Growth Injection

In this edition of the Smart Investor newsletter, we examine the world’s third-largest pharmaceutical company. But first, let us delve into the latest Portfolio news and updates.


Portfolio Updates

❖ Adobe (ADBE) stock rallied over the past week after several Wall Street analysts offered optimistic outlooks and upwardly revised price targets, citing Adobe’s dominance in its market and future growth potential.

❖ Broadcom (AVGO) surged by more than 8% over the past week as investors snapped up the AI networking champion’s stock in anticipation of its 10-for-1 split on July 12th.

❖ Taiwan Semiconductor (TSM) saw its market capitalization touch the benchmark $1 trillion mark as semiconductor stocks staged a strong rally and several brokerages – including Bernstein and Goldman Sachs – lifted their price targets ahead of the chip foundry giant’s Q2 report on July 18th.

❖ KKR & Co (KKR): TD Cowen lowered its price target on the stock to $145 from $157 as it moderately decreased the outlook for alternative asset managers heading into the Q2 reporting season. However, the lowered price target still implies an upside of 38% in the next 12 months.

❖ The S&P Industrials Sector has been an underperformer in the past two months, giving up some gains from its strong run-up to May. This underperformance has been weighing on several Portfolio stocks, such as Howmet Aerospace (HWM), General Dynamics (GD), Pentair (PNR), EMCOR Group (EME), Parker Hannifin (PH), and IIT Corp. (ITT). All these companies are expected to post strong results in their upcoming quarterly reports, which should support their stock performance. However, we are closely watching their stock behavior as well as market sentiment and economic developments that may impact these stocks.

❖ Another set of stocks that have been underperforming the S&P 500 in the past two months belongs to the Financials. As the Technology sector has established its leadership, value-oriented sectors such as Financials have been lagging the market. This trend has affected several Portfolio holdings, with the largest effects seen in the performance of Visa (V). Visa is struggling after a federal judge rejected the settlement for a dispute over swipe fees reached between Visa, Mastercard, and retailers. While we believe it will have little impact on the company’s revenues, we are closely following the developments.

❖ Oracle (ORCL) stock fell on report that the talks with Elon Musk’s xAI startup about expanding the agreement have ended without a deal. The cloud infrastructure company already provides xAI with access to NVIDIA chip-based systems. Instead of expanding this agreement, Musk decided to buy chips from NVIDIA to build a data center of its own, explaining that xAI’s “fundamental competitiveness depends on being faster than any other AI company.”


Portfolio Earnings and Dividend Calendar

❖ The Q2 2024 earnings season is kicking off this week, with Interactive Brokers (IBKR) scheduled to report on July 16th.

❖ The ex-dividend dates for GE Aerospace (GE) and Oracle (ORCL) are July 11th, while for EMCOR Group (EME) it is July 15th.



New Buy: Merck & Company (MRK)

Merck & Co., Inc. is an American multinational healthcare company that delivers health solutions through prescription medicines, biologic therapies, vaccines, and animal health products.


The Making of Merck

Merck was established in 1891 as the American subsidiary of the German science and technology company Merck Group, becoming an independent entity in 1919. Merck & Co. holds the trademark rights to the “Merck” name in the U.S. and Canada and works under the name “MSD” in the rest of the world.

For over 130 years, the company has developed essential medicines and vaccines. It has multiple healthcare innovations under its belt, helping to treat various health conditions, prevent diseases, and support health and wellness. For instance, Merck was the first to synthesize vitamin B1 in the 1930s. In the decades that followed, Merck’s scientists were at the forefront of medicinal innovation, introducing such groundbreaking treatments as streptomycin, cortisone, statins, and numerous drugs used for treatment of high blood pressure, heart disease, and other conditions.

In addition, Merck has also been a leader in vaccine development. It developed the MMR, pneumococcal, Hepatitis B, HPV, and multiple other vaccines protecting millions of people around the world against preventable diseases.

After the 2009 merger with Schering-Plough, Merck & Co. became the second-largest pharmaceutical company in the U.S. and the third-largest in the world. With a market capitalization of $320.3 billion and annual revenues of $60.1 billion, Merck ranks #69 on the Fortune 500 list.


Preventing and Treating Health Disorders

Merck operates through two business segments: Pharmaceutical and Animal Health. The Pharmaceutical segment includes human health pharmaceuticals and vaccines. Human health pharmaceuticals are prescription treatments for human disorders in oncology, infectious diseases, cardio-metabolic disorders, immunology, and neuroscience. Merck’s human health vaccines include pediatric, adolescent, and adult vaccines. These vaccines are sold mainly to physicians, wholesalers, distributors, and government entities.

The Animal Health segment develops and markets veterinary pharmaceuticals, vaccines, and health management solutions for livestock and companion animals. It also offers digital identification, traceability, and monitoring products, sold to veterinarians, distributors, farmers, and pet owners.


Diversified Portfolio and Pipeline Depth

The company is well diversified, though almost 90% of Merck’s revenues come from pharmaceutical sales or prescription medicines, with animal veterinary pharmaceutical and vaccine products contributing ~9%. Merck generates a majority of its revenues, around 47%, from the U.S., while around 22% of revenues come from Europe and the Middle East.

Merck has an extensive oncology portfolio, serving 2.6 million people globally, with 53 approved indications by the U.S. FDA across 23 different types of tumors, and also has more than 70 indications in the EU and Japan. Moreover, Merck is strengthening its oncology portfolio by developing antibody-drug conjugates to treat cancers in both the early and late stages. As a result, the company expects its oncology business alone to contribute more than $20 billion in sales by around 2034-35. The company’s oncology therapy Keytruda is a major driver of its pharmaceutical business, comprising around 47% of this segment’s revenues in FY23. Keytruda’s sales in the first quarter soared by 24% year-over-year to $6.9 billion driven by strong demand for the injection. Even as the Keytruda patent expires in 2028, its oncology pipeline remains strong.

Recently, the company also received approval from the U.S. Food and Drug Administration (FDA) for Winrevair, the first-in-class treatment for adults with high blood pressure. This treatment has also been endorsed in the EU and was launched earlier this year.

In terms of the company’s vaccine portfolio, Gardasil, Merck’s Human Papillomavirus (HPV) vaccine continues to exhibit strong sales. Gardasil’s sales jumped by 28.8% year-over-year to $8.88 billion in FY23 and comprised 16.5% of the company’s pharmaceutical sales. In the first quarter alone, this vaccine generated $2.2 billion in revenue.


Acquisitions Supplement Internal Growth Effort

The company is actively pursuing acquisition opportunities that can drive its long-term and short-term growth. Thus, it acquired Acceleron for $11.5 billion in 2021; in 2022, MRK bought Prometheus and Erbi Biosystems. Last year, it announced the acquisition of Harpoon Therapeutics, completed in March 2024, which is expected to significantly strengthen Merck’s oncology pipeline. Furthermore, earlier this year, Merck announced the acquisition of EyeBio for around $3 billion. This acquisition is expected to significantly expand the company’s presence in ophthalmology and strengthen its pipeline.

These acquisitions are a part of the company’s business development strategy of constantly expanding its portfolio, adding to Merck’s own internal drug and vaccine development. Thus, currently, it has over 30 Phase 3 and over 80 Phase 2 trials underway in the areas of oncology, respiratory, antiviral, cardiovascular, immunology, endocrinology, and neuroscience, as well as a new Dengue fever vaccine.

In 2023, Merck spent $13.6 billion on internal research and development efforts, $100 million more than in the previous year, with R&D spending comprising ~23% of total revenue. Together with charges related to the acquisitions and partnerships, the annual R&D budget was a whopping $30.5 billion, the largest among global pharma companies.


Stellar Fundamentals, Fast Growth

Merck has exceeded analysts’ EPS estimates in all quarters since Q2 2021. In Q1 2024, the company posted a 9% year-over-year growth in revenues while EPS surged by 48%. Revenue and earnings growth was led by Keytruda, with the sales of the drug jumping by 24% year-on-year. Some other company’s products showed a triple-digit growth in sales, but their effect on total revenue is far less pronounced due to lower weight in the revenue mix compared to Merk’s blockbuster drug; however, some of them show potential to become future revenue growth drivers. Analysts estimate that the company’s earnings are likely to grow by about 24% annually in the next three years.

Merck’s robust Q1 results and strong Keytruda and vaccine sales prompted the pharma major to raise its FY24 outlook. Looking forward, Merck expects its FY24 sales to be at the midpoint range of around $64 billion, an increase of ~1% from its prior outlook. The company has projected that adjusted earnings will be at the midpoint range of $8.59 per share, an increase of 1% compared to its prior guidance.

The company’s net debt-to-equity ratio of 70.8% is slightly on the higher side, but the pharma major has actively worked to reduce this over the past five years. In addition, the company’s high credit ratings – “A3” at Moody’s and “A+” at S&P – underscore its financial strength and stability. Merck’s debt is well covered by its operating cash flows while its interest payments are covered by EBIT many times over.

The company’s strong balance sheet supports its growth potential through M&A opportunities. In terms of capital efficiency and profitability metrics, Merck’s return on equity has grown by 28.1% over the past five years on average. The company’s return on equity is expected to skyrocket from 5.8% to 39.1% over the next three years.

Merck’s price-to-FCF metric stands at 29.01, higher than the industry average of 19.72, indicating the company’s fundamentals are intact. The company’s return on capital employed stands at 21.7%, higher than its 17.2% rate some three years ago, indicating both improving profitability and capital efficiency.


Dividends and Stock Buybacks

Merck’s dividend yield is at 2.4% as compared to the industry average yield of 2.2% with a cash payout ratio of 70.7%, showing that its dividend payments are well covered by its cash flows.

The company has declared a quarterly dividend of $0.77 per share for the third quarter payable on July 8th. Merck’s dividends have been stable and increasing over the past ten years.

The company’s stock buybacks have been modest compared to pre-pandemic trends, with share repurchases of $121.6 million in the first quarter. Merck’s management has indicated that it intends to continue with stock buybacks.


Growth at a Reasonable Price

Merck’s forward P/E multiple of 14.3x is at the higher end as compared to some of its competitors, even though it represents a discount versus the Healthcare sector. However, the premium over competitors seems more than justified given Merck’s strong track record of growth and future outlook. Considering the company’s future cash flows, MRK appears to be about 55% undervalued.

In the past year, MRK stock has risen by 14.4%, underperforming the S&P 500 and most of its peers in the industry. All this occurred despite the company’s strong Q1 results, raising its FY24 guidance and strengthening its drugs pipeline. However, Wall Street analysts remain bullish on the stock and see a 17% upside from current levels.


Investing Takeaway

We view Merck as a strong Growth at a Reasonable Price (GARP) play. With the company pursuing a twin strategy of aggressive acquisitions to grow strategically and at the same time strengthening its pipeline, we believe that the stock can be a valuable addition to the Smart Investor portfolio.



New Sell: Cigna (CI)

The Cigna Group provides a broad range of insurance and related services within the United States. The company has two primary divisions: Cigna Healthcare, which provides health benefits including Medicare plans, and Evernorth Health Services, which provides various pharmacy services. The latter is responsible for roughly three-quarters of Cigna Group’s revenue and has been a significant contributor to the company’s stable growth over several years.

Cigna is a financially healthy company with solid capital efficiency and profitability ratios. After a difficult period in 2022-2023, over the three most recent quarters it has clocked in double-digit EPS growth rates. Wall Street analysts rate it a “Buy”, foreseeing a ~20% upside in the next 12 months.

However, its stock hasn’t lived up to these expectations in recent months, strongly declining from its all-time high registered in April. While it outperformed most of its large-cap Healthcare peers year-to-date, it strongly underperformed the S&P 500. Most of this underperformance has been sector-specific, as the tech stock’s surge has put counter-cyclical sectors such as Healthcare in the back seat.

While Portfolio diversification is of utmost importance and Healthcare stocks provide a cushion against turbulence during times of market stress, we believe that Cigna’s stock may encounter additional downward pressure in the next several months.

One of the factors for that is the ongoing litigation against Cigna’s and UnitedHealth’s pharmacy benefits management businesses in Arkansas over their alleged role in the state’s opioid crisis. In addition, the increased regulatory pressures on pharmacy benefit managers (PBMs) are concerning, which may further impact investor sentiment. In the latest development, the Federal Trade Commission (FTC) has accused PBMs of stifling competition, thus profiting at the expense of patients by contributing to higher drug prices.

While the future effects of these developments on Cigna’s stock are still unclear, we believe that it’s prudent to sell the stock, locking in the gains. However, we may revisit this Healthcare champion in the future, if and when the regulatory skies become less stormy.



Portfolio Stocks Under Review

❖ PayPal (PYPL) remains under review as we assess the potential impact of Apple’s introduction of new features simplifying money transfers and expanding BNPL options. Although we believe that PayPal’s new management is capable of dynamizing the payments giant once more—and we have welcomed the news regarding its AI-powered advertising business plans—we have yet to see a strategic turnaround that would help it increase FCFs and maintain (much less grow) its market share. Analysts from Susquehanna have recently raised their rating on PayPal from “Hold” to “Buy”, saying that the company is now focused on profitable growth, which they believe will expand margins. Although this process could take some time, we are awaiting the company’s Q2 earnings report on July 30th for some signs that PYPL is indeed back on the growth path.



Smart Investor’s Winners Club

*The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.

The markets rose in the past week, with the gains mostly concentrated within the technology space. Since our Winners list currently holds mostly tech stocks, it remained unchanged from last week with 12 members: SMCI, GE, AVGO, ANET, TSM, AMAT, EME, ORCL, APH, VRTX, GD, and CHKP.

The next in line to enter the lucrative club are TPL and PH with 28.3% and 27.9% gains, respectively, since their purchase dates. Will they close their minute gaps, or will someone else outrun them to the finish line?



Smart Investor Portfolio

 Portfolio YTD Return
Portfolio Volatility (Beta) Portfolio Dividend Yield
20.45% 1.15 0.63%


New Portfolio Additions

Ticker Date Added Current Price
MRK Jul 10, 24 $126.04

New Portfolio Deletions

Ticker Date Added Current Price % Change
CI Jul 12, 23 $328.37 +22.21%

Current Portfolio Holdings

Ticker Date Added Current Price % Change
SMCI Nov 8, 23 $895.61 +250.67%
GE Jul 27, 22 $163.13 +191.93%
AVGO Mar 22, 23 $1733.31 +174.73%
ANET Jun 21, 23 $365.75 +141.40%
TSM Aug 23, 23 $184.52 +96.74%
AMAT May 31, 23 $251.47 +88.65%
EME Nov 1, 23 $363.56 +76.17%
ORCL Dec 21, 22 $140.68 +72.61%
APH Aug 9, 23 $68.62 +55.18%
VRTX Aug 2, 23 $485.99 +39.76%
GD Dec 22, 21 $279.51 +37.18%
CHKP Jul 19, 23 $169.89 +33.44%
ITT Oct 18, 23 $125.97 +31.89%
TPL Jun 5, 24 $750.00 +28.32%
PH Oct 11, 23 $508.68 +27.87%
DELL Mar 27, 24 $145.74 +27.12%
MCK Dec 13, 23 $586.81 +26.98%
HWM Apr 10, 24 $80.24 +21.85%
ADBE May 29, 24 $566.02 +18.31%
REGN Feb 7, 24 $1054.03 +12.39%
AIT Dec 6, 23 $183.80 +11.57%
IBKR Jun 19, 24 $125.25 +4.60%
PNR Jun 26, 24 $75.01 +0.94%
AIG May 1, 24 $75.75 +0.58%
ABNB Jul 3, 24 $152.45 -1.22%
EMR May 22, 24 $109.59 -3.61%
DOV May 8, 24 $175.13 -3.68%
KKR Jun 12, 24 $105.58 -4.20%
V May 15, 24 $265.44 -4.43%
PYPL Apr 17, 24 $59.00 -6.98%






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