Earnings

Critical Comparison: Merck & Co., Inc. (MRK) vs. Eli Lilly and Company (LLY)

Merck & Co., Inc. (NYSE:MRK) shares are down more than -5.27% this year and recently decreased -2.37% or -$1.32 to settle at $54.45. Eli Lilly and Company (NYSE:LLY), on the other hand, is up 17.01% year to date as of 12/05/2017. It currently trades at $85.19 and has returned 1.19% during the past week.

Merck & Co., Inc. (NYSE:MRK) and Eli Lilly and Company (NYSE:LLY) are the two most active stocks in the Drug Manufacturers – Major industry based on today’s trading volumes. Investors are clearly interested in the two names, but is one a better choice than the other? We will compare the two companies across growth, profitability, risk, valuation, and insider trends to answer this question.

Growth

The ability to grow earnings at a compound rate over time is a crucial determinant of investment value. Analysts expect MRK to grow earnings at a 4.62% annual rate over the next 5 years. Comparatively, LLY is expected to grow at a 11.78% annual rate. All else equal, LLY’s higher growth rate would imply a greater potential for capital appreciation.



Profitability and Returns

Just, if not more, important than the growth rate is the quality of that growth. Growth can actual be harmful to investors if it comes at the cost of weak profitability and low returns. To adjust for differences in capital structure we’ll use EBITDA margin and Return on Investment (ROI) as measures of profitability and return., compared to an EBITDA margin of 19.16% for Eli Lilly and Company (LLY). MRK’s ROI is 6.40% while LLY has a ROI of 11.60%. The interpretation is that LLY’s business generates a higher return on investment than MRK’s.

Cash Flow 




The amount of free cash flow available to investors is ultimately what determines the value of a stock. MRK’s free cash flow (“FCF”) per share for the trailing twelve months was -1.06. Comparatively, LLY’s free cash flow per share was +1.03. On a percent-of-sales basis, MRK’s free cash flow was -7.26% while LLY converted 5.35% of its revenues into cash flow. This means that, for a given level of sales, LLY is able to generate more free cash flow for investors.

Liquidity and Financial Risk

Balance sheet risk is one of the biggest factors to consider before investing. MRK has a current ratio of 1.40 compared to 1.40 for LLY. This means that MRK can more easily cover its most immediate liabilities over the next twelve months. MRK’s debt-to-equity ratio is 0.71 versus a D/E of 0.90 for LLY. LLY is therefore the more solvent of the two companies, and has lower financial risk.

Valuation

MRK trades at a forward P/E of 13.70, a P/B of 3.98, and a P/S of 3.83, compared to a forward P/E of 18.58, a P/B of 6.09, and a P/S of 4.23 for LLY. MRK is the cheaper of the two stocks on an earnings, book value and sales basis. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.

Analyst Price Targets and Opinions

Just because a stock is cheaper doesn’t mean there’s more value to be had. In order to assess value we need to compare the current price to where it’s likely to trade in the future. MRK is currently priced at a -16.69% to its one-year price target of 65.36. Comparatively, LLY is -6.95% relative to its price target of 91.55. This suggests that MRK is the better investment over the next year.

The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 2.20 for MRK and 2.30 for LLY, which implies that analysts are more bullish on the outlook for LLY.

Risk and Volatility

No discussion on value is complete without taking into account risk. Analysts use a stock’s beta, which measures the volatility of a stock compared to the overall market, to measure systematic risk. A stock with a beta above 1 is more volatile than the market. Conversely, a beta below 1 implies a below average level of risk. MRK has a beta of 0.79 and LLY’s beta is 0.34. LLY’s shares are therefore the less volatile of the two stocks.

Insider Activity and Investor Sentiment

The analysis of insider buying and selling trends can be extended to the aggregate level. Short interest, which represents the percentage of a stock’s tradable shares currently being shorted, captures what the market as a whole feels about a stock. MRK has a short ratio of 1.89 compared to a short interest of 3.46 for LLY. This implies that the market is currently less bearish on the outlook for MRK.

Summary

Merck & Co., Inc. (NYSE:MRK) beats Eli Lilly and Company (NYSE:LLY) on a total of 9 of the 14 factors compared between the two stocks. MRK is more profitable, higher liquidity and has lower financial risk. In terms of valuation, MRK is the cheaper of the two stocks on an earnings, book value and sales basis, MRK is more undervalued relative to its price target. Finally, MRK has better sentiment signals based on short interest.

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