Merck vs. Sanofii: Which Stock Is Better Pre-Q4 Earnings?

As fourth-quarter earnings results are pouring in, the focus is back on the healthcare sector. High on President Trump’s agenda was an attempt to repeal and replace the Affordable Care Act. In less than a year, the Trump administration achieved its primary objectives, tax cuts and a new healthcare legislation, through the Tax Cuts and Jobs Act of 2017. The new law effectively repeals the individual mandate, which is essential to the proper functioning of Obamacare. (Read More)

However, upbeat quarterly results, rise in demand for new product sales, successful innovation, FDA approvals and product line expansion, strong clinical study results as well as continued strong performance of legacy products propelled the large-cap drug sector to new highs in 2017. These tailwinds are expected to drive the sector’s growth even in 2018. (Read More)

The healthcare sector jumped 28.8% in the past year, better than the S&P 500’s 23.7% rally. Signs of the sector’s success became more evident in the last three months, when the NYSE ARCA Pharmaceutical Index and the Nasdaq Biotechnology Index gained 13.7% and 21.1%, respectively. The broader industry grew 9.7% in the same time period.

With Merck & Co., Inc. MRK and Sanofi SNY scheduled to report on Feb 2 and Feb 27, respectively, this may be a good time to figure out which of these is a better stock. Both stocks carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Other major pharma earnings scheduled during this period include Bristol-Myers Squibb Company BMY and Astrazeneca PLC AZN.

Price Performance

Merck has seen a gain of 7.4% over the past three months, while Sanofi has declined 5.9%.So Merck is a clear winner in this respect with better returns than both rival Sanofi and the broader industry, which rose 4.5% during the same period.

Valuation

The most appropriate ratio to evaluate these two drug makers is perhaps EV/EBITDA. This metric is usually used to compare two stocks in the same industry. It is superior to other metrics such as P/E because it is not affected by the different capital structures of the two companies.

Coming to the two pharma majors, both Merck and Sanofi are undervalued relative to their broader industry, which has an EV/EBITDA value of 13.74. However, Sanofi holds the edge here with a lower EV/EBITDA value of 8.13 compared with Merck’s value of 10.44.

Dividend Yield

Over last year, Merck and Sanofi offered dividend yields of 3.24% and 2.5%, respectively, while the industry returned a dividend yield of 2.83%. So Merck has taken lead here too, with respect to both Sanofi and the broader industry.

Net Margin

The pharmaceutical industry enjoys higher profit margins than several other sectors. This is possibly one of the reasons why critics of the sector continually draw attention to allegedly exorbitant drug pricing, which helps the sector maintain its steep margins.

With a net margin value of 19.94%, Sanofi underperforms rival Merck, which has a net margin value of 26.98%. In comparison, the broader industry has a net margin value of 25.79%.

Return on Equity

Return on equity (ROE) is one of the key financial ratios for pharma companies as these entities employ huge amounts of capital to bring its products to the market. In this respect, using ROE will help in evaluating the company’s ability to generate ample profits from its equity capital.

Both pharma companies, Merck and Sanofi have a comparatively lower ROE of 27.08% and 25.19%, respectively, than the broader industry’s value of 29.87%. However, while comparing individual performance, Merck holds an edge over Sanofi.

Earnings History and ESP

Considering a more comprehensive earnings history, Merck has delivered positive surprises in all the prior four quarters with an average earnings surprise of 7.76%. In comparison, Sanofi delivered an average positive earnings surprise of 1.03% in the trailing four quarters. Merck managed to post earnings beats in all the four trailing quarters.

Meanwhile Sanofi registered an earnings beat only in the first quarter of 2017, while results were in line with estimates over the next two.

When considering Earnings ESP, Merck is once again the clear winner. With an ESP of -0.29%, Sanofi is at a disadvantage, since Merck’s ESP is +0.67%.

Conclusion

Our comparative analysis shows that Sanofi holds an edge over Merck when considering only EV/EBITDA ratios. However, when considering price performance, ROE and net margins Merck is at an advantage over Sanofi. Additionally, Merck also sports a better dividend yield than Sanofi and with a more comprehensive look at its previous earnings performance, Merck is clearly the better stock.

What clinches the case in favorof Merck at this point of time is that it has a positive ESP, which is a leading indicator of a likely positive surprise. This is why it may be better to bet on Merck over Sanofi as both prepare to report earnings over the next few days.

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