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Merck's (NYSE:MRK) Returns Offer Investors a Fundamental Baseline, but their Pipeline is Still Risky

This article was originally published on Simply Wall St News

Merck (NYSE:MRK) looks like it has bottomed out and set to potentially enter a bull run. We are going to take a look at how well has Merck been investing funds, and do the fundamentals present a baseline from which the company can grow.

How well a company invests its capital can be a leading indicator to the long term performance. That is why so many investors are interested in return metrics such as Return on Equity (ROE), Return on Assets (ROA), Return on Capital Employed (ROCE).

We will focus on ROCE here, but you can view the other return measures in our company report HERE.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Merck, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.24 = US$17b ÷ (US$91b - US$22b) (Based on the trailing twelve months to June 2021).

Therefore, Merck has an ROCE of 24%.

In absolute terms that's a great return and it's even better than the Pharmaceuticals industry average of 11%.

View our latest analysis for Merck

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In the above chart we have measured Merck's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Merck here for free.

What Does the ROCE Trend For Merck Tell Us?

Merck is showing promise, given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 113% over the last five years.

This shows that Merck has been employing funds in projects that are now more successful than in the past. This means that the company has made some significant breakthroughs and that management has been choosing better projects.

So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably.

Pipeline Developments

While their main revenue generator, the oncology drug Keytruda is expected to lose patent exclusivity by 2035, their two diabetic drug Januvia and Janumet are expected to lose their patents as soon as 2023, and the company has currently no exclusive alternatives for diabetes. Merck made about 11% from their diabetes drugs in the last quarter, and this portion of revenues may be jeopardized by the end of 2023.

The company received some great news yesterday, as a preclinical study reported a 658% increase in STING agonist when used in combination with Vesselon Inc.'s Drug. In a nutshell, the combination of approaches by both Merck and Vesselon on the treatment, reduced the close and distant tumors in 44% of subjects achieved with intravenous administration.

The recent study is very interesting and can be read here.

Unfortunately, the company has also discontinued their COVID-19 vaccine candidates in a news release today. Interestingly, the news is bundled together with their statement that they are continuing the development of Two Investigational Therapeutic Candidates.

Key Takeaways

On a fundamental level, the company looks like it is stabilizing and building on growth potential with smarter investments and a return on capital employed of 24%.

There have been some very important recent developments in their pipeline, with the promising results for cancer treatment being offset by the shutting down of their COVID-19 vaccine development. It seems that Merck is stabilizing on a fundamental level, and investors might want to wait and see if the initial results can be incorporated in the future financial performance.

On a separate note, we've found 4 warning signs for Merck you'll probably want to know about.

Merck is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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