Merck 2010 Sales Line Exposed -- To Euro's Woes

Prior to Merck's take-over of Schering-Plough, about 55 percent of legacy Schering-Plough's sales were exposed to movements in the euro. Pre-takeover, Old Merck was less than 30 percent, but I don't ever recall seeing a specific figure. [My guess is that the "blended rate" is likely to be in the high 30s or low 40s, all in, for full year 2010.]

Now, post the bust-up, New Merck indicates that EU and Canadian sales, aggregated in Q1 2010 were 32 percent of total revenue -- but much is clearly excluded, there (both animal health and consumer health businesses are missing). See chart at right, a cut-out from one of the New Merck R&D Day presentation slides.

In addition, Merck primarily manages currencies to minimize impact on the balance sheet (i.e., assets), not the income statement -- that is, not to "normalize" the sales revenue comparisons, period to period.

So, net/net -- as the euro weakens against the US Dollar (think: good for US tourists; bad for Merck), New Merck's reported European sales, converted to US Dollars, at the end of each quarter, will fall -- unless hedged. Merck is more aggressively hedged than legacy Schering-Plough historically was, but still the exposure is large.

My guess? Merck's reported sales, globally, are likely to be lower in Q2 2010 by about 10 percent due to the most recent euro weakening. From Merck's SEC Form 10-Q for the first quarter (at page 11):

. . . .Where the U.S. dollar is the functional currency of the Company’s foreign subsidiaries, the primary objective of the balance sheet risk management program is to protect the U.S. dollar value of foreign currency denominated net monetary assets from the effects of volatility in foreign exchange that might occur prior to their conversion to U.S. dollars. In these instances, Merck principally utilizes forward exchange contracts, which enable the Company to buy and sell foreign currencies in the future at fixed exchange rates and economically offset the consequences of changes in foreign exchange on the amount of U.S. dollar cash flows derived from the net assets. Where the U.S. dollar is not the functional currency of the Company’s foreign subsidiaries, Merck executes spot trades to convert foreign currencies into U.S. dollars based on short-term forecast needs. These U.S. dollar proceeds are then invested until required by the Company’s foreign subsidiaries. Merck routinely enters into contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The Company will also minimize the effect of exchange on monetary assets and liabilities by managing operating activities and net asset positions at the local level. . . .

We shall see.