Merck posted fourth-quarter sales that were in line with our expectations, but earnings came in better than expected due to cost cutting. Total sales in the quarter increased 6% organically. The Serono division increased 4%, largely driven by 7% growth in Rebif. Consumer health sales fell 7% in the quarter, but earnings increased as the firm’s new focus on profitability has led to the divestiture of unprofitable product lines.
Performance materials posted impressive 17% organic growth due to strong demand out of China. However, it has come at the expense of margins as EBITDA margins in the segment fell from 48.1% to 44.7%. Millipore revenue grew at a healthy 6% rate.
Merck initiated three price increases last year, and has already passed along another 8% increase this month. Management did acknowledge that it expects global Rebif sales to start seeing negative growth rates in the back half of 2013, however, it has been conservative in the past. In early 2012, management forecast for 2012 Rebif sales to be stable or slightly declining, but in fact they finished the year up more than 7% on a constant currency basis.
The other major contributor to our fair value increase is better than expected results from the firm’s new efficiency plan. Announced last year, the firm’s “Fit for 2018” plan laid out a long-term strategy to improve efficiency across all business segments by 2018. The firm now appears to be ahead of schedule, and we may have underestimated how many opportunities it has to increase margins.
In addition to reducing head count and consolidating some operations, the company has identified numerous seemingly simple strategies, such as raising drug prices at similar rates to competitors, exiting unprofitable product lines, and rewarding managers based on their units’ bottom line rather than top line. During 2012, Merck realized EUR 115 million in cost savings compared to the previously expected EUR 55 million. Management raised its guidance to EUR 385 million in annual savings by 2018, up from its earlier forecast of EUR 365 million.
Rebif has held up better than expected, and may continue to surprise to the upside for a few more quarters, but we still believe it is just a matter of time before the product starts declining. Rebif makes up nearly a third of Serono’s sales and likely a much larger portion of profit, so it will be a tough to offset, especially with the firm’s below average pipeline, reduced R&D spending, and Erbitux sales growth appearing to stall.
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