Merck's Earnings Are Up, But a Huge Drop may be Coming

Merck & Co. (NYSE: MRK) reported GAAP earnings of 49 cents per share (97 cents on non-GAAP basis with exclusions) on revenue of $12.29 billion, up 2% from the previous year. For the year, Merck had total sales of $48 billion, an increase of 4%, thanks in large part to a benefit from currency exchange rates.

The company's best seller remains Singulair, the asthma medicine that will be available as a generic later this year, after Merck loses its patent protection in August. The asthma drug represented over 10% of total sales, at $1.46 billion. The secondmost bestseller was Januvia, a diabetes management medicine which Merck received a patent for in 2008.

Analysts have held a median price target of $41 on the company, despite concerns that revenue might slow in the coming year. However, 2011 earnings grew on 2010's figures, and analysts have hoped that an increase in cash flow (expected to climb over $5 billion for 2011) would allow the company to reverse its contraction. Earlier last year, the company announced plans to cut as much as 13,000 jobs in an effort to contain costs.

Those plans may change, now that the company has returned to profitability. The company's earnings before taxes, at $1.58 billion, are a healthy turnaround from the previous year's quarterly loss of $701 million.

The company has also been helped by a lowered tax rate, which fell to 2.3% for the quarter, thanks largely to a tax settlement that ended in Merck's favor to the tune of around $700 million--a sharp turnaround from the $147 million tax charge the company suffered due to health care reform in the previous year. The company will pay an effective tax rate of 12.8% for the year, down sharply from 2010's rate of 40.6%.

Investors will want to look at Merck more carefully, partly because the company's small increase in sales was also met by a bigger jump in margins, thanks in part to falling materials costs, although the biggest cut was in research and development expenses, which fell 47% from $4.56 billion to $2.42 billion, thanks to the company's restructuring. Such a contraction may be a short-lived benefit, as it will make it harder for the company to develop new profitable drugs as it faces a patent expiration on its asthma cash cow.