Novice Investing - Earning Per Share Calculation

Date: Tuesday 13th 2008f May 2008 06:32:48 PM

EPS Estimation for MRK
This is the heart of our analysis. All we try to do is to predict the company's profit for the coming fiscal year. I spent most of the analysis predicting revenue because without it, there will be no profit! Therefore, predicting revenue is essential for other components of the income statement.

Revenue Estimation
Merck's main revenue stream currently consists of four blockbuster drugs; Zocor (cholesterol), Fosamax (Oestoporosis), Cozour Hyzaar (Hypertension) and Singulair (respiratory). Together, they represent 65% of the company's revenue stream. Other than Zocor, these three blockbuster drugs showed a double digit growth in revenue in fiscal year 2004. I expect the trend to continue since patent expiration for the three drugs are still years away. Merck's cholesterol drug, Zocor, will lose its patent in a year and sales has been dwindling between 5-10% annually since 2002.

There are two drugs that I believe would make up for the lost revenue of Zocor. Both drugs are marketed with fellow pharmaceutical company, Schering Plough (SGP). Zetia is a cholesterol absorption inhibitor drug currently has around $ 750 M in sales. Vytorin works by reducing the so-called bad cholesterol (LDL) and currently has around $ 350M in annual sales. Both are expected to show extraordinary growth as new users seek a more effective cholesterol treatment.

Here is estimate on the revenue stream for each blockbuster drugs in the future

Revenue	Growth rate '03-'04	Fiscal 2005	Growth rate 2004-2005	Fiscal 2006	Growth rate 2005-2006
Zocor	(5%)	$ 4,700 M	(9.6%)	$ 4,000 M	(14.9%)
Fosamax	18%	$ 3,600 M	12.5%	$ 3,960 M	10%
Cozaar/Hyzaar	14%	$ 3,200 M	12.5%	$ 3,520 M	10%
Singulair	30%	$ 3,200 M	23.0%	$ 3,840 M	20%
Zetia	53%	$ 960 M	74.5%	$ 1,440 M	50%
Vytorin	N/A	$ 325 M	90.1%	$ 569 M	75%
Prilosec & Nexium	Not found	$ 800 M	0%	$ 840 M	5%
Vioxx*	-	$ 500 M	(75%)	$ 1,000 M	100%
Others	9%	$ 6,000 M	9%	$ 6,450 M	7.5%
TOTAL		$23,285 M		$25,619 M
* Vioxx is currently pulled out of the market due to safety concern

Pipeline
Merck's promising pipeline that are on the late stage of research are mainly vaccines and diabetes treatment. I believe revenue category 'Others' can grow faster than estimate based on current information about late-stage pipeline. Meanwhile, Merck's late-stage diabetes treatment, will in my opinion be a blockbuster drug with revenue north of $2 Billion. As of right now, it is excluded in the revenue estimation due to my uncertainty regarding the release of the product.

You might notice that I put Vioxx revenue as $500 M in 2005. In september of 2004, Merck decided to pull Vioxx from the market due to its health risk. However, last Friday FDA panel approved Vioxx to be sold with black-box warning on it. My believe is that MRK will want to re-sell Vioxx to the market to recover the R&D expense associated with it. Finally, with the panel announcement, potential legal damage from Vioxx has been reduced.

Gross Profit Estimation
I estimate Gross profit margin to stand at 78% for MRK. For the last two fiscal years, gross profit margin consistently stands at 80%.

SG&A Estimation
Research & Development will be at $ 4.0 B for 2005 while SG&A Cost is predicted to rise to $ 6.82 B for fiscal year '05. This is a modest increase from fiscal year 2004 and a conservative estimate due to the fact that MRK did not plan any new hires for the year. Furthermore, MRK benefits from$ 300 M of cost saving due to the elimination of 4400 positions announced on October of 2003.

Interest & Income tax expense
As of Sept 04, long term Debt stood at $ 4.40 B for Merck while cash stood at $ 6.95 B. I believe MRK earn more interest income from its cash in the bank to offset the interest payments on its long term debt. Therefore, interest expense is $ 0.

Tax rate for Merck is predicted to be around 28% based on the previous fiscal years.

Shares Outstanding Estimation
MRK board of director has authorized a $ 8.5 B buy back program. Assuming they will use half of that money up buying its own depressed shares, the share count will decrease by 145 M shares. Current shares outstanding stands at 2.22 Billion shares. Therefore, in fiscal year 2005, Merck's shares outstanding will probably fall to 2.08 billion shares.

Pro Forma Income Statement for MRK	Fiscal year 2005	Fiscal year 2006
Revenue	$ 23,285 M	$ 25,619 M
Cost of Goods Sold	$ 5,123 M	$ 5,636 M
Gross Profit	$ 18,162 M	$ 19,983 M
SG & A	$ 6,820 M	$ 7,161 M
R& D expense	$ 4,000 M	$ 4,200 M
Interest Expense	$ -	$ -
Profit Before Tax	$ 7,342 M	$ 8,622 M
Income Tax Expense	$ 2,055 M	$ 2,414 M
Net Income	$ 5,287 M	$ 6,208 M
Shares Outstanding	2.08 Billion Shares	1.98 Billion shares
EPS Estimate	$ 2.54	$ 3.14

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