EFTA00306883.pdf

J.P.Morgan North America Equity Research O2 June 2014 • Merck & Co., Inc. Pushing Ahead Aggressively in PD-1 Development We attended Merck's ASCO analyst meeting today where the company reviewed new data and development plans for its PD-1 (pembrolizumab). Overall, we increasingly see Merck playing a leadership role in the immuno-oncology space given its aggressive clinical development approach to pembro with compelling data seen thus far in melanoma (Yervoy-naive and refractory), NSCLC (I st-line and pre-treated), and head and neck cancer. Further, we expect pembro to be the first PD-1 to launch (post- Yervoy melanoma, admittedly small indication) with a PDUFA in October. • Merck confirms PD-I efficacy in IL PD-L1+ NSCLC with 47% irRC ORIL First data from Merck's phase lb study of pembrolizumab in IL NSCLC showed a 47% (21/45) ORR by irRC (26% based on RECIST) across all three doses, and we note that 80% of patients had at least some tumor shrinkage, suggesting a clear place for PD-1 in this patient population. Merck is initiating a phase III for pembro in front-line PD-L1+ NSCLC in September. We note that Bristol initiated a phase III study of nivo in PD-L1+ IL lung earlier this year. Pembro head & neck data supports move into phase III. Merck highlighted its head and neck data, which was highly encouraging in our view. The study, which enrolled PD-L I+ recurrent and metastatic head and neck cancer patients, showed an ORR of 20% (11156) and 51% of patients exhibiting at least some tumor shrinkage. There was preliminary evidence that even within this population, the highest PD- L1+ expressers showed a much higher response rate (45% RR (5/11) above cut- point and 11% RR (5/44) below cut-point). We note that even the response rate in lower PD-LI expressers is in line with Erbitux, the only targeted therapy approved for head and neck. Pembro shows 69% 1-year survival in advanced melanoma, nivo/combo comparisons remain difficult. Today Merck presented data from KEYNOTE-001, a very large phase lb study in which pembro showed a 69% I -year survival rate and an estimated 62% 18-month survival rate. One-year survival was 74% in patients without prior Yervoy treatment and 65% in Yerboy-experienced patients. This data appears at least as strong as and potentially stronger than nivo's monotherapy data, although we see a promising role for PD-I/CTLA-4 combo therapy in melanoma. • Several catalysts ahead for pembro. These include FDA action for the product on October 28, additional proof of concept data in further tumor types (i.e., bladder, triple negative breast, and gastric) later this year or in 2015 as well as a potential filing in NSCLC in 2015 (based on phase II/III study in 2/3L PD-L1+ patients). Merck 8 Co., Inc. (MRK;MRK US) EYE Dec 2O13A 2O14E 2015E 2O16E 2017E EPS - Recurring ($) 01 (Mar) 0.85 0.88A 02 (Jun) 0.84 0.81 03 (Sep) 0.92 0.87 O4 (Dec) 0.88 0.88 - FY 3.49 3.44 3.67 4.19 4.41 Bloomber EPS FY $ 3.50 3.47 3.64 3.99 Source: Company data. Bloomberg. Morgan estimates. Sternberg' above denotes Bloomberg consensus estimates. Overweight MRK, MRK US Price: $57.93 Price Target: $64.00 Pharmaceuticals — Major 8 Specialty Chris Schott, CFA AC (1-212) 622-5676 Bloomberg JPMA SCHOTT <GO' Jessica Fye (1-212) 622-4165 Wendy L Lin (t-212) 622-5350 Dana C Flanders (1-212)622-1256 M. Morgan Securities LLC Mee Porlomanee EN a Mn arg D1411 Neu Am. — MOM snare Moo ON $19500 0.0*INO YID lm 3m 12m Ate I l5.7% -0.5% 1.6% 19.6% Rel I 11.6% .21% -1.9% 22% Company Data Pike (5) 57.93 Date Of Price 02 Jun 14 52-week Range (5) 59.84.44.62 Market Cap ($ mn) 171,786.00 Fiscal Year End Dec Shares 0/S (mn) 2,965 Price Target (S) 64.00 Pike Target End Date 31-Dec-14 See page 4 for analyst certification and important disclosures. I . Morgan does and seeks to do business with companies covered in its research reports. Asa result, investors should be aware that nn may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. EFTA00306883 Chris Schott. CFA North America Equity Research (1-212) 622-5676 02 June 2010 J.P.Morgan Investment Thesis, Valuation and Risks Merck & Co., Inc. (Overweight: Price Target: $64.00) Investment Thesis Maintain Overweight rating. Ultimately, we believe Merck has fundamentally changed its approach to its business over the past year, and we see this increased focus translating into better performance for the company and the stock. We see MRK shares as well positioned for multiple expansion with the company offering healthy earnings growth (7% CAGR through 2020E), one of the lowest valuations (16x our 2014E EPS), and with several low-expectation pipeline updates over the next 12.18 months. Valuation Merck trades at 16x our 2014 EPS estimate of $3.44. This is a 10% discount to its US major pharma peers. Recall that the US major pharma group currently trades at a 12% premium to the 500 on 2014E PIE. Maintain Dec 2014 price target of $64. Our price target is based on a DCF methodology as we believe this best captures the overall value of these businesses. For our Merck DCF, we take the present value of cash flows within our forecast window and thereafter wind down the existing products business while including risk-adjusted contributions from pipeline assets. We use a 0% sector terminal growth rate and a WACC of 9.0% (above recent norms based on a higher equity risk premium given the litany of issues facing the sector over the next few years). This translates to a DCF value of $64. Risks to Rating and Price Target Risks to our Ovenveight rating and price target include I) another leg down in cholesterol sales, 2) failure to effectively manage the core Januvia/vaccines portfolio, and 3) setbacks to key pipeline assets. 2 EFTA00306884 - North America Equity Research 02 June 2014 Merck & Co., Inc.: Summary of Financials Inacne Statement - Anmial FY13A FY14E FY15E FY16E Income Statement Guarterly 1O14A 2014E 3014E 4014E Revenes 44.031 42,800 43,363 44.812 Revenes 10,284A 10.711 10,669 11,154 Cosi of products sold (11.332) (11,008) (11,058) (11.203) Cosi ol woducts sold (2,658)A (2,785) (2,721) (2,844) Gross profil 32,699 31,792 32,306 33.609 Gross pro0t 7,606A 7.926 7,949 8,310 SG8A (11,873) (11,172) (11,080) (11,060) SG8A (2,692)A (2,857) (2,697) (2,926) (7,124) (6,739) (6,571) (8.439) N (1,523)A (1,705) (1,701) (1,811) Operating income 13502 13,881 14,875 18,110 Operaling income 3,391A 3.365 3,551 3,573 Net intetet! (inn) /expense (533) (554) (480) (434) Nei inteves fincome1/ expense (127)A (1371 (137) (153) Other income r (expense) 118 283 (5) 20 Other income r (expense) 290A 10 (17) (1) Prata income 13,485 13,609 14,190 15,695 Prata income 3,554A 3.219 3,398 3.419 kome laxes (2,927) (3,373) (3.477) (3,787) Income taxas (027)A (793) (832) (820) Net alCOMO • redning 10.446 10,177 10.714 11,928 Nel incwne • temming 2,601A 2.412 2.565 2.598 Dimed snares outstanding 2,996 2,963 2.919 2,848 Dikned snares outstanding 2,971A 2.965 2.960 2.954 EPS • exduding nonremming 3.49 3.44 3.67 4.19 EPS • exduding non-return 0.88A 0.81 0.87 0.88 EPS • recurring 3.49 3.44 3.67 4.19 EPS • recurang 0.88A 0.81 0.87 0.88 Balanse Stoet and Cash Flow Data FY13A FY14E FY15E FY16E Ratio Analyslo FY13A FY14E FY15E FY16E Cash and cash ecairralents 15.621 15,786 17,237 19,680 Sales grand) (6.8%) (2.8%) 1.3% 3.3% Short Term Investment t.865 1.865 1.865 1.865 BIT grovnh (10.8%) (02%) 5.7% 9.8% Accounts receivable 7.184 6.817 6.625 6.846 EPS grooth • resning (8.7%) (1.5%) 6.8% 14.2% Invenlories 6.226 6.005 5.836 5.913 Other current assels 4,789 4.016 3,903 4.033 Gross margin 74.3% 742% 74.5% 75.0% CLerent essets 35.685 34.488 35.466 38.337 EBIT margin 31.6% 32.4% 33.8% 35.9% PP8E 14.973 14.893 14.841 14.852 Total assels 105,645 104.118 104.794 107.427 Tax rate 21.7% 24.8% 24.5% 24.0% Net margin 23.7% 23.8% 24.7% 26.6% Total dobl 25.060 25.060 25,060 24.060 Total IiabiWies 55,880 54,456 53,651 52.466 Return on assets (ROA) 9.9% 9.8% 10.2% 11.1% Shareholders' equdy 49,765 49,882 51,142 54261 Return on equity (ROE) 21.0% 20.5% 20.9% 21.7% Net income (including charges) 4,517 10,177 10,714 11.928 Free cash kw yield 5.9% 5.9% 6.7% 7.4% 6,988 2,041 2,037 2.031 Charme in working capital (794) 438 168 (114) Other (221) (200) 1200) (200) Cash kw (rom 11,654 10,957 12,719 13,845 operations Capex (1448) (1,712) (1,735) (1,792) Free cash Bow 10.323 10.188 11,347 12,183 Cash Bow from investing activities (3.148) (1,185) (1,735) (1,792) Cash Bow from hnancing aclivities (5.990) (9,607) (9.533) (9.410) Source: Company reports and Morgan estimates. Note: S in Mitt011S (except porshare data).Frscal year ends Dec J.P.Morgan 3 EFTA00306885 Chits Schott. CFA North America Equity Research tit-2121622-5676 02 June 2014 J.PMorgan Analyst Certification: The research analyst(s) denoted by an "AC" on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an "AC" on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no pan of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. For all Korea-based research analysts listed on the front cover, they also certify, as per KOFIA requirements, that their analysis was made in good faith and that the views reflect their own opinion, without undue influence or intervention. Important Disclosures • Lead or Co-manager: N. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for Merck & Co., Inc. within the past 12 months. • Client: Morgan currently has, or had within the past 12 months, the following company(ies) as clients: Merck & Co., Inc.. • Client/Investment Banking: M. Morgan currently has, or had within the past 12 months, the following company(ies) as investment banking clients: Merck & Co., Inc.. • Client/Non-Investment Banking, Securities-Related:.. Morgan currently has, or had within the past 12 months, the following company(ies) as clients, and the services provided were non-investment-banking, securities-related: Merck & Co., Inc.. • Client/Non-Securities-Related:M. Morgan currently has, or had within the past 12 months, the following company(ies) as clients, and the services provided were non-securities-related: Merck & Co., Inc.. • Investment Banking (past 12 months): M. Morgan received in the past 12 months compensation from investment banking Merck & Co., Inc.. • Investment Banking (next 3 months): Morgan expects to receive, or intends to seek, compensation for investment banking services in the next three months from Merck & Co., Inc.. • Non-Investment Banking Compensation: M. Morgan has received compensation in the past 12 months for products or services other than investment banking from Merck & Co., Inc.. Company-Specific Disclosures: Im rrtant disclosures. includin covered com ies b visitin screen coin ies not covered b Mo Merck & Co., Inc. (MRK. MRK US) Price Chart lee 90 — 72 PriceIS) es 36—' Is - 0 rice charts, are available for compendium reports and all Morgan- calling 1-800477-0406, ore-mailing with your request. Morgan's Strategy, Technical, and Quantitative Research teams may an. For important disclosures for these companies, please call 1-800477-0406 or e-mail OW 344 1 Cnifl OW 98 I OW $40 04 ow sat OW S ow see j ow s OW Se0 OW 862 IOw Owns .— t I I I Oct Apr Oct Apr Oa Apr 06 08 09 ii it 14 Socace. 0soonnong and M . Morgan. price data acinento4 for scorn splits and Chrennch. Brea an COalfaQ. Jan 24.2008 Jan 06.1009 Date Rating Share Price Price Target (5) ($) 24-Jun-08 OW 35.83 06-Jan-00 OW 29.97 38.00 04-Nov-09 OW 30.67 40.00 05-Jan-10 OW 37.16 44.00 13-Jan-11 OW 34.23 42.00 02-May-11 OW 35.95 44.00 30-Jul-12 OW 45.10 52.00 03-Jun-13 OW 48.45 54.00 30-Jul-13 OW 48.34 52.00 01-Oct-13 OW 48.37 53.00 02-Dec-13 OW 49.83 55.00 05-Feb-14 OW 53.53 60.00 06-May-14 OW 57.11 64.00 4 EFTA00306886 Chris Schott. CFA North America Equity Research 1-21 622-5676 02 June 2014 J.P.Morgan The chart(s) show M. Morgan's continuing coverage of the stocks; the current analysts may or may not have covered it over the entire riot M. Morgan ratings or designations: OW - Overweight, Neutral, UW Underweight, NR Not Rated Ex lanatlon of Equity Research Ratings, Designations and Analyst(s) Coverage Universe: Morgan uses the following rating system: Overweight (Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] Neutral (Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] Underweight (Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.) Not Rated (NR): E. Morgan has removed the rating and, if applicable, the price target, for this stock because of either a lack of a sufficient fundamental basis or for legal, regulatory or policy reasons. The previous rating and, if applicable, the price target, no longer should be relied upon. An NR designation is not a recommendation or a rating. In our Asia (ex-Australia) and U.K. small- and mid-cap equity research, each stock's expected total return is compared to the expected total return of a benchmark country market index, not to those analysts' coverage universe. If it does not appear in the Ira runt Disclosures section of this report, the cettifying analyst's coverage universe can be found on M. Morgan's research website, Coverage Universe: Schott, Christopher: AbbVie (ABBV), Actavis plc (ACT), Allergan (AGN), Amarin Corporation (AMRN), Bristol-Myers Squibb Company (BMY), Eli Lilly & Company (LLY), Endo International PLC (ENDP), Forest Laboratories, Inc (FRX), Hospira, Inc. (HSP), Impax Laboratories (IPXL), Kythera Biopharmaceuticals (KYTED, Mallinckrodt (MNK), Merck & Co., Inc. (MRK), Mylan Inc. (MYL), Perris° Company (PRGO), Pfizer Inc. (PFE), Sagent Pharmaceuticals (SGNT), Teva Pharmaceuticals (TEVA), Valeant Pharmaceuticals (VRX), Zoetis (ZTS) M. Morgan Equity Research Ratings Distribution, as of March 31, 2014 Overweight Neutral Underweight (buy) (hold) (sell) S. Morgan Global Equity Research Coverage 44% 44% 11% lB clients° 58% 49% 40% JPMS Equity Research Coverage 45% 48% 7% BEI clients° 78% 67% 60% ',Percentage of investment banking clients in each rating category. For purposes only of FINRANYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category. Please note that stocks with an NR designation arc not included in the table above. 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