pharma -- to consider which stock offers the better investing opportunity right now.

Better stock: Merck or Pfizer?These two Big Pharmas tend to command a lot of interest among investors because they offer instant brand recognition and dividend yields that are near the top of the entire healthcare sector. Nevertheless, they have approached the patent cliff from almost entirely different angles.

Merck, for example, has gobbled up a couple of smaller companies to build out its anti-infective product portfolio and clinical pipeline, placing a huge emphasis on next-generation hepatitis C drugs and antibacterials in the process.

Pfizer, on the other hand, has arguably focused more on the organic development of its clinical pipeline to bring new products to market in key growth markets like cardiovascular disease, oncology, and infectious diseases. Unlike Merck, Pfizer has chosen to mainly rely on external research partnerships to augment its pipeline in these areas, rather than buying entire companies.

And if you ask Wall Street, Pfizer's strategy appears to be the more promising of the two:

Based on data provided by S&P Capital IQ, Pfizer's bottom and top lines are both expected to grow at a faster rate than Merck's over the next five years. But perhaps what's most telling about this comparison is that Merck appears to be far more dependent on share buybacks to boost its bottom line than Pfizer, shown by its markedly lower five-year revenue projection but comparable growth rate in terms of EPS. That means Merck will have less cash available -- on a relative basis -- to fund further M&As or other value-creating activities such as large external partnerships than Pfizer.

Turning our attention to the dividend, Pfizer would appear to have an edge on this front as well. Although Merck presently offers a slighter higher yield at present (3.5% vs. 3.25%), Pfizer's 12-month trailing payout ratio of 50% suggests that its current yield is more sustainable than Merck's, with its 76% payout ratio at present levels. Given that Pfizer's top line is expected to grow at a faster rate moving forward, I think it's therefore reasonable to assume that Pfizer will also be able to support further increases to its dividend easier than Merck. In fact, Merck may have to keep its dividend payout flat over the next few years or possibly cut it to support other cash-intensive endeavors.

Why does Wall Street favor Pfizer over Merck?The answer to this question is relatively straightforward. Pfizer is pursuing a "best-in-class" strategy with products that should have long commercial lives. Pfizer's new breast-cancer drug, Ibrance, for instance, is already off to a great start and appears to have the ability to rack up additional indications moving forward. Ibrance could thus be a megablockbuster product for Pfizer for a decade or more.

Merck has decided to dive into lucrative markets with far shorter product life cycles and perhaps far more competition to boot. While its efforts in the hep C market may result in some novel products with shorter treatment times on average, Wall Street is starting to believe this market is already on the back end of its commercial potential as a whole. Basically, Merck may be arriving at this particular party too late.

Merck's efforts in the area of antibacterials is also uninspiring from a commercial perspective. In general, novel antibiotics often peak quickly in terms of sales because bacteria are so adept at adapting to new treatments, requiring yet another round of innovation.

Tying it all togetherComparing pharma giants like Pfizer and Merck is certainly no easy task. After all, we could easily devote an entire article to their emerging immuno-oncology programs. So, what I've tried to do here is give investors a broad outline regarding how the Street is looking at these two pharma stalwarts right now.

Having said that, I think there are several wild cards that could come into play that investors need to have in the backs of their minds. First up, Pfizer may decide to break up into an innovative business and a separate legacy products business, which would obviously negate this broad strokes comparison.

Next, we don't have a great deal of insight into either company's vast immuno-oncology programs at this point. But if Pfizer stubs its toe and Merck doesn't in immuno-oncology, this one key area could radically change this comparison.

Finally, I think both companies are going to continue to engage in the M&A game, and this issue is certainly a factor to keep an eye on moving forward.

So, as things stand now, Pfizer looks like the better long-term investment, but this is a highly fluid situation that is definitely subject to change at a moment's notice.

The article Battle Royale: Merck & Co. vs. Pfizer originally appeared on

George Budwell has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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