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The Reasons behind Merck’s Improving Profitability

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Profitability

Merck & Co.’s (MRK) profitability was affected by the ~1% decrease in revenues in 1Q16. Adjusted net income increased to $1.5 billion in 1Q16, compared to $1.3 billion in 1Q15.

The company surpassed analysts’ estimates for adjusted net income and earnings per share in each quarter over the last two years.

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Changes in profit margins

Gross margin decreased by 0.5% to 61.6% in 1Q16 compared to 62.1% for 1Q15. Gross margin was driven by increased costs of sales due to the unfavorable impact of acquisitions and divestitures and restructuring costs. The operating profit margin improved by ~2.7% to 17.9% in 1Q16 compared to 15.2% in 1Q15.

Marketing and administrative expenses declined to $2.3 billion in 1Q16, compared to $2.6 billion in 1Q15. The decline was due to the favorable impact of foreign exchange and the divestment of its Consumer Care business. Research and development expenses decreased by 6% compared to 1Q15, following lower licensing expenses. Other income decreased to $48 million for 1Q16.

Revised financial guidance

Merck revised its 2016 adjusted EPS (earnings per share) to $3.65–$3.77, including a negative foreign exchange impact. Merck also raised its midpoint for revenues and narrowed the range to $39.0 billion–$40.2 billion for 2016. This revenue estimate includes a negative foreign exchange impact of 2%.

Merck expects its marketing and administrative expenses to be lower in 2016 over 2015. However, the company expects R&D (research and development) expenses to be slightly above 2015 levels.

Merck, Johnson & Johnson (JNJ), Pfizer (PFE), and GlaxoSmithKline’s Indian subsidiary (GSK) have announced share repurchases of $10 billion, $11.7 billion, $13.0 billion, and ~$1.0 billion, respectively, over the last two years.

Investors can also consider the Health Care Select Sector SPDR ETF (XLV), which holds 5.8% of its total assets in Merck and is focused on pharmaceuticals and healthcare companies.

In the final part of our series, we’ll see if Merck’s recent new developments can make a difference.

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