Wednesday, January 7, 2015

Big Pharma's Biggest Grudge Match

They compete in the diabetes market. The same holds true for the cardiovascular, neuroscience, oncology, and osteoporosis markets. Their animal health units go head to head. You might even say that Eli Lilly (NYSE: LLY  ) and Merck (NYSE: MRK  ) are engaged in big pharma's biggest grudge match.

Which of these two rivals makes the best investing choice right now? Let's look at how Lilly and Merck stack up.

Apples to apples
There truly are plenty of areas for apples-to-apples comparisons between the two pharmaceutical companies. Merck's animal health unit stands as the larger of the two, pulling in $840 million in revenue during the first quarter versus $499 million for Lilly. Both units grew sales roughly 2% year-over-year. Lilly's animal health business comprises around 9% of total sales, while Merck's makes up nearly 8% of total sales.

Both Lilly and Merck do quite well in diabetes. Lilly's Humalog generated $633 million in sales last quarter, with Humulin garnering nearly $312 million. The company also launched Tradjenta in 2011. Lilly's U.S. patent for Humalog expires this month, but no biosimilars have yet emerged.

Merck, meanwhile, pulls in even higher sales figures. In the first quarter, diabetes drugs Januvia and Janumet racked up combined revenue of nearly $1.3 billion. While Merck's sales numbers were higher, Lilly's growth numbers looked better last quarter.

Lilly is arguably better positioned for the future in terms of products on the way. The company counts three diabetes drugs in late-stage trials plus empagliflozin in regulatory review. Merck has one diabetes drug in a late-stage study.

What about other therapeutic areas where both companies compete? Merck again outscores Lilly in cardiovascular-related revenue. Its Zetia and Vytorin combined for slightly more than $1 billion in sales last quarter. Lilly's Effient and other cardiovascular drugs brought in nearly $694 million. However, Merck's cardiovascular revenue declined slightly last quarter, while Lilly saw more than 8% sales growth for the therapeutic category.

Lilly's biggest area is neuroscience, accounting for $1.85 billion in sales for the first quarter. Merck trails behind significantly, with products like Maxalt and Remeron bringing in less than $100 million in sales during the quarter.

However, Lilly faces declining sales from Zyprexa. The company also loses patent exclusivity for Cymbalta at the end of this year. Lilly's antidepressant edivoxetine and Alzheimer's disease drug solanezumab are in late-stage trials, but neither seems likely to make up for the revenue loss from Zyprexa and Cymbalta.

Merck awaits regulatory decisions for insomnia drug suvorexant and neuromuscular blockage reversal drug sugammedex. The company has a drug targeting Parkinson's disease in a late-stage study.

Lilly claims a lead in oncology, too. Its cancer drugs, primarily Alimta and Erbitux, notched sales of $764 million during the first quarter. Merck made $332 million from Temodar and Emend. Both companies also have promising cancer drugs in late-stage studies.

In osteoporosis, Lilly again claims an advantage. Its Forteo and Evista combined for more than $522 million in sales during the first quarter. Merck's Fosamax generated sales of $137 million during the same period.

Apples to oranges
Despite several overlapping markets, Lilly and Merck focus on other areas that set the two companies apart.

Merck's respiratory products, including Singulair and Nasonex, brought in $830 million in revenue last quarter. Lilly doesn't market any comparable respiratory drugs.

Vaccines also make up a significant portion of Merck's revenue. Its vaccines, with Gardasil leading the way, generated more than $1.1 billion in the first quarter. Lilly doesn't compete in the vaccine market.

However, Lilly makes products targeting some therapeutic areas that Merck does not. For example, Lilly's Cialis, which is used to treat erectile dysfunction and benign prostatic hyperplasia, saw sales of $515 million during the first quarter. The company's attention-deficit hyperactivity disorder drug Strattera garnered nearly $167 in revenue during the period.

There's also the matter of size. Merck's market cap of nearly $140 billion doubles that of Lilly.

Grudging opinion
Who wins out in this hypothetical grudge match? I'd go with Merck.

Lilly has a huge challenge before it with several of its top drugs losing patent protection. The company counts plenty of drugs in its pipeline, but it will have a steep hill to climb in making up for lost revenue. Merck faces revenue decline related to expiring patents as well, but it shouldn't feel the brunt quite as much as Lilly.

Looking back over the last year, there's no question that Lilly's stock has performed better. However, the two companies' valuations now appear to be nearly mirror images. Lilly's trailing price-to-earnings ratio stands at 13 with a forward multiple of 20. Merck has a trailing P/E of 23 and a forward multiple of 12. Merck is much more attractively valued looking ahead.

Merck offers one more bonus. It's dividend yield of 3.7% narrowly beats the 3.5% yield of Lilly. All things considered, I think this grudge match goes to Merck.

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