Merck is on the mend

(FORTUNE Magazine) -- In the dark autumn of 2004, when Merck withdrew its blockbuster heart drug Vioxx over concerns it caused cardiac arrest, the company lost roughly a third of its market value within days. But in 2006, Merck's shares quietly surged 40%. What's more, there may be enough upside left to this recovery to make the company a solid long-term investment again.

Merck (Charts) is delivering on new CEO Richard Clark's recovery plan, making improvements and eking out efficiencies in all aspects of its business. The company garnered more FDA approvals than any of its competitors in 2006, launching five new drugs, including the first-of-its-kind cervical-cancer vaccine, Gardasil. And Merck is improving research productivity. Since 2005, the labs have cut seven months from drug development times. That means the company's experimental drugs will reach the final stages of research in 30 months, vs. the industry average of 44 months.

There's also a sense of order in the court for Merck. The first Vioxx lawsuits went to trial last year, and the results were better than expected. In the 18 cases scheduled during 2006, juries decided in Merck's favor nine times. The company lost four cases, and another five were withdrawn from trial calendars. Analysts believe that the Vioxx lawsuits no longer weigh on Merck's shares the way they once did. "They've won two-thirds of the cases, and everything seems to be in control," says Herman Saftlas, an analyst with Standard & Poor's.

John Boris of Bear Stearns upgraded Merck shares to market overweight on Jan. 3. Boris believes that Merck, which has a nifty 5% yield, will probably outperform the S&P in 2007, with a gain of roughly 22%. His year-end target price: $53.