Keytruda romps through Q1, but Merck needs fuel beyond the I-O star

On Tuesday morning, Credit Suisse analyst Vamil Divan dashed off a note calling Merck “a story that we believe is currently overly reliant on Keytruda.” The source of Divan’s worry? A first-quarter earnings report dominated by the immuno-oncology blockbuster.

Merck reported revenues for the quarter of $10 billion, in line with expectations, and earnings per share of $1, beating analysts’ estimates by a nickel. Keytruda, a checkpoint inhibitor that’s now approved to treat seven tumor types, brought in sales of $1.46 billion during the quarter, representing 151% year-over-year growth and easily surpassing average forecasts of $1.37 billion.

“We’re pleased that due to the strong execution we’ve had, Keytruda has the potential to be the largest product Merck has ever had,” said CEO Kenneth Frazier during a conference call with analysts after the earnings report.

Perhaps, but the product’s success hasn’t translated to shareholder return, one analyst pointed out during the call. Merck’s stock has fallen 6% over the past year, for example, while the S&P 500 has gained 11%. And even though Merck’s shares have advanced nearly 30% in the last five years, the S&P has risen more than 63% during that time.

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Concerns about over-reliance on Keytruda were only compounded this quarter by a couple of notable under-performers in Merck’s lineup. Sales of the company’s hepatitis C treatment Zepatier came in at $131 million, way below the consensus estimate of $236 million. The product faces a tough new rival in AbbVie’s Mavryet, which brought in a whopping $919 million during the quarter—nearly double what analysts were expecting.

Merck’s shingles vaccine Zostavax is also struggling in a competitive market. Sales of Zostavax were $65 million during the quarter, missing the consensus estimate of $106 million, as GlaxoSmithKline snaps up market share with its newly approved vaccine Shingrix.

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Frazier said during the call that he’s as frustrated as analysts are about Merck’s stock performance, but he doesn't believe the company's growth opportunities are limited. And dealmaking is playing a role in his plans. The company’s business-development strategy, he insisted, positions Merck for “long-term growth and value creation,” and its future revenue opportunities “are somewhat underappreciated,” he said. “We continue to look for opportunities to augment our growth in our pipeline through business development.”

Merck has shied away, however, from “transformational deals”—read multibillion-dollar mergers—a strategy that many have questioned. Instead, it has racked up a series of alliances designed to build its pipeline in key areas, not the least of which is immuno-oncology. The most recent such deal was its $394 million purchase of Viralytics, an Australian company that’s testing a cold virus in combination with Keytruda.

RELATED: Merck inks $394M takeover of oncolytic virus play Viralytics

So how can Merck unlock more shareholder value? One obvious choice could be spinning off its animal health business. That unit did well in the first quarter, with revenues growing 13% year over year to $1.1 billion. Both its companion- and farm-animal products grew, it reported.

But Frazier has been reluctant to bid animal health goodbye—an instinct that he said he trusts even more now that investors are pressuring Merck to think beyond Keytruda.

“Our goal over the longer term is to drive long-term growth, and we think animal health—a business that generates really good cash flows that actually helps fund the human-health R&D—is a way of generating long-term shareholder value,” he said. “I guess, ironically … this provides diversification from Keytruda as well as the rest of our human-health portfolio.”