quote: "Success is a thought process"
MGSM 840 ACCOUNTING FOR MANAGEMENT
SYNDICATE PROJECT
Team Members: Paul Ho Kang Sang et al.
INTRODUCTION
This paper provides an overview of the pharmaceutical industry and the key drivers that influence the performance of two companies Pfizer Inc and Bayer AG (ADR) both listed on the New York Stock Exchange (NYSE). The main focus of this paper will be the in-depth financial analysis of the two companies and the resulting diagnosis and recommendations derived from the analytical review. For ease of reading, we shall refer to Pfizer Inc. and Bayer AG (ADR) respectively as Pfizer and Bayer.
Stock markets throughout the world have rallied. Some stock markets have reached historical levels of stock valuation. The NYSE has reached new highs in 2007. Many companies have reported increased earnings, which in turn drive share prices higher. However, the US economy is showing signs of a slow down. Certain leading indicators such as housing starts are on the decline and sub-prime mortgages default is on the rise. With the US economy expected widely to slow in 3rd and 4th quarter of 2007 leading into the 2008, it is expected that more companies will report reduced earnings thereby making the Price to earnings multiple very high. The market should ease from the current high levels. The US stock market has high correlation to many of the world’s stock market and hence it is expected that a US stock market fall will impact many other markets, although we felt that the European market could instead rise.
While we cannot predict when the market will correct, we are of the opinion that at current stock market levels, the risks far outweigh the potential gains. We encourage investors to rebalance their portfolio to take profit and rebalance in favour of non-cyclical stocks such as the pharmaceuticals which holds steady value and pays regular dividends.
Pharmaceutical stocks typically have relatively stable demand and huge latent demand. On top of that, pharmaceuticals also typically pay regular dividends and can ride out the boom and bust of the stock market and economic cycle.
There are many existing health ailments that plague the human body. There are more new diseases and threats from viruses and new strains of bacteria. The revenue upside is only limited by the ability to produce a cure. Thus as long as there is a good drug to ameliorate a disease or ailment and at a price consumer can afford, pharmaceutical companies will make money. There are very few industries in the world today with a latent demand with such high degree of certainty of the pharmaceutical industry.
As evidenced by global sales rise reaching USD 646 billion in 2006 (IMS Health, 2007) . The pharmaceutical industry is one of the world’s prime growth industries; if good investing strategies are applied (Sivy, 2006), not only is it a safe investment, the upside potential is great.
PFIZER AND BAYER
We will profile and analyze two companies that have strong international presence; namely Pfizer and Bayer.
Pfizer
Pfizer is a research based pharmaceutical company incorporated in June 1942; with two key business segments – Pharmaceutical and Animal Health (Reuters, 2007). The company’s star products include Viagra®, Lipitor®, Celebrex® and Caduet®. Pfizer remains “the biggest pharmaceutical player worldwide, reporting USD 3.39 billion profits in Quarter1, 2007” (Yahoo Financial News, 2007).
Pfizer spends millions of dollars annually on marketing efforts and patent protection (The New York Times, 2006). Taking for instance, Viagra® (sildenafil citrate) their well-established solution for erectile dysfunction faces strong competition from Levitra®(Bayer Healthcare) and Cialis® (Eli Lilly); both promising similar therapeutic results. Analysts from Lehman Brothers Inc estimated sales in 2005 for Viagra being the market leader, to reach an estimated USD 2.3 Billion, Levitra 500 million and Cialis 700 million (Pfanner, 2003).
Bayer
German drug maker Bayer is the 14th largest company globally in terms of its pharmaceutical sales. The NYSE listed company (2004) counts its Healthcare, CropScience and MaterialScience divisions as top revenue contributors (The Associated Press, 2006).
On the healthcare front, Bayer’s core strengths include treatment solutions for diabetes (Glucobay®), cancer (DTIC-Dome®), infections (Ciproxin®), cardiovascular (Adalat LA®) and kidney diseases (Nevarax®).
Bayer’s recent track records demonstrate a zealous push for growth and expansion. An eight year review shows high level spending on Aventis CropScience(2001), Roche Consumers(2005) (Park, 2006), Schering AG (2006). The Roche Consumer acquisition made Bayer the top three supplier of non-prescription drugs (Park, 2006). The acquisition of Schering AG involving USD 22.5 billion was the highest investment for a healthcare business in Germany to date (RP news, 2006). This merger also resulted in a once-off restructuring costs USD 1.34 billion (Bayer News, 2006).
With such mergers Bayer is charting its course to becoming an industry leader that is competitive internationally (Bayer News, 2006). To fund some of its expansion efforts Bayer divested its diagnostic division to Siemens for USD 5.4 billion in Jan 2007 (Park, 2006). Bayer informed of securing further loans from Citi Group and Credit Suisse (Bayer News, 2006) for this purpose.
REVIEW OF INDUSTRY- SPECIFIC FACTORS
DEMOGRAPHIC CHANGE
The demographic situation is changing in favour of pharmaceutical companies as the baby boomer generation (defined as people born between 1940s and the 1960s) are entering their 40s to 60s. There is a whole generation of demand generated from this population group. A good percentage of this category will require some form of long term medications especially for cardiovascular, oncology and neurodegenerative conditions. As this generation age there's increase in their reliance on some form of long term medication be it for treatment of symptoms, preventive care or therapeutic maintenance and control.
BARRIERS TO ENTRY
Pharmaceutical sector has a particularly high barrier of entry with limited competition as indicated by a low return on assets of 11.86% (Reuters, 2006). According to Porter(Carter, 2007), the five competitive forces are all at play in pharmaceuticals: -
1. The bargaining power of suppliers’ Technical expertise
2. The bargaining power of buyers
3. The threat of substitutes
4. The threat of new entrants
5. The intensity of rivalry among competitors
The fixed cost and hence barrier involved in entering the pharmaceuticals sector is very high. According to the Quaker economics (Carter, 2007), “It costs billions to develop drugs; many of them don’t make it to market”. The cost of capital investment for manufacture is also a high fixed cost. However, “the cost to manufacture is a pittance.” Due to the nature of the cost structure, where marginal cost is low, if demand is high, high revenue and profit can be achieved (Morton, 1998). Most drugs have patents that protect them from generics for up to 20 years. For instance, Viagra’s patent rights shall expire by 2014 (The New York Times, 2006).
When the patent expires, threat of new entrants is still largely limited to high volume and high price drugs as the fixed cost of producing a drug is very high while marginal cost is low. The new entrants also have to consider additional barriers such as testing, regulatory approvals as well as price-demand elasticity between generics and originals (Ajmani, 2005). Moreover pharmaceutical companies have to face with the new challenge of combating counterfeits medicine in the market. For example, Pfizer has to compete with Chinese-made (Redherring, 2004) counterfeits since 2000. Generic Viagra is widely sold via the internet too.
The risks involved in investment to develop the next drug are high, to add to the risks, an assumed market potential may be reduced immediately if another pharmaceutical competitor produces a drug which is similar in efficacy and price. In the case, if a direct more efficient substitute drug is found, the investments made developing the drug may never be recovered.
Owing to the high barriers to entry indicated by the high fixed cost investments and the huge marketing budgets, and stable revenue streams, the pharmaceutical companies have the resources to ride through most short term market conditions. And in the case of patented drugs, pharmaceutical companies also likely have pricing power which means they can forecast their earnings to a high degree of accuracy on existing products. This is a major plus point for the pharmaceutical sector.
SURVIVAL STRATEGIES OF PHARMACEUTICAL COMPANIES
Pharmaceutical companies are resilient and have adopted various survival strategies to cope with the high cost of developing a new drug to full commercialization. It is estimated that the cost of developing one compound up to the stage of concluding the clinical trials is more than USD 800 million (Sokoll, 2007). Drug companies find new strategies to survive – including taking shorter routes in the drug regulatory pathway by re-profiling marketed drugs for alternative therapeutic indications. For instance, recent studies on Viagra (Pfizer) by Argentina's National University in Buenos Aires suggest possible treatment for jet lag in humans (CNA News, Singapore, 22 May 2007).
Secondly, a major drug company may acquire smaller ones or their competitor(s) that have demonstrated good earning potential with promising technology and pipelines with novel compounds (RP News Wires, 2007). Established pharmaceutical giants such as Pfizer, GlaxoSmithKline, Johnson & Johnson and even mid-sized Bayer use this approach as they are aware that products in their own pipelines are not adequate to sustain future profit growth (PBR, 2004). Companies that opt for this strategy may stand to reap substantial earnings from newly developed drugs. If the company is able to bypass some parts of the lengthy R&D process, clinical trials and application of new patents then it stands to gain (Sokoll, 2007). In this instance, the risks of product failure, wasted resources and opportunity costs are therefore reduced.
Thirdly with the acquisitions of promising drug makers, divesting non-core entities, continued restructuring and cost cutting measures are employed to ensure earnings growth – Pfizer reports a target of 10,000 job cuts by 2008 (PBR, 2007)whereas Bayer shall released 6,100 staff worldwide by 2009 (Baynews, 2007).
STOCK CHART
Note: Charts adapted using Google Finance.
COMPARISON OVER 5 YEARS
RETURNS VERSUS THE NYSE
(Dividend bar shows Pfizer’s dividend payout)
Bayer has out performed the NYSE, especially in 2007 by almost 30% while Pfizer has actually lost 27% of the share value from 2002 (if dividends are not taken into account) and under-performed the NYSE by 80%. If dividends are included (not taking into consideration time value of money), an investor would still have lost some 14% of their share value.
TRADING VOLUME
The average trading volume of Pfizer is much higher and liquid as compared to Bayer. However, both companies are actively traded and in this case, the trading volume is not a major impact unless the investment value is into the millions of shares, in which case, a sale or purchase will impact the market price of Bayer which has a daily trading volume of around 300,000 shares while not necessarily that of Pfizer. There is also no noticeable run-up of Bayer share prices prior to any major launch of drugs or approvals of drugs, it could be indicative of the confidentiality of the Bayer management. The price spike of Bayer is upon confirmation of drug releases or approvals. This lack of share price run up could be indicative of no insider trading and overall good business ethics.
PRICING
Both companies trade at around the same Price Earning Ratio (P/E Ratio). However Bayer showed growth as the Forward P/E is forecasted to be 7.17 times while Pfizer expects a reduction in earnings in 2008. Bayer is traded on the NYSE on American depository receipt (ADR). Company results and share price of Bayer in Euros are converted into US dollars for trading on NYSE (ADR).
CURRENCY OF PURCHASE
It is expected that the USA will reduce interest rates from the current 5.25% with the impending economic slowdown while in Europe; ECB is likely to raise interest rates from the current 3.75% to control inflation. US dollar is expected to trend weaker to the Euros.
Comparison between Pfizer and Bayer shows that the former has stronger assets presence in the US particularly their R&D plants. Pfizer may exhibit slower growth. Whereas, Bayer may do well to continue trading well in its European markets and shall not be adversely affected by the Euro dollar as it is traded on the NYSE under American Depository Receipt (Investopedia, 2007). The strengthening of the Euro dollar will shall impact positively on Bayer for its European trades. However it is important to note that Bayer’s debt is also in Euro dollars.
THE ECONOMY
The US economy will slow down. In the Euro zone, inflation is expected to cause interest rates to raise thereby slowing growth. In Asia, the economies which exports mainly to the US will slow, while those which can fiscal spending to stimulate domestic economy will continue to grow fast. Overall, the world will enter a phase of slower growth in the next few years. However, Bayer is optimistic that the slowdown in the US will only cause moderate effects on the global economy (RP Newswire, 2001). Bayer recognizes that continual imbalances in the global economy may results in risks that affect the predictability of their performance. Of its three core divisions Bayer expects minor growth in its crop protection market, positive trend for its MaterialScience market sector (region dependant), but do not expect major change in their pharmaceuticals market compared to 2006.
MARKET CHARACTERISTICS
While patents are in force, the drugs supply operates like a monopoly. Profitability is very high. The marketing prowess of the pharmaceuticals influence the way doctors prescribe drugs. Often pharmaceutical companies are able to maintain a large market share even after patents run out by virtue of their marketing reach to hospitals and doctors. This is another positive market characteristic in favour of pharmaceutical companies.
Owning to the significantly large marketing and education sponsorship budgets that these pharmaceutical companies have, they are better able to maintain a certain level of customer loyalty. In addition, there is an industry norm for charging a sales markup for drugs dispensed in Singapore. For instance, if the mark-up price is 35 percent of the drug cost, then it works out to better gains for the doctor who prescribes the proprietary drugs. As generic drugs are generally much cheaper than the proprietary drug, doctors stand to benefit less when dispensing them.
MEDICAL INSURANCE TREND
There is a growing trend towards controlling escalating healthcare costs. Healthcare providers in the USA, Europe and Asia are progressively required to work within a given budget and observe specific guidelines on prescription drugs spending (Pfanner, 2003). This phenomenon is also prevalent in Singapore for selected managed healthcare schemes such as NTUC Managed Healthcare, EzyHealth and IHP.
Increasingly, insurance companies in order to control the cost of insurance premiums are mandating alternative drugs. This poses potential earning threat to producers of the original drugs (proprietary); however it is not an immediate or overwhelming threat. The table below shows the key products for Pfizer and Bayer. Majority of these are prescription drugs with patent rights except for Norvasc which expires in 2007. It is interesting to note that competing generics are already in the market.
Our survey shows that insurance companies such as CIGNA Insurance in general allow for the proprietary drugs; whereas the generic ones are approved on case to case basis.
Ratio Analysis
Strength and Weakness of Pfizer:
Strengths
Pfizer is a company which is highly funded by shareholder equity. Looking at the debt to equity ratio, Pfizer has a ratio of less than 1. This is an indication that the assets within the company are mostly funded by equity. The equity ratio and debt ratio have further proven this point. Pfizer has a healthy balance of being almost 40% debt funded and 60% equity funded. Pfizer is therefore able to generate cash internally much more easily as compared to Bayer who is more reliance on debt. This is indicated by the ROE ratio. This definitely instills greater confidence in their creditors.
One of the greatest strengths of Pfizer is the strong liquidity status. We can also analyze from the short term investments that Pfizer has a higher ratio in the recent 3 years and it is not declining in the numbers from the ratios shown. It is showing more than 0.4 each year and is still climbing. This implies that they prefer to invest in short term assets so that they will have quicker turnover cash flows as compared to the long term investments which will hold their cash for a longer period of time, rendering them to a situation with lesser cash flow for turn over. Long term investments and loans are kept to the minimal as they have ratios of less then 0.05 for each year.
In addition in the year 2006, Pfizer was able to make a huge payment of the short term borrowing using cash (Refer to the cash flow statement in 2006). This shows that Pfizer has cash on hand and thus able to make such payments on their short term borrowing.
The current asset ratio for year 2006 versus current liabilities is two times. This further proves that Pfizer has a strong short term financial strength with the ability to pay off short term debts. Pfizer does not have much liquidity locked under inventories, account receivable or long term investments/loans.
In terms of profitability, the net income has steadily increased over the years and 2006 marked the highest net income. This could be due to Pfizer reaping benefits from their R&D and marketing effort.
Pfizer dividend payout in year 2006 was almost 100% more than that in 2005. Being largely equity funded, it is important for Pfizer to give good dividends to keep the shareholders happy to continue to hold on to Pfizer’s shares. As Pfizer has shown a US$25.886 billion in short term investments (roughly one fifth of their market capitalization of US$150 billion) which are not core to their operations, this show that they have far too much money and could have the financial strength to pay huge dividends. Big enough investors could force Pfizer management to return shareholder funds in excess of operational needs.
Weaknesses
On the flip side, Pfizer being more equity funded than Bayer will have to pay a higher taxation per dollar of revenue to the government (assuming that they are faced with the same corporate tax regime). Income tax payable has increased over the years from a ratio of less then 0.1 to year 2006 with a ratio of 0.3. Of course, this increased taxation could also be due to the fact that Pfizer has earned more profit over the years thus having to pay a higher taxation. Bearing in mind the concept that debt is cheaper than equity, by being a more equity funded company, Pfizer is not using debt leveraging to generate better returns. This is negative on the company growth but reduces financial risks.
Taking a close look at the nature of Pfizer short term and long term investment, it is stated in the 2006 financial report that “Our short-term and long-term investments consist primarily of mutual funds invested in debt financial instruments and high quality, liquid investment-grade available-for-sale debt securities.”
The short term investment represents more than half of the company’s revenue of $48,371 million in 2006. This is a giant sum of investment not core to their operations. The gains from mutual funds and debt securities may or may not generate a positive return and is a financial risk to equity, while the company’s short term debt do require to be repaid with interest. As the company still has short term and long term debts, since Pfizer chooses to invest in short term investments, while they could have instead repaid their debt, it is not clear if Pfizer is getting a positive spread on their investments.
It is not performing well in terms of shares for the recent year of 2006 as the ratio has drop from 1 to less than 1. Moreover, as compared to Bayer, Pfizer is not that effective in collecting their debts from their customers as indicated by the low Receivable Turnover Ratio. The amount under Account Receivable for Pfizer has remained consistent over the last five years. It could be an indication of the nature of distribution and channel structure of sales which is deemed a weakness or a cost of sales to encourage doctors to dispense or prescribe their drugs.
Strength & Weakness of Bayer
Strengths
Bayer is a company that uses a high debt to equity leverage compared to Pfizer. They have high financial liabilities especially in the year 2006, whereby the current and non-current financial liabilities amount double that of Year 2005. This is further verified in the debt to equity and debt ratio. At least 60% of Bayer’s assets are funded by debts as compared to an average of 40% over percent by Pfizer.
Bayer is also more effective in collecting cash as their accounts receivable turnover ratio is better than Pfizer. Bayer may have a discount policy to encourage their customers to pay them faster.
Bayer seems to have a better inventory turnover as compared to Pfizer. Bayer’s products are sold faster than those of Pfizer. But there is a slight drop in the ratio from year 2005 to 2006.
With regards to the acquisition of Schering AG, if all projections go as planned, the year 2009 onwards will see Bayer reap savings of Euro$700 Million of savings a year. These savings should be sufficient to cover depreciation/write-down of goodwill and intangible assets. The relentless pursuit of enhancing cost efficiencies as well as gaining size in an industry dominated by giants is a positive sign.
Bayer will need an average of four to six years to fully repay its long term debt at current earning capacity. (Debt Coverage ratio) However due to the high debt nature, the amount of taxation Bayer has to pay is relatively less than Pfizer too.
Both Pfizer and Bayer have stable source of revenues from their respective branded drugs. Bayer’s ability to repay debt should not be a big concern unless there are major incidents.
The financial risks should not be overstated as Bayer has an unused credit facility of over Euro$4.9 billion after the acquisition of Schering AG while being able to generate cash of USD 1.513 Billion after tax. On top of that, Schering AG is cash flow positive at the point of acquisition. The restructuring costs of Euro$200 to Euro$300 million is seen as an investment for projected savings of Euro$700 million per year from the year 2009 onwards.
Weaknesses
Bayer seems to have a reasonable short term financial strength as indicated in their current ratio. However a closer look into it using the Acid Test Ratio, Bayer does not have the ability to convert current assets into cash to meet its current liabilities. Most of the current assets for Bayer are locked under inventories, which is “dead money.’
As compared to Pfizer, Bayer has lesser capability to generate cash internally. Banks could be reluctant to offer further loans to Bayer due to its existing high borrowing. The high borrowing, low cash and cash equivalent, inability to generate cash internally and having a huge amount of “dead” monies locked under inventories put Bayer in a dangerous position of not being able to have sufficient cash flow in times of emergency. Bayer has lower liquidity as compared to Pfizer and represents a bigger financial risk in comparison.
Bayer is moving towards the direction of expanding the company. This is evident in their efforts spend on Research and Development. Bayer spent a higher percentage of expenses on R&D as compared to Pfizer. The expansion of debt is due to acquisition of companies deemed synergistic to their core operations. The higher debt in 2006 is due to their acquisition of Schering AG, Berlin. This is a financial risk.
Bayer has resorted to debt financing for their acquisition. It can be shown on their 2006 balance sheet that goodwill amounts to US$8.23 Billion and other intangible assets amounts to US$15,807 Billion are associated with the acquisition of Schering AG, Berlin. Schering AG has revenues of Euro$3.082 Billion at point of acquisition. Short term impact of the acquisition of Schering AG is negative on Bayer as there are associated costs of restructuring. At the time of purchase, Schering AG was trading at a Price/Earning ratio of 29 times (The Wall Street Journal, 2007) while Bayer itself is trading at only around 10 to 11 times. While the projected savings of Euro$700 million a year of synergy is tangible, it will take many years for Bayer to recover the price premium paid for Schering AG. The year 2008 is expected to be negative for Bayer as there will likely still be cost associated with the acquisition, restructuring as well as higher debt financing costs.
Trend Analysis / Horizontal Analysis
In addition to the above, it is also important to conduct an analysis on Pfizer’s notable trends on key accounts during the period in question – these significant shifts are highlighted below. To conduct an analysis on Pfizer’s notable key accounts.
Analysis of the ratio (Cost of Goods Sold / Revenue) indicates that this particular statistic shows signs of fluctuation. In particular, the year 2003 shows a particularly high ratio of 1.74 compared to the base year of 2002 (figures can be found in Appendix B). Ensuing years showed a dip in this ratio, but still considerably higher than the base year of 2002. Bayer has a higher cost of goods sold of around 50% to 60% which is much higher than Pfizer’s COGS/Revenue of around 15%, however COGS for Bayer is trending downwards.
As an indicator of a corporation’s ability to control costs respective to revenue, this indicates that Pfizer’s raw materials or processes costs may be rising, and if this is indeed accurate, profit margins will be affected. In order to maintain viability as Pfizer continues to grow, this is one ratio that needs to be kept in check.
In 2003, Pfizer acquired Pharmacia (previously the merged entity of Pharmacia/Upjohn and Monsanto). As a result of this acquisition, Pfizer incurred several major expenses, including a one-time R&D (Research & Development) charge of more than US$5 billion reflected in the 2003 financial reports. This substantial expense adversely affected net income in that year. Subsequent years showed lower expenses incurred in this account – thus, the total cost of acquisitions or similar ventures will have to be calculated with these costs in mind.
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Pfizer’s net income over the five years in question has fluctuated – dipping particularly low in 2003 and spiking greatly in 2006. The 2006 performance, however, was increased by a one-time extraordinary gain on sales of discontinued operations which artificially inflated revenues (it constituted 40% of net income for FY2006). With this exception, Pfizer’s core operations continue to contribute the vast majority of its income – other than an under-performing 2003 (which itself was affected by a one-time R&D charge) it is showing consistent, if relatively slow, signs of growth. The acquisition of Pharmacia in 2003 also greatly boosted market share, translated into substantially higher total revenue figures in the subsequent years, although the one-time charges incurred related to this acquisition also made 2003 a less-profitable year on paper.
wer forward P/E for year 2008).
The balance sheets for the years 2003 and 2004 indicate that Pfizer spent substantial amounts on litigation settlements with no similar expenses in the years 2005 and 2006. The cases involved (among others) were asbestos-related, and Neurontin-related (including promoting the drug for unapproved uses). The lack of litigation-related settlements in subsequent years may indicate a trend towards a more wary and/or responsible corporate culture in Pfizer, resulting in fewer (or none) lawsuits and ensuing higher profitability.
Long-term debt fluctuated from US$5,755 in 2003 to $7,279 in 2004 before reverting to 2003 levels in 2006 (US$5,546). Coupled with the steadily shrinking Deferred Taxes account, Pfizer is slowly but surely reducing the long-term portion of its liabilities. This may be in line with company strategy to reduce financial risk (by reducing liabilities altogether in favour of shareholder’s equity), or taking on short-term debt instead of long-term.
A company with Pfizer’s financial resources is unlikely to experience problems in obtaining financing of the nature it prefers. Thus, an active choice to utilize short-term debt over long-term, may indicate a company strategy or management’s view towards the industry’s or the company’s outlook.
The total revenue of Pfizer (after its acquisition of Pharmacia in 2003) has remained fairly constant at the USD 50 billion mark. In the past, Pfizer has shown a cannibalistic attitude towards boosting revenue (Warner-Lambert was acquired by Pfizer in 2000, thereby acquiring the rights to the No.1 selling drug Lipitor), and this seems to be a recurrent company strategy to maintain market share and revenue. This is perhaps made more likely by the sale of the consumer healthcare division (funds were partially directed towards more liquid, short-term investments) and the resultant short-term asset-rich state of the corporation. It appears that Pfizer may be priming itself internally for an acquisition of an industry player by positioning its resources in this way.
The ratio of A/R to revenue for Pfizer has remained fairly constant over the years. This is an indication that Pfizer has not adjusted credit policies in order to boost sales, and also possibly means that Pfizer has a relatively rigid sales infrastructure in place – it may not be easy or possible to adjust credit policies to impact growth. This lack of flexibility may possibly be seen as a negative, depending on the company’s needs and outlook in the future.
Strengths and Weaknesses of the Analysis
Our analysis has taken into account changes not only in the quantum, but also in the ratio of key accounts relative to total assets/liabilities or revenue/expenses. This has allowed us to chart the movements of these key accounts without bias to industry shifts or other factors that may affect the accuracy of merely measuring changes in quantum.
Further, the common-sized analysis comparison has allowed us to make a fair comparison of the two corporations, disregarding the factor of size. As such, the peculiarities of each company can be more easily identified and compared.
On the other hand, there was a lack of sufficient information on the financial report for Pfizer for years 2002 and 2003. The financial reports for these two years were not available online and our key source of information regarding Pfizer, was unable to get hold of the financial report. As such, we had to conduct our analysis with the information we had at hand.
There are both adjusted and unadjusted figures for the financial reports. For example, some of the figures stated in AR (Annual Report) 2005 were different from those stated in the corresponding report in 2006. Therefore we decided to use the unadjusted figures for comparison’s sake in our analysis.
Another limitation was that the information stated in the annual report is subject to change. Some of the entry items listed in the balance sheet and the income statement were subjected to discrepancies amongst the various financial year reports. For instance, some entries were lumped together or listed as separate entities in different financial years.
There is very little information with regards to the performance of the Short Term Investments of Pfizer and this represents a major lack of transparency. Furthermore, the magnitude of that investment is USD 25.887 billion.
In analyzing financial risks, the Quick ratio shows certain elevated risks compared to Pfizer Inc, and it may impair investment decisions due to the perceived higher risks. On a closer look, it is understood that Bayer has an unused credit facility of Euro$4.9 Billion (Bayer Annual Report 2006). This is sufficient to tide over major economic turbulences as pharmaceutical revenue streams are fairly stable and are cash flow positive. It is to be noted that not all financial reports reveal the existence of credit facilities, and without such information an investor could miss the chance to invest in a well managed debt leveraged company.
Recommendation:
The pharmaceutical industry is by and large a fairly stable industry regardless of the economic climate. Medical health care is an important and basic need demanded by every living human being. Coupled with the aging population, higher standard of living, more rampant diseases, longer life expectancy of developing and developed countries, a constant and stable demand for medication can be expected. Both Pfizer and Bayer have their stable sources of revenue from their respective branded drugs
For a low risk and short term investment, we would recommend Pfizer. Pfizer being the largest pharmaceutical company globally has strong business foundations. Their business methods are decidedly safe and secure, focusing more on short term investment. They have strong liquidity. Being 60% equity funded and 40% debt funded, the company can withstand major economic shocks.
Pfizer still has its growth potential with the discovery of new drugs. Moreover, Pfizer also has some excellent proprietary drugs which will still bring in good, reliable revenue such as Viagra, Lipitor, Celebrex, etc.
The percentage growth of big established firms is usually small, but it offers greater stability and security to its shareholders. Dividends paid to shareholders are generous in times of good profit as evident in the payouts for the year 2006.
For Bayer, the growth potential is huge but the financial risks are also higher than Pfizer. It should be noted that Bayer is heavily geared towards debt and has a high debt-equity ratio. As such Bayer faces a higher financial risk and is less able to withstand economic shocks due to less cash sufficiency.
In the coming year 2007 and 2008 are expected to be negative for Bayer as there will likely still be costs associated with the acquisition of other companies, including higher financing and restructuring costs. If all projects go as planned, the year 2009 onwards will see Bayer reap savings of Euro$700 million a year. For pharmaceuticals, it is important to have economies of scale. It is evident that Bayer is buying into a growing revenue stream from Schering AG’s stable of drugs plus cost savings synergy, this presents a good top line and bottom line growth story.
For a longer term investment, we recommend Bayer as it represent growth opportunities, dividends as well as potential capital gains, while there are higher short term financial risks going into 2007 and 2008. Beyond 2008, we are convinced the benefits of the merger should start to appear on the balance sheet.
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Posts
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