Pharmaceutical Industry in United States - Assignment Example

?Contents Executive Summary 2 Introduction to the Pharmaceutical Industry in United s 3 Introduction to retail business in America 4 Ratio analysis 6 Profitability Ratios 7 Efficiency and Liquidity ratios 9 Gearing Ratios 11 Comparison with competitor 11 Executive Summary Johnson & Johnson and its subsidiaries (the Company) have approximately 127,600 employees worldwide engaged in the research and development, manufacture and sale of a broad range of products in the health care field. The Company conducts business in virtually all countries of the world with the primary focus on products related to human health and well-being. The paper presents the financial ratio analysis of Johnson & Johnson for the past three financial years and highlights its financial outlook. The ratios presents the company’s financial outlook is strengthened and is able to manage its finances prudently. The ratio analysis shows that the company has enough liquid assets through which it can pay off its liabilities and also can finance its operation for the foreseeable future. Moreover, the company is efficient enough, as represented by the ratios, to reduce its cash operating cycle and convert its sales into money quickly. The analysis shows that it would be prudent to invest in the company as the shareholders can earn significant return through capital gain, by disposing the shares later, and also through dividend. Introduction to the Pharmaceutical Industry in United States The top of the worldwide pharmaceutical market is the US and it is expected to hit almost $345 billion in 2014. The second largest market is the Japanese market and then the European market including Germany France, and Chinese market (Market line industry guide, 2012). However, the International Federation of Pharmaceutical Wholesalers (IFPW) shows that growth rates in developed and developing markets based on their capability to recover from the economic crisis is significantly inconsistent. According to the research of Urch Publishing (2012), the global pharmaceutical industry in 2014 is expected to be worth over $1 trillion with a 5% compound annual growth rate. The pharmaceutical industry becomes more competitive. Major competitor companies Company HQ location Pharmaceutical Segment Sales Total revenue Share of pharmaceutical segment $Million $Million % Johnson & Johnson US 25,400 67,224 38% Pfizer US 51,214 58,986 87% Novartis Switzerland 32,153 56,673 57% Merck US 40,601 47,267 86% Roche Switzerland 35,200 45,500 77% Sanofi-Aventis France 39,940 42435 94% AstraZeneca UK 43,143 43,143 100% GlaxoSmithKline UK 27,758 40,722 68% Eli Lily US 19,934 22,603 88% Source: 2012 Annual Report of the companies As Table5 shows, the majority of the largest pharmaceutical companies not only focused exclusively on pharmaceutical products such as AstraZeneca and Sanofi-Aventis but also developed and manufactured other health care products. However, they still regard pharmaceutical partitions as the core of their business that offer over 50% of their incomes. However, Johnson & Johnson is an exception because its sales of pharmaceutical products are 38% of total sales. I will analyze GlaxoSmithKline firstly because it is significant competitor of AstraZeneca in the UK. GlaxoSmithKline (GSK) is a science-led global healthcare corporation researches and develops a wide range of innovative products. GSK is Britain’s biggest drug maker (Hirschler, 2012). A balanced synergistic business, with multiple growths, drivers supporting a core pharmaceutical R&D operation (2010 Annual report, p3). It has three primary areas of business including Pharmaceuticals, Vaccines and Consumer Healthcare. It has created more diversified business for past five years. Moreover, delivery of sustainable growth across portfolios is GlaxoSmithKline’s objective. It has 87 manufacturing sites and R&D centers in the UK, USA, Spain, Belgium and China. Its purpose of R&D is to improve its pipeline products safely and efficiently to produce new medicines, which deliver improved treatments that are assessed by both patients and payers. GlaxoSmithKline’s R&D expenditure is used into the three primary areas of business. The investment in the three respects is not based on a fixed proportion of sales. In 2010, GSK’s turnover was ?28.4bn. In 2011, its total turnover was ?27.4bn, which pharmaceuticals represent ?18.7bn. In 2012, its total revenue was ?26.4bn and its 68% was from pharmaceutical segment. Its total operating profit was ?7.4bn and earnings per share were 112.7p in 2012 (2012 Annual Report, p1). Introduction to retail business in America In order to analyze the market potential of Johnson and Johnson in USA, it is of prime importance that the retail market of USA is evaluated. The growth in the USA retail market for the financial year 2012 saw an escalation as compared to the previous financial years. During every quarter of the financial year, the retail industry in USA experienced a growth of 1%. The analysts are of the view that this particular growth in the industry is a definite positive sign if it is compared to the last two financial years. The retailing conditions in the past two years remained quite adverse for the companies but now the situation appears fruitful and lucrative for the companies. A Comparison of financial year 2012 with the financial year of 2011 presents that fact that the volume of sales in the retail industry in USA increased by 2.7 percent. Changes in reported retail sales between August 2011 and August 2012 standard reporting periods (by size of business)     Pre-dominantly food Non-specialized pre-dominantly non-food Textile, clothing and footwear House-hold goods Other non-food Non-store retailing Pre-dominantly automotive fuel Total All Retailing including automotive fuel                     increase 107 32 138 72 375 64 23 811 All decrease 97 33 104 77 306 46 50 713   total 204 65 242 149 681 110 73 1524                     Large increase 66 32 110 42 158 30 n.a. 438 decrease 56 33 73 47 107 19 n.a. 335   total 122 65 183 89 265 49 n.a. 773 Small increase 41 n.a. 28 30 217 34 23 373 and decrease 41 n.a. 31 30 199 27 50 378 medium total 82 n.a. 59 60 416 61 73 751 [Ons.gov.uk (1999) Retail Sales: August, 2012] With respect to the food merchandise business, there were certain hardships that were faced by the retailer. During the year 2012, costs of both food items and fuel increased, particularly of fuel which resulted in an escalation in the manufacturing cost of the merchandise. Johnson and Johnson has in place an import team which constantly monitors the fluctuation in prices of cotton. For the purpose of reducing the cost of fuel, the retailers are now acquiring the help from the appropriate technology to manage the distribution in the most cost effective manner. In addition to that, retailers are now opting annual fixed price contracts. It is considered that the food industry is comparatively remaining consistent. However, it the prevailing market condition especially the low demand of food ingredient in EU countries significantly influence the market and brought the fluctuation the food market. The deterioration in macroeconomic environment as the result of existing financial crisis also negatively affects this sector. Additionally, the market is passing through from the bad time because the consumer and government are more focusing on the healthy lifestyle. A lot of advertisement is doing on the published media, social media to create awareness among consumers to adopt the healthy life style. Ratio analysis Ratio analysis is considered to be a very accurate and reliable tool when it comes to analyzing and interpret the financial outlook and performance of an entity. The main reason for performing a ratio analysis is to quantify the results of the financial operations of an entity and analyze them in the light of financial performance of the prior year(s) in order to assess different aspects of the financial feasibility. [Peavler, R. (2001)] The financial ratios are usually divided into various sub categories such as profitability, gearing and liquidity, each put emphasis on a different area of the financial outlook of the organization. These analyses form an integral part of the financial statement analysis, especially from the investor’s point of view, which are always looking for avenues to invest in countries having strengthened and stabilized financial ratios and representing an upward trend. It is of great significance that the ratios must be benchmarked against a standard in order for them to possess a meaning. Keeping that into account, the comparison is usually conducted between companies portraying same business and financial risks, between industries and between different time periods of the same company. [Investopedia.com (2012] The financial ratio performance of J&J has been evaluated for the last three years in order to draw attention to various financial trends and significant changes over the period. The analysis is divided into three main categorize namely Profitability, Liquidity and Gearing. Profitability ratios identify how efficiently and effectively a company is utilizing its resources and how successful it has been in generating a desired rate of return for its shareholders and investors. Liquidity ratios measure the ability of the company to quickly convert its asset into liquid cash to settle its short term liabilities.[Cheng, A & McNamara, R (2000] Whereas, the Gearing ratios identifies the extent to which the company is financed through debt and to what degree the operations are being conducted from the finance raised through raising equity capital or otherwise. For the purpose of financial ratio analysis, the financial year from 2010-2012 have been evaluated in order to analyze the financial outlook of J&J. The information has been extracted from the annual report of the company and the figure utilized in the financial ratio analysis is of the entire group. Profitability Ratios Gross profit margin is an analyzing tool which assists in identifying how effectively and efficiently the company is utilizing its raw materials [1], variable cost related to labor and fixed costs such as rent and depreciation of property plant and equipment. The ratio is calculated by dividing the sales revenue by the gross profit. If we analyze the gross profit margin trend of J&J it appears that there is considerable change in the percentage over the prior five financial years. This presents that fact that the company has been able to maintain its cost of sales and made sure that it remains in constant proportion with the revenue. The company has been able to manage the impact of inflation in the cost of material and labor. Net profit margin, on the other hand analyzes the profitability of the company before deducting the taxation and finance charges from the earnings [2]. The ratio is calculated by dividing the profit after interest and tax with the sales revenue of the current financial period. The ratio highlights how well the company is managing its selling and administrative expenses it also highlights the other income generated by the company during the course of its operations. The net profit increased significantly in the financial year 2012 as compared to the financial year 2010. The primary reason behind such increase in the net profit margin is that the operating expenses of J&J although increased in the financial year 2012, but they increased with a great proportion as compared to the revenue of the company. In the financial year 2011 the net profit margin has also shown an increase though marginal. Return on total assets (ROA) is, according to the analyst, is considered to be the most significant ratio in order to evaluate a company’s performance from an investor’s point of view. ROA measures a company’s ability to earn a return on all of the capital that is being employed by the company [3]. The ratio is calculated as net income upon total capital employed, which is the sum of debt and equity financings. The return on capital employed is showing a fluctuating pattern as presented in the tabular representation. If we evaluate the tabular information, the ROCE increased sharply from the financial year 2010 to financial year 2011. The net profit of the company increased during the financial year 2011 which resulted in a sharp incline in the return on capital employed. However, in the financial year 2012, the ratio shows a lesser incline. The primary reason behind such incline is the increase in the net profit for the company. There are several reasons for the incline in the net profit of the company. The operating profit of the company increased due to proper management of general and administrative expenses. The reason behind such hiked up administrative expenses is the cost expanded on the refurbishment and setting up of the acquired stores and outlets, which were acquired on account of the merger and acquisition transactions. In addition, the finance charge of the company also increased during the current year due to the fact that the company acquired additional financing facilities from several banks and financial institutions in order to finance its working capital requirements. A comparison with the industry figures will present the fact that when it comes to gross profit margin, the company is performing below the general expectations. This could be due to the fact that the company has not been able to curtail its production cost and at the same time, has not able to generate enough sales resulting in decreasing gross profit margin. On the other hand, the company’s net profit appears to be better than the industry average which is a positive sign showing that the company has been able to control and curtail its administrative expenses. The figure which appears most impressive is the return on capital employed which is significantly greater than the industry average. This might be the primary reason that the share price of the company is at an escalated price. EBIT are considered one of the most important financial ratios from the investor’s point of view. The ratio highlights the average earnings from the shares transacted and is calculated by dividing the profit attributable to the common share holders and multiplying them with the weighted average number of shares outstanding during the period. The earnings per share trend follow the same pattern as that of the net profit margin. Efficiency and Liquidity ratios The liquidity ratio measures the company’s ability to pay its short term liabilities. The ratio illustrates that how quickly a company can convert its assets into cash and cash equivalent in order to pay off its short term liabilities [Investopedia.com (2012)]. The most commonly used liquidity ratio, the current ratio, which is calculated by comparing the current assets and current liabilities. The strengthened the current ratio the more ability the company has to pay its debts and short term obligations over the next 12 months. As apparent from the above financial ratio analysis, the current ratio of the company has always remained above 1 which shows that the company has the ability to discharge its current liabilities. The current ratio of the company has increased from the financial year 2010 to financial year 2011, which was primarily due to the increase in the accounts receivable balance of the company. The accounts receivable of the company increased in line with the revenue. Although from one point of view, it appears to be a positive sign for the financial outlook of the company that its current assets are increasing in the form of accounts receivable. But on the other hand, this shows that the company has been slower in recovering in cash from its customer thus resulting in a higher accounts receivable to revenue percentage. The acid test, which is also regarded as the quick ratio, is calculated by subtracting the inventory balance from the total current assert balance. Out of the current assets mentioned, inventories are regarded as the one which takes comparatively more time to be converted into cash or cash equivalent. The acid test ratio has followed the same trend as the current ratio and only marginal change has been experienced in the acid test ratio. Receivable turnover represents how quickly the cash is received from the debtors. The ratio is calculated by dividing the revenue generated from the sales by the receivable balance as mentioned in the balance sheet of the company. The formula calculates the number of times the debtors are turned over during a year. The higher the value the more efficient the management is or it could also mean that the debts are more liquid. The accounts receivable turnover ratio has remained constant over the past three financial years. Inventory turnover represents how quickly a company’s inventory is sold, which can be calculated by dividing the sales revenue by the average inventory balance as at the year end. High inventory level is not beneficial for the company as it represents that the company’s investment is tied in inventory and currently it is not generating any income. A lower inventory turnover period represents that the sales are poor and there is excess inventory in the storage. Whereas a higher turnover period might represents that sales are comparatively higher. An inventory turnover period can also decreased due to the shift in the operation policy of the management e.g. if the management decides to increase the level of ‘safety stock’ then the balance of closing inventory would be greater and thus inventory turnover period would decrease, although the sales would have increased during the period. The inventory ratio has also remain constant over the past few years and the level which it is on currently presents the fact that the company is able to recover cash from its inventories at a quick pace. Both the current asset and acid test ratio of the company is greater than the industry average which presents the fact that the company has more than enough liquid assets to discharge its current Gearing Ratios The gearing ratios and indicate the level of risk taken by a company as a result of its capital structure [Peavler, R. (2012)]. These ratios are a great source of determining the level of financial risk to which the company is exposed and thus helps in reducing it to the optimum. The equity ratio indicates how much of the entity’s assets are financed through the finances generated through the revenue generated from the operations of the entity and raising financing through equity issue rather than acquiring debts or other financial institution. The debt to equity ratio of the company has remained almost the same throughout the period. If we analyze the statement of financial position of J&J for the current financial year, it will present the fact that the long term debt has decrease during the current period, but the increase in the equity (mainly due to the retained earnings balance) has maintained the ratio. The company is resorting towards financing its operation and ventures through the funds generated internally and thus has been able to significantly reduce the finance charge during the year. Comparison with competitor The primary competitor of J&J in the current US market is Pfizer, which is also involved in the pharmaceutical manufacturing and marketing. For the purpose of competitor analysis, the financial ratios of both the companies for the financial year 2012 have been used. As apparent from the above financial ratios comparison of the two companies, the profitability of J&J appears to be more strengthened as compared to the Pfizer. Although the net profit margin of the company is lower, but the return on assets shows that the company is able to generate enough value for the shareholders and has been able to utilize its assets in a more prudent manner as compared to its competitor. The return on equity of both the companies is the same. One interesting thing to note here is that the debt in the capital structure of Pfizer is higher as compared to that in the capital structure of J&J. This is a negative sign for Pfizer and a positive indication for J&J. Also, J&J has been able to recover most of its interest charge as mentioned in the table above, its interest coverage being higher than that of Pfizer. Coming to the efficiency ratios, the inventory turnover of J&J is significantly higher than that of Pfizer which shows that the company J&J is not being able to convert its inventory into cash readily. This is the point that the company should put its immediate concern too if it has to further improve its cash flows. Same is the situation with receivables turnover. Overall, the financial outlook of J&J is quite better than that of Pfizer. The analysis shows that it would be prudent to invest in the company as the shareholders can earn significant return through capital gain, by disposing the shares later, and also through dividend. References 1 Investopedia.com (2012) Profitability Indicator Ratios: Profit Margin Analysis | Investopedia. [online] Available at: http://www.investopedia.com/university/ratios/profitability-indicator/ratio1.asp [Accessed: 24 Oct 2013]. 2 Investopedia.com (2012) Understanding Financial Liquidity. [online] Available at: http://www.investopedia.com/articles/basics/07/liquidity.asp [Accessed: 24 Oct 2013]. 3 Investopedia.com (2012) Equity Financing Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/e/equityfinancing.asp [Accessed: 24 Oct 2013]. 4 Peavler, R. (2001) Profitability Ratio Analysis. [online] Available at: http://bizfinance.about.com/od/financialratios/a/Profitability_Ratios.htm [Accessed: 24 Oct 2013]. 5 Peavler, R. (2013) Debt and Equity Financing. [online] Available at: http://bizfinance.about.com/od/generalinformatio1/a/debtequityfin.htm [Accessed: 24 Oct 2013]. 6 Qfinance.com (2010) Gearing Ratios - Definition of Gearing Ratios - QFINANCE. [online] Available at: http://www.qfinance.com/dictionary/gearing-ratios [Accessed: 24 Oct 2013]. Appendix B –Ratios J&J J&J J&J Pfizer Liquidity ratios 2010 2011 2012 2012 Working Capital ($ Millions) 23.55 27.72 18.01 17.65 Current Ratio 1.90 2.38 2.05 2.15 Inventory turnover ratio 8.97 10.35 11.45 1.53 Days in inventory (days) 41 35 32 238.82 Receivables turnover ratio 5.94 6.15 6.30 4.54 Avg. collection period (days) 70 63 56 80.40 Solvency ratios 2010 2011 2012 2012 Debt to total assets ratio 1.82 1.99 1.87 2.29 Times interest earned ratio 38.25 22.65 26.89 25 Profitability ratios 2010 2011 2012 2012 Earnings per share ($ per share) 8.64 -26.99 10.60 52.76 Gross profit rate (%) 21.65 14.87 16.14 24.70 Return on assets ratio (%) 13.50 8.93 9.24 7.80 Asset turnover ratio 0.62 0.60 0.57 0.32 Read More