Merck KGaA (MRK) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to the Merck KGaA from Darmstadt, Germany presentation. I've got to get that clear. At the JPMorgan Healthcare Conference. I'm Richard Vosser, European pharma analyst with JPMorgan. It's my great pleasure to welcome the CEO, Belen Garijo, who is going to do the presentation. The Q&A is in this room. So we've got no problems with those logistics. So Belen, welcome to the conference.

Thank you very much. Thank you, Richard, and good morning, everyone. It's a pleasure to be here one more year, keeping the tradition of starting of the new year with the presentation at JPMorgan. So Happy New Year, everyone. I'm very pleased to be here. So let me -- next, please. So let me start by stating and even, I would say, celebrating that we have left behind a very tough transition year in 2023. And now we are looking forward to the future with a strong confidence. And why is that? First of all, because despite all the market challenges that we have navigated during 2023, we have delivered at or above market expectations and also outperformed most competitors, in particular, in Life Science and Electronics, which is where we faced the more challenges in 2023, every single quarter during the first 9 months of 2023. Second and most importantly, because we are anchored on very solid fundamentals, which remain basically intact. And those fundamentals of our business will enable our company to not only deliver growth in 2024, but will also fuel our mid- and long-term growth journey. In a nutshell, we continue to operate from a position of strength in relation to our multi-industry business model having in front of us in 2023 -- in 2024, multiple near-term catalysts, particularly related to the turnaround of the market in life science and to the uptake of semiconductor material solutions, which have been very, very soft in 2023. And most importantly, because of our resilience in relation to the globally diversified multi-industry model in which we operate and being a reliable cash generator throughout the cycle. And last but not least, a strong track record in deal execution, which characterizes our company. Now here, you have a bit more color on the way we see 2024 unfolding. And this is offering a sector view. First of all, Life Science, which continued to make the biggest percentage of our business, both in terms of revenues and EBITDA pre is returning to organic sales growth and EBITDA pre growth in 2024. And this is in relation to 3 main factors. One, the COVID period is behind us. We are expecting almost 0 sales and 0 contribution from COVID in 2024. Second, and importantly, the inflection point for sales in Process Solutions, which is expected post destocking at our customer level, which is expected at some point in time in H1 2024. And last but not the least, the solid contribution of our science and lab solutions business unit in relation to the product portfolio that we have on the multiple range of applications. For healthcare, we are expecting growth to normalize in 2024. And whilst that growth will be normalizing because healthcare delivered very solid growth in the 9 months of 2023, double-digit growth, significant margins. And now and that was mostly driven by the launches, as I will repeat later on. But there were also some one-off effects in relation to some of the supply shortages that we saw in our competitors in fertility in particular and also in general medicine, and this will disappear and phase out in 2024. The main driver for pharma continues to be the pipeline. And in this respect, in 2024, we are in front of 2 major milestones. The first one is the interim analysis of xevinapant, which we can discuss later on in the Q&A and then Cladribine moving into Phase II in myasthenia gravis. For electronics, our smaller but still very strategic business sector. We are expecting the recovery of the market a mid-partial customer destocking. And of course, the next stage of secular growth in relation to the technology trends, artificial intelligence, Internet of Things, et cetera, et cetera. Now our long-term growth will be fueled by our ability to capture the attractive megatrends driving the markets in which we operate. And when I mean attractive megatrends, I'm referring to revenue potential but also margins and innovation power, leveraging our foundation as a truly global player enabled to build on the geographical diversification that we have already gained in recent years. In Life Science, we see continued emergence of complex and novel modalities, while the growth from traditional modalities, in particular monoclonal antibodies will remain attractive. In Healthcare, we will continue to build on the increasing burden of oncology, neurology and immunology, conditions on patients to ramp up our specialty business while keeping our very resilient core business performing as we have seen in recent years. In electronics, artificial intelligence, Internet of Things are driving increasing demand for materials for chips, for leading-edge chips. And just to illustrate the attractiveness of this market and the opportunity ahead, please keep in mind that today, only single-digit percentage of material revenues are driven by artificial intelligence. So you can imagine that in the context of the explosion of these new technologies, the potential for the market is huge. In order to be able to fund our growth and the opportunities that I have briefly mentioned already, we need to make sure we generate cash. And cash is keen and cash generation is and will remain our north star, mainly in the context of higher interest rates. Our diversified multi-industry model truly drives high-quality cash flows at all times. And this, of course, will allow us to make bolder moves as we have done organically investing in generating capacity mainly for life science and electronics and investing in R&D for healthcare and also inorganic moves, combined with rapid deleveraging. And keep in mind that rapid deleveraging is going to be key for us as it will ensure strategic flexibility in times of very heavily increased uncertainty. So deleveraging is one element, but execution is a very other important factor. And those need to be perfectly in sync. We will continue to honor our track record on capital allocation, both ways, obviously, integrating potential acquisitions, but also divesting businesses which may have less strategic fit for us and build on this spotless integration track record that we have already developed because we have the capabilities and the capacity to act. Let me emphasize very clearly that our capital allocation strategy remains unchanged. And it is a priority for the Board to accelerate our inorganic agenda in 2024. We have very well-defined guardrails, first of all, strategic guardrails. So each and every potential acquisition needs to fit, support and accelerate our organic profitable growth strategy. And those of you who know Merck KGaA Darmstadt, Germany, excuse me, who know us very well, will not be surprised to hear that we will continue to take a very disciplined approach, also focusing on very well-defined financial guardrails that we can mention later. Back to 2024, I would like to offer a bit more color of what is supporting our return to growth this year. And the first and most important driver in 2024 will stay with Life Science and Process Solutions, as you see on that slide. The end of destocking in Process Solutions, expecting strong H2 2024 gains, then low basis and an inflection point at some point in time in H1 2024, the most important, then SLS, Science & Lab Solutions returning to resilient growth in 2024, an element that actually deteriorated and have a negative influence on our performance in Life Science last year, which was a very complex SAP migration that has been completed at the end of '23. Based on the market views that we have and most importantly, our conversations with the customers, our position for the midterm growth outlook for Life Science remains unchanged. Process Solutions is the key driver due to the positioning that we have with our portfolio and offering in an attractively growing biopharma market. As you very well know, product pipelines are becoming stronger in monoclonal antibodies and across novel modalities. Monoclonal antibodies still form the main part of the market and will remain the backbone of the market growth. As you see on the slides, with novel modalities gaining on importance growing meaningfully above the traditional market. Our focus in novel modalities is not everywhere, not going everywhere, but building on -- specifically on mRNA, where we have made, signed small acquisitions in recent past, ADCs where we have a strong legacy and big capabilities in Life Science coming from our Sigma acquisition, high potency APIs and last but not least viral vectors. Something that is important to keep in mind is the biotech and pharma explosion in Asia, particularly in China. So we see Asia overall as a breeding ground for drug development and manufacturing. And there are multiple examples of this, not least, South Korea, establishing a local hub for biomanufacturing, which is increasing the attractiveness of that market. So in that perspective, we confirm our midterm organic sales growth ambition for Life Science of a CAGR of between 7% and 10%. The underlying market fundamentals remain attractive beyond the temporary developments that we have seen such as the destocking in Process Solutions that I mentioned already. So we expect Process Solutions to return to growth once destocking will come to an end. The biopharma market continues to offer attractive growth opportunities, which we intend to grab through our innovative and differentiated offering. Life Science Services will be a fast-growing business after the temporary headwinds that we have seen, mainly the biotech funding will disappear Life Science Services is the business unit within Life Science, which is more exposed to biotech funding. So we see that Life Science will progressively improve in parallel to these temporary headwinds and will be enabled by our strategy to become an integrated an end-to-end CTDMO across novel modalities, across -- with differentiated technologies. Science & Lab Solutions, what we call SLS is expected to deliver sustainably profitable and resilient growth. Thanks to the product portfolio that we have, the broad range of our applications and the multichannel approach that we have established over the years. Remember that SLS is the backbone of Life Science with a revenue share of almost 50% within the life science sector. Let me conclude on Life Science. First of all, we enjoy already a leading position, position #3 in the whole market. We operate in markets that we consider to be attractive, as I defined before, and we are confident for those reasons to deliver between 7% and 10% midterm organic sales growth. So moving into healthcare. To date, healthcare has been driven by the first wave launches, Bavencio and Mavenclad in particular, but also a very highly resilient core business, mainly fertility and general medicine. In 2023, healthcare contributed very significantly to mitigating the shortfalls that we have seen in other business sectors. Besides, we repatriated Bavencio obtaining for half of the year, the benefit of a higher margin due to this repatriation of the profits that we were sharing with our partners. [ Wuxi ] Pharma has a business with attractive growth, mainly on the basis of new launches. [indiscernible] brand, in particular, with first-in-class and best-in-class potential, Enpatoran, a TLR7/TLR8 inhibitor, having passed futility in SLE. And the most important element for healthcare is that we accelerate external innovation, which we have done already in recent months. You may have seen the announcement in 2023, just to name a few, to get better on -- or to enhance our presence and strengthen our DDR portfolio. We have entered also a partnership with Henry in this respect, in licensing and next-generation selective part 1 and also an option deal on an antibody drug conjugates. And only last week, we announced another deal to license a Phase II asset in colorectal cancer, which is one of our sweet spots. Now we cannot go through healthcare without speaking about Evobrutinib. And in this context, what I would like to say and to leave with you is the following. First of all, unfortunately, the contribution of Evobrutinib in 2024 will be very positive, absolutely very positive. And of course, I say unfortunately because we would like to have it for the longer term. For our longer-term guidance, this is not a supporting factor. However, we see no impact on our aspiration of 25/25 because the participation of evo in that was very limited. And the main gap that we need to fill is in 2027. So that's why I insist the acceleration of our external innovation will be very, very critical. In terms of our guidance, and as I mentioned, this is not going to be a supporting event. We stick to a mid-single-digit CAGR as we have communicated before. However, for a while, we are expecting to move a bit more -- a bit towards the lower part. Once again, we will -- we are very actively accelerating the in-licensing agenda in order to be able to prepare to fill the gap that will appear in 2027. Now something that is also a big lever for our future in healthcare is the high degree of diversification that we have geographically. So Europe and Asia Pacific are as of today, the 2 strongest regions for healthcare in terms of revenues. And of course, we continue to have as a top priority, the increased U.S. exposure that will come with our new launches and eventually with U.S.-specific in-licensing activities. While at the same time, we base all our growth on a truly solid established portfolio, which on top captures potential in emerging markets. Just before I go to the conclusion, let me take a moment to show you that besides our optionality in R&D, we continue to be very focused on our ESG strategy. And there, we have been for many, many years, committed to contributing to the elimination of schistosomiasis as a public health problem by 2030. And as we speak a few weeks ago, the EMEA or the CHMP gave us a positive opinion for a formulation that is very, very fit for the children that we have to treat. By the way, this is just one of the drivers bringing Merck into the global top tier of the access of the -- access to medicine index in which we run #5. So in conclusion, message #1, we are leaving behind a tough transition year and stay very highly confident to return to growth in 2024. Our company remains very resilient and poised for midterm growth in relation among other things by the global diversification of sectors, within sectors and our geographical diversification. And last but not least, despite all the challenges that we have been confronted with in 2023, our growth strategy remains unchanged. And 2024 is, therefore, a year in which we will fully focus on rigorous and vigorous execution of our strategy in order to deliver long-term profitable growth. With this, I want to thank you very much for your attention. I know I have gone 1 minute above my time. And now we will be happy to take your questions. Thank you.

Thanks very much, Belen. And for the Q&A period, we've also got the CEO of Life Science, Matthias Heinzel, and the CEO of Healthcare, Peter Guenter with us as well. So it's now time for your questions, if you have any. Put your hands up, please. Maybe I'll kick it off. Belen, you -- obviously, you talked about Evobrutinib and the disappointment there. Maybe you could touch on how that's changed if at all, the sort of business development strategy or the overall strategy of Merck?

At the group level, Remember, we have discussed this even before we knew of the readout. And what has changed is not the how, what has changed is how fast right? So now we have to accelerate our licensing activities for healthcare, make sure that we stay very focused, at the same time that we broadened the scope of in-licensing activities and that we -- in a very disciplined approach, identified those potential risk -- positive risk reward options that will fill the gap in 2027 that is for pharma. Peter, I don't know if you want to add anything.

No, I think it's very clear. You have seen in the last couple of months, an acceleration of the licensing activities with the Hengrui deal, the Abbisko deal and then the latest deal with Inspirna. And of course, we will more than ever, I think, continue to focus and perhaps put the accent more on late-stage in-licensing in order to match the "timeline" that Belen mentioned which is basically 2027. .

But overall, for the group, we continue to be, as mentioned many times, adhering to our top priority, which stays with Life Science, taking Life Science to the next level, accelerating licensing for pharma and eventually identifying small technology opportunities for electronics.

Makes sense. Maybe Peter, just expanding it. Those first deals, we've seen the acceleration has been more oncology based. Is that the key focus? Or could we think of immunology transactions. How should we think about that?

Yes. I think, of course, oncology is definitely a priority. That's for sure. But we're not only looking at oncology deals. If you -- you may have seen also on the slides that we have passed futility for enpatoran for example, in systemic lupus. And also we looked at cutaneous lupus. So we are, of course, seeing that as a possible entry into the broader immunology space. We're looking also at things that may be in line with that. But we would also be potentially looking at other TAs. I do believe that great products make great franchises. And as long as the commercial execution is overseeable. So you're in specialty care, you're in -- not confronted "with large commercial construction of commercial infrastructure". We would also look at so-called white spaces.

Questions? Maybe another healthcare-related one from me. I mean you talked about, Belen, on the slide, some of the headwinds for healthcare in '24 around some of the key franchises competition coming back, one area of extra competition is maybe for Bavencio as well. So I'm wondering how you see that developing post the sort of Padcev data?

Yes. So look, I think that, first of all, the -- what is important is that sequencing will be extremely important. So you will have seen in the data also now the U.S. label of Padcev is out, 67% of patients get peripheric neuropathy. Out of these patients that get it, 87% have it for the rest of their lives. So it stays. In other words, if you start with Keytruda plus Padcev, all those patients that develop neuropathy can no longer in second line go to a chemotherapy-based treatment. If you do it the other way around and you start with the standard of care, which is chemotherapy plus Bavencio, you still have the opportunity to add a second line with Padcev to those patients. We are working hard on characterizing real-world data and bring them to ASCO GU. So I would say, stay tuned on that. We are very confident that this data will demonstrate, and we're talking about a massive number of patients. We are very confident that these data will show you that, that sequencing Padcev as a second line drug rather than a first-line drug, you'll give additional months of life to patients and a significant number of lives to patients, so that's the second argument. The third argument is, of course, an argument of cost benefit, right? And if you combine Keytruda and Padcev, you will have -- you will be looking at the budget impact, especially in Europe, which we think will be a bit of an uphill battle from a pricing and reimbursement standpoint which of course, we don't have with Bavencio in maintenance in those countries. So I think there is a lot of excitement. But I think if you look at the data, you also see that there are some discrepancies between what was said at ESMO and what is in the U.S. label on Padcev. So some data were not shown at ESMO. I give you an example, if you look at patients with adverse effects leading to discontinuation, 35% of patients. If you look at adverse effect leading to dose reduction, 42% of patients, so I think it will be an interesting fight. We think that in academic centers in the U.S., there may be more uptake of Padcev. I think in the nonacademic centers where you are perhaps less equipped to deal with the side effects. I think that Bavencio will remain a very important therapeutic option.

Maybe one more healthcare directed question and then we'll move on. You talked about the [ unfortunate ] benefit of evo not coming through was -- and I think touching on maybe some cost savings or something like that. So maybe just on R&D when you're thinking about the phasing. Is there a reallocation -- obviously, there's a reallocation of that budget? How should we think about the development in that budget?

I think first of all, the straight answer is most of the Evobrutinib launch spencers speaking about low 3 figures amount will go to our EBITDA pre. I think the team has done a fantastic job in becoming very efficient on funding our development programs. And once this is over in '24, definitely the majority will go back to the margins unless we find a promising in-licensing opportunity that will be served and that will require funding. But that's not been the case, our base case is that this will benefit our margins in '24.

I have one complementary information. So we've guided for R&D cost to sales to low 20s, yes. Of course, you have to take that with a bit of grain of salt. You can't really manage that as a Swiss clock. It depends what comes out, what goes in. I've talked about a couple of these licensing-in deals. But I think a good rule of thumb for R&D spend to sales will be low 20s and will remain low 20s.

Makes sense. Maybe moving to Life Sciences and Belen, you talked about the recovery. And I think the recovery is on everybody's minds and how long the destocking lasts? And maybe the simple question is where are we with the destocking? How much longer do we have to wait on that front?

Yes. Sure, Richard. I can take that. Look, I think we're in the corridor of what we said before between -- so we talk about order intake as an inflection point between Q4 and Q1 in that corridor and with a little delay then given lead times seeing an inflection point in sales come later H1 and I think that pretty much mirrors, I think, what we've seen in your JPMorgan conference material, where I think you also did a survey with customers, I think sample-size 40, where your customers you serve had responded about 30-plus in Q1 and about 34-ish in Q2. So about 2/3 of the customers you serve it, say, hey, during H1, we will see the inflection point. I think we're in that corridor.

And maybe thinking about the longer-term growth of that business. Maybe you can point us to the -- what gives you the confidence that those long-term trends are intact around the sort of high single digits, low double digits growth?