Goldman upgrades Merck, calls it one of the firm's favorite stocks because of Keytruda lung cancer breakthrough

Employees walk past a Merck sign in front of the company's building in Summit, N.J.
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Goldman Sachs upgraded shares of Merck to buy from neutral and named it to its Americas Conviction List of favorite stocks on Monday because of potential booming sales from the drugmaker's blockbuster lung cancer treatment Keytruda.

Merck shares rose 2.4 percent in premarket trading on the Goldman call.

"We believe the narrative for this company is quickly changing with the success of Keytruda (a potential $16bn asset by 2025E) driving a significant shift in product mix from a large primary care evolving into a specialty biopharma," Jami Rubin wrote in a note to clients.

Rubin's 12-month price target of $73 calls for a 24 percent increase for the shares from Friday's close.

Earlier this month, a late-stage trial showed Keytruda allowed previously untreated lung cancer patients to live longer. The drug is already approved to treat patients with certain forms of lung cancer.

"Our refreshed analysis points to significant margin upside from product mix shift with much higher Keytruda sales than we had previously modeled," the Goldman note said. "We believe MRK operating margins could go from 32.5% in 2017 to 40% by 2025E and come close to other LC specialty biotech names, with that inflection point starting to happen 2H:18."

Merck shares are up 8 percent this month through Friday on the successful Keytruda trial. However, the Dow Jones industrial average member is still down by 5 percent over the last 12 months.

"We believe there is trapped value in the stock based on our SOTP (sum of the parts) analysis that implies a $73 value driven by Keytruda and Animal Health," wrote Rubin.