Merck's Challenges Include Lawsuits, New Drug Pipeline

Andrew Leckey
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Posted: Oct 16, 2008 12:01 AM
Merck's Challenges Include Lawsuits, New Drug Pipeline

Q. What are the prospects for my shares of Merck & Co.? I'm devastated. -- J.B., via the Internet

A. The drug giant has suffered setbacks from continued litigation and a disappointing new-product pipeline.

It is experiencing the financial aftershocks of Vioxx, the painkiller used by millions of people that it removed from the market in 2004 after its study indicated increased risk of heart attack or stroke.

A federal appeals court, reversing a lower court decision, recently ruled that a Vioxx-related shareholder lawsuit seeking billions of dollars can move forward.

That is separate from a previous $4.85 billion Vioxx settlement between Merck and plaintiffs who filed personal injury lawsuits.

Shares of Merck & Co. (MRK) are down 54 percent this year following gains of 33 percent last year and 37 percent in 2006. The company has plenty of cash flow to cover litigation, excellent credit, a strong balance sheet and is completing a restructuring.

The company, however, is losing profits from some major drugs to generics and hasn't found replacements.

It halted development of experimental anti-obesity drug taranabant, which blocks brain receptors that regulate appetite, due to psychiatric side effects. In April, the Food and Drug Administration rejected an experimental cholesterol drug, and the company eliminated 1,200 jobs.

The New England Journal of Medicine also said test results could neither prove nor disprove a possible link to elevated cancer risk associated with Vytorin, a cholesterol drug produced jointly by Merck and Schering-Plough Corp.

On the plus side, about one in four U.S. girls 13 to 17 years old last year received at least one dose of the company's Gardasil cervical-cancer vaccine, according to a Centers for Disease Control and Prevention survey.

Sales of Gardasil have slipped this year but may be boosted because the FDA updated the label on Gardasil to note protective effects against two other gynecological cancers. Another promising drug is Januvia for diabetes.

Recommendations on shares of Merck by Wall Street analysts, according to Thomson Financial, are three "strong buys," four "buys" and 11 "holds."

Earnings are expected to rise 3 percent this year compared with 10 percent predicted for the major drug-manufacturing industry. Next year's expected increase is 9 percent, or about 1 point lower than the industry forecast. The five-year annualized growth rate of 6 percent lags its peers by 2 percentage points.

Q. Fairholme Fund was suggested to me as a fund that can withstand anything. Is this true? -- P.A., via the Internet

A. It has performed better than most large-capitalization growth-and-value funds, but it has taken serious whacks from the market lately.

It buys three-fourths of its portfolio based on the Warren Buffett philosophy of choosing fairly priced stocks to hold long term. The remainder goes to small positions in riskier, beaten-down stocks with turnaround potential.

It often holds a lot of cash, which helps in market downturns.

The $9.3 billion Fairholme Fund (FAIRX) is down 31 percent over the past 12 months, yet ranks in the top 3 percent of its fund category. Its flat three-year annualized return and five-year annualized return of 8 percent rank in the top 1 percent of peers.

"We highly recommend Fairholme Fund for long-term investors, with the caveat that it could get hit hard due to its concentrated nature," said Michael Breen, analyst with Morningstar Inc. in Chicago. "A strength is that (lead) portfolio manager Bruce Berkowitz and his team have a great record of stock picking."

The fund reduced Berkshire Hathaway Inc. Class A holdings this summer, explaining in its semi-annual report that it didn't see how Berkshire could "replicate its past stellar performance given its current size and the age of key personnel." It trimmed energy holdings before oil prices began to slip. It didn't hold troubled insurer American International Group Inc. or investment bank Lehman Brothers Holdings Inc. because it distrusted their exposure to derivatives.

It bought shares of Florida landowner St. Joe Co. because it saw long-term value in its vast undeveloped land. The fund also made Pfizer Inc., Wellpoint Inc. and Sears Holdings Corp. significant portfolio holdings this year.

Nearly one-third of Fairholme Fund is in health care, with another one-fifth in financial services. Energy and media are additional concentrations. Among its recent holdings were Berkshire Hathaway Class A, Pfizer, Canadian Natural Resources Ltd., Dish Network Corp., Sears Holdings, Wellpoint, Leucadia National Corp., Forest Laboratories Inc., Mohawk Industries Inc. and Mylan Inc.

This "no-load" (no sales charge) fund requires a $2,500 minimum initial investment and has a 1 percent annual expense ratio.

Q. What kind of deduction can you take for donating stock to a charity? -- M.I., via the Internet

A. If the stock has increased in value since you bought it, you can avoid paying capital gains tax by donating it.

If the security is being donated to a charitable organization, the total amount will still be eligible for a tax deduction based on the fair market value of the stock.

"There's an advantage to donating stock instead of cash so long as it is a stock you've owned for a year or more and you have a gain," said Mike Busch, certified financial planner with Vogel Financial Advisors in Dallas. "You basically get a tax deduction for the fair market value of the stock, as opposed what you paid for it, and you escape taxation on the gain."

Let's say you bought a stock for $1,000 and it is now worth $2,000. You donate it, get a $2,000 deduction and don't have to recognize the $1,000 gain on your tax return.

"However, if you had a loss, you would want to sell the stock first and donate the proceeds because you want to take the loss on your tax return," Busch said. "You don't want to give up that loss for yourself."