Merck KGaA (MRK) Earnings Call Transcript & Summary

Welcome to the Merck KGaA from Darmstadt Germany presentation at the 41st JPMorgan Healthcare Conference. I'm Richard Vosser, European pharma analyst at JPMorgan. And it's my great pleasure to introduce the CEO of Merck KGaA, Belen Garijo, but before I hand over to Belen, I would just remind you that we're staying here for questions first time. And we will do them using a mic, so please put your hand up and we'll get to your questions after Belen's presentation. Belen, welcome to the conference.

Thank you so much, Richard, for the introduction. And good morning, everyone. Happy new year to all of you. I'm super excited to be here in person, finally, after several years of virtuality, as we call it, so what I would like to do during the next 20 minutes is to take you through a brief strategy update as well as give you a bit additional information and additional color on our 2 major business sectors, Life Science and Healthcare. And then after we do this, I will be happy together with my colleagues to take your questions. So to start with, over the years, the group has gone through a major transformation, really driven by our very active and successful portfolio management that has allowed us to become globally diversified science and technology company, which is uniquely positioned in fast-growing markets mostly driven by our 3 major pillars, what we call the BIG3, our 3 growth engines that I will speak about with a bit more detail later in the presentation, but that you have on the slide, mostly composed by process solution within life science, the healthcare pipeline and the semiconductor solutions. So through focusing our efforts and our capital and our investment behind these 3 business pillars, we are extremely well placed and poised to continue to deliver sustainable growth, addressing some of the major trends that have accelerated during the pandemic, for example, novel modalities in life science, of course, connectivity and think of the needs for cheaps and how well we are positioned in this market, which will continue to boom in coming years. So -- the diversification of our business is a major strength of the Merck Group and it's a major strength because it allows us to be much more resilient and to deal with adversity as you will see later on in a very effective way. We operate a multi-industry business as you see on the slide, that is composed of 3 major sectors, Life Science, Healthcare and Electronics, mainly the semiconductors business that I mentioned before and over the years and through this very active portfolio management that I already mentioned, Life Science became our major business sector. Being also diversified within the business sectors -- within the business sector and becoming an industry leader with a global podium position. Process Solutions, for example, we cover the full value chain upstream to downstream and through science and lab solutions in -- within Life Science. We have one of the broadest portfolio offers of consumables for R&D and quality destined. Healthcare has gone through a big turnaround of our R&D pipeline over the last few years and is now driven mostly by the new launches after having made a very decisive move a few years ago to becoming a global specialty innovator. In electronics, we are a leading player in semiconductor solutions. We have one of the strongest portfolios of materials and related equipment and services, and we are helping our customers to create the next generation of faster, smaller and more energy-efficient devices. I mentioned resilience already. And if you think of our company as a company which has been in business for more than 350 years, resilience is something that resonates very well with us. But of course, we cannot expect without doing nothing to be resilient forever. So this year, we conducted a very deep analysis on -- including all our business units on -- are we at the right level of resilience taking into consideration that to thrive in these unprecedented times, resilience is a key word. And here, you have some of the data that we actually uncovered through this very deep analysis that was conducted in the fall of last year. And for the Med Group, I am very proud to say that we showed a very strongly resilient business built on a very solid foundation for future growth. Exceptionally strong financial backbone operating in markets with very low business cyclicality, customer diversification, scoring very, very high, leveraging different geographies, different industries, different customer segments and different channels. And last but not least, in a macroeconomic downturn scenario, we see overall limited demand exposure mainly backed by our Life Science and Healthcare businesses. So turning into a brief business update, let me give you a bit more color on our Life Science business. As I said, our biggest sector at this time, both in terms of top line and also profitability and Healthcare later on. Our 3 business sectors operate as 3 highly independent pillars. On managing the business, those operating models are very highly differentiated and at the commercial level as well as the R&D level, they operate very independently. However, the capital allocation is managed at group level, as we will mention later on. Process Solution is dedicated to products for pharmaceutical manufacturing, some biotech Life Science Services is in contract testing, development and manufacturing services for both biotech and Pharma and Science and Lab Solutions is covering and addressing research and the testing lab space. Each of these businesses have a very well-established position in the markets that we serve and collectively provide a diverse and very balanced footprint on what constitutes very dynamic markets. Despite a rapidly declining COVID business, we can discuss that in more detail later on. If you are curious to know more about this, we remain highly confident in our Life Science midterm financial ambition to deliver 7% to 10% organic sales CAGR. We see an attractive market outlook moving forward. And of course, we have heavily invested in building and expanding our capacity, further regionalization in that context and expanding on high-growth segments, in particular, novel modalities like mRNA, antibody drug conjugate through also some bolt-on acquisitions. Back to COVID. During the last couple of years, we have highly benefit from the COVID wave in some of the units mainly single-use bioreactors and filtration, also providing services to some of these customers, we have seen that since 2022, the growth of Process Solutions is mainly driven by our core business. As I mentioned before, in the face of COVID decline that is actually faster and faster so far because the booster uptake is quite limited so far, and the number of doses of vaccines are actually declining as well. When it goes to Healthcare, I mentioned already that -- can you give me the next one -- that over the years, we have turned a business that was mostly composed by general medicines and fertility into a business that is emerging very solidly to address specialty medicines and mostly driven in terms of growth by the Healthcare launches over the last few years. I think when we look at Healthcare, you have to take into consideration that after the R&D turnaround and the refocusing of the Healthcare business, exclusively into pharma after the divestiture of Consumer Health, biosimilars, Alergo Pharma, et cetera. Now we are entering a phase in which we are in front of the new wave of transformation for R&D, which is going to encompass not only a productive R&D pipeline coming from our internal efforts and investment, but also additional external innovation, as you will see in the next one. For Healthcare, we are confirming the midterm guidance of mid-single-digit growth that we have communicated. Last year, we are expecting our established portfolio to continue to be very resilient mostly because of the development of this part of the portfolio in emerging markets, specifically in China, and we are talking about mostly Erbitux fertility and general medicine. Launches will come on top. And Mavenclad and Bavencio are now driving almost 90% of the growth of the Healthcare business. And in the midterm, we are expecting our later-stage assets, in particular, our BTK evobrutinib and xevinapant to contribute further growth of pharma in the coming years, which is bringing me to R&D productivity, what you have in the next slides. So with me is our Head of R&D for Healthcare, so he can further detail this if you are interested. But as I mentioned before, now we are in a phase in which we need to build on the existing strength and capabilities in biology, continue to be very focused rather than on platform therapies, what we call focused leadership, but importantly, to increase the contribution from external innovation to over 50% in our core areas of expertise bolstering our capabilities. Something that has been a challenge as for many other companies, is to ensure the right agility and the right adaptation of the way that we operate our R&D teams in the current times, right, much more competitive in the environment and of course, with the need to simplify and accelerate the way we operate. We have, over the years, taken our R&D budget to peer levels coming from a very high R&D budget before. And in the last 24 months already, we have given good examples of what we mean by focus leadership. We have in-licensed xevinapant, we have in-licensed a selective PARP inhibitor, which is very fit to our DDR strategy and we have done a couple of other acquisitions, which are complementing very nicely what we are doing internally. a responsible company, we are firmly committed to now executing on our sustainability strategy. Here, you have our goals. First of all, contribute to advancing human progress through our health care sector, obviously to global access to medicines, but also through enabling cutting technologies through Life Science, creating sustainable value chains is the second one. So we are aiming to integrate sustainability in our value chains by 2030. And this is a tremendous task that we have when we are dealing with more than 60,000 suppliers. By 2040, we are aiming to achieve climate neutrality and of course, across the board, in the whole company in each and every country in which we operate, we are extremely focused on diversity and inclusion, not only on gender, but also to improve the participation of active minorities and underrepresented population on communities. So how is this translating into numbers? In May 2021, we already communicated our aim to deliver EUR 25 billion by 2025 of our top line. This is going to be driven mainly by the 3 growth engines that I mentioned at the beginning, which will become half of the revenues of the group in 2025. For that, we need to deliver EUR 1 billion incremental sales every year until 2025. This is only organic. So M&A is excluded and so far, we are tracking nicely if you look at what we deliver between 2020 and 2021 already. We have also spoken about the -- our ability to deleverage from the recent acquisitions. At this time, because of our operating leverage, our great business performance and our ability to keep cost under control. We have deleveraged very quickly from the Berson acquisition, which, as you may recall, was announced in 2018, if I'm not mistaken, 2019 and we have the basis for all our growth ambitions behind the BIG3 behind the CapEx implementation, the CapEx investment that we are now executing, increasing R&D across the 3 sectors, but also increasing capacity to make inorganic moves. We are targeting in terms of investment, EUR 2 billion CapEx per annum across regions with the intention to expand capacity mainly for Life Science and also for semiconductors. And in terms of inorganic moves, we have generated the capacity between EUR 15 billion and EUR 20 billion. We keep the flexibility on when and how we are going to operate this. I'm sure this is a question that will come later on. But the fact that we have capacity doesn't mean that we are going to immediately move into one or several acquisitions and capital allocation has been very much at the heart of our strategy and will continue to be like this. To close, we are, as I mentioned, already uniquely positioned to deliver resilient growth through our current leadership in fast-growing markets and as a result of the rigorous portfolio management that we have done over the years. We are aiming to grow despite the macroeconomic challenges that we have been confronted with already in 2021, 2022 and that will continue to be with us definitely for the next 2 to 3 years. In terms of innovation, I mentioned briefly our ability to deliver innovation within the sectors, but something that is making Merck unique is the fact that operating in Life Science, Healthcare and Electronics, we have -- we are at the sweet spot of what we call Bioconvergence, and we are already piloting some of the potential complementarities that we have between Healthcare and between Life Science. Those are pretty obvious, right? For example, aiming to deliver new delivery systems for lipid nanoparticles or targeting artificial intelligence to improve our discovery productivity, but also working on bioelectronics, clear synergy between our electronics sector and healthcare. And last but not least, we are a company that has now achieved a level of development in sustainability that is positioning us to go above and beyond the business financial gains that we are bringing to our owners and investors, but we are also aiming to create value for society on everything that we do across the 3 sectors. And with this, I'm going to thank you for your attention and take all your questions together with my colleagues.

Thanks, Belen. So we're now entering the Q&A phase. So please, if you have a question, put your hand up and you may have to shout if you're behind the pillar as well. Maybe a question for me then to kick us off. Just you highlighted the midterm targets to EUR 25 billion in '25. I had the idea that we were midway through them, but we're not midway through them. So -- but just in terms of what's going better than you thought in terms of the delivery to those targets? Maybe what pressures do you see areas with -- and how do you address those.

Well, I can tell you what is not going better than we thought in our assumptions, which is the macroeconomic environment, which is really challenging. I think what is -- first of all, we have adapted and really customized our life science operating model to better capture the opportunities ahead, right? Earlier last year, we announced the separation of the products versus the service business in Life Science, and this has proven to be extremely estimate useful to get the right people in the organization and to drive that business faster. Obviously, the pandemic has confronted us with severe constraints in certain countries for our Fertility franchise. However, both Mavenclad and Bavencio continues to go really very, very well performing on track. And obviously, Erbitux is also shining after the inclusion in the NRDL in China for [indiscernible]. So in terms of our product portfolio, we have been quite precise on forecasting the way we are going to get there, right? We have significant headwinds coming from the geopolitical environment that we are confronted with, and of course, the macroeconomic environment, inflation, interest rates, et cetera, et cetera. So a good balance.

Maybe talking about some of those headwinds, maybe the COVID one in particular, I will go there. You said very significant. We can see no one wants to be vaccinated anymore. How should we think about that? And maybe broadening that out, how is the demand in the underlying business within the Life Science segment is how resilient is that?

So let me give some perspective for those of the -- for those members of the audience who may have not been that close to our business. But in 2022, we already saw a significant decline of the COVID business. And what is great to see is that at the same time that we were bringing capacity online, our core business was picking up, right, to -- as we were expecting, right? And when you look at the 3 quarters that we have communicated, right, Life Science continues to deliver on expectations and beyond due to the strength of our core business. Our order book continues to be very strong in Life Science. And of course, as we bring capacity online, our lead times are moving from 9 months in the past to 4 to 6 months today. So we are digesting the order book. And we will -- we are expecting to continue to do that during 2023. We see a fast decline. We are expecting a fast decline in 2023 of probably more than 50% of the business we have generated in -- that we have guided last year in 2022. Despite that COVID decline, we are highly confident that our order book is very solid and with capacity and supply improving, we will continue to deliver to expectations.

Question here in the front, please? Maybe just sorry just.

You. Spoke briefly about a deemphasis on generics or divestiture and intensification of your focus on innovator drugs. Can you drop down a little and speak a little bit more about what therapeutic areas and indications are your highest priority for R&D investment?

Right. Good. So when we refocused to Global Specialty, we decided to progress oncology, Immuno-oncology at the time in a very focused way and immunology. But within those very broad areas, we are building on the position that we have in certain tumor types, particularly colorectal, head and neck, and this is the reason why we integrated xevinapant is one of our latest stage products. And of course, in immunology, we are primarily focused on neuroinflammatory -- neuroinflammation, mainly multiple sclerosis and some of the adjacent areas like myasthenia gravis and others, but I think Danny can give further detail on this one.

Yes. Just you're absolutely right. So we are focusing on these tumors, maybe adding urothelial cancer just because of a strong position in with Bavencio. And in terms of immunology, neuroinflammation, the [indiscernible] child is multiple sclerosis. We recently acquired back the rights for cladribine in myasthenia gravis and in NMOSD, which are other [ other poster childs ] for neuroinflammation, more on the periphery side. We are looking more with interest into the neurodegenerative aspect of neuroinflammation because there is no inflammation in the pure neurodegenerative diseases, looking into that and exploring some options. But this is -- this is actually how we translate focused leadership to action.

Maybe to add on that, one of the assets you've in-licensed I xevinapant, and we're waiting for Phase III data at some point in the 12 to 18 months. How should we think about that asset, very strong Phase II data? How -- what's your level of confidence in the product? And head and neck has been -- not a huge amount of innovation, immuno-oncology hasn't done so well there. So just your thoughts.

No, I can take that. So you're absolutely right. The Phase II data when we first saw them, I think that we first saw them when they were at the 3-year mark or something like that. We told ourselves it's too good to be true. And just to remind everyone, we're talking about a randomized controlled trial in Western countries well conducted on top of standard of care in locally advanced head and neck and the standard of care hasn't changed in the last 2 decades. It's chemo-radiotherapy. And what we see today at the 5 years market was presented at ESMO is at 5 years, you start talking about cure. You see actually doubling of the cure rates or actually having mortality depending on how you look at that. This is something which is quite unheard of more important or at least as important. In terms of the mechanism of action, xevinapant is a chemo-radio-sensitizer. It actually convincing the cancer cell to commit to a site that's in likely convincing it. And as a chemo-radio-sensitizer, you need to be very careful in order not to sensitize the toxicity of the chemo radiotherapy because otherwise you get into a vicious circle. There is toxicity so you reduce the chemo-radiotherapy and then the patient closes from -- for the wrong reason. What we saw in this Phase II study, is that there were no dose reductions whatsoever of the chemo-radiotherapy, and no additional toxicity, which further increases our confidence. So the Phase III study is ongoing. I guess that in a couple of weeks from now, we will announce completion of recruitment of 700 patients worldwide and we are very excited about this option. There has really not been any innovation. We are first-in-class in this category maybe to some extent, only in that class. And then to your point, we saw the results of the keynote for 12 a couple of months ago in this particular setting, which did not show anything.

We have a question.

Why does the tools business, a CDMO business, a pharma business and a semiconductor materials business belong together? Would you not create a lot more value by thinking that each division being independent and having its own much cleaner and simpler equity story?