Earnings estimates for Merck & Co. (MRK) are on the lower side following the release of fourth quarter and full-year 2009 results. The company’s earnings per share (EPS) came in at 79 cents (excluding non-recurring items), marginally beating the Zacks Consensus Estimate of 78 cents but lower than 87 cents reported in the year-ago period. Full-year earnings declined 5% to $3.25.

For the full year, Merck reported a 15% rise in revenues to $27.4 billion, which included Schering-Plough operations since the merger closed on Nov 3, 2009. Revenues would have been higher but for the unfavorable foreign exchange movement, which affected global sales by 2%.

Merck will provide 2010 guidance in April along with its first quarter results.

Estimate Revisions Trend

Following the release of 2009 results, many analysts covering the stock have revised their estimates. Over the past 30 days, 9 of the 18 analysts following the stock have lowered their earnings estimates for fiscal 2010, with only 1 moving in the opposite direction. On balance, 2010 earnings estimates have gone down by 4 cents with the current Zacks Consensus Estimate being $3.43.

A negative bias, though not so prominent, can be witnessed for 2011 as well, with 5 of the 15 analysts covering the stock reducing their estimates in the past 30 days, with 4 analysts raising them. In the last 7 days, 1 analyst has raised estimates. On balance, 2011 earnings estimates have gone down by 2 cents with the current Zacks Consensus Estimate being $3.95.

Although many of Merck’s drugs recorded robust growth during 2009, it is facing patent expiration of two of its key drugs, which has led analysts to lower their outlooks for the next few quarters.

The company’s hypertension franchise products, Cozaar (losartan potassium) and Hyzaar (Cozaar and hydrochlorothiazide), that generated sales of $3.6 billion in 2009 are slated to lose their patents in the U.S. and some of the major European markets in the first half of 2010. Sales are expected to plunge with the entry of generics. These drugs accounted for more than 13% of total revenues.

Meanwhile, Merck is witnessing a steady decline in sales of one of the most significant products in its portfolio, Gardasil — the cervical cancer vaccine. Although Gardasil (approved for the age group of 9-26 years) sales ramped very quickly following its launch, sales have struggled recently due to the difficulty in penetrating patients.

Global sales of the vaccine in 2009 came in at $1.1 billion, a 20% decline from the previous year. In addition, the vaccine is witnessing increased competition from GlaxoSmithKline’s (GSK) cervical cancer vaccine, Cervarix. However, in order to recoup some of the lost sales, Merck is aiming to get Gardasil approved for the age group of 26-45 years.

The negative bias in estimate revisions can be witnessed for the first two quarters of 2010 as well. For the first quarter, 4 of the 15 analysts covering the stock have reduced their estimates in the past 30 days with 2 doing the reverse.

However, we witness a clear negative trend for the second quarter of 2010, with 6 of the 13 analysts covering the stock lowering their estimates. No upward revision happened during the same period.

Another issue which is of concern to investors is related to the rights to Remicade and Simponi. Johnson & Johnson (JNJ) had licensed ex-U.S. rights of the drugs to Schering-Plough (now a part of Merck). According to J&J, the merger has triggered a change-of-control provision in the agreement allowing J&J to reclaim full rights to both drugs.

An arbitration panel is likely to decide on the issue by Sept 2010. Sales of Remicade were $431 million for the post-merger portion of 2009. Merck would suffer if it loses the ex-U.S. rights to these drugs.

Our Recommendation

We currently have a Neutral recommendation on Merck, which is supported by the Zacks #3 Rank (Hold). We believe Merck’s merger with Schering-Plough will help the company address certain impending patent cliffs and pipeline failures. In addition, the company’s pipeline must deliver to recoup some of the lost sales of Cozaar and Hyzaar.

Merck’s pipeline consists of more than 20 candidates in phase III development or under regulatory review targeting areas of unmet medical need. With a large number of candidates in the final stages of development, the company’s R&D budget is likely to increase in 2010.

Some of the recent product approvals of Merck include Simponi (golimumab), Saphris (asenapine) and Elonva, (corifollitropin alfa injection). These drugs should be able to contribute to the top line with time.

Read the full analyst report on “MRK”
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Read the full analyst report on “JNJ”
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