Assets to net worth (A/NW). This measures the ratio of debt to common stock in a firm's capital structure. The higher the ratio, the more aggressive
a firm is in using debt. Another word for this is "leverage." More debt in a capital structure leverages profitability, or
at least one measure of profitability, net profit to net worth (total assets minus liabilities). The ratio, by itself, is
not indicative of performance, but it is used with the other two ratios, profit to sales and sales to assets, to produce net
profit to net worth.
Although Wyeth and GSK have a leverage of more than 3-to-1, this is still a very conservative ratio, indicative that the drug
industry is still conservative when it comes to taking on debt. Still, even this modest amount of debt can leverage profitability
in terms of net profit to net worth."
The Dupont formula also shows that there are three paths to improving a company's profitability:
- margin management—net profit/sales
- asset management—sales/assets
- financial management—assets/net worth.
Net profit to net worth (NP/NW). By drilling down into 30 or more line items in a company's income statement and balance sheet, NP/NW can be improved. GSK
uses modest debt to achieve the highest profit in terms of NP/NW. An interesting point of comparison here is Wyeth, the most
leveraged of the pharmas. Unfortunately for Wyeth, the company doesn't do nearly as well in margin management and asset management
as GSK, and as a result, Wyeth's NP/NW is about average.
Also interesting is the so-so profitability of the biotechs, Amgen and Genentech. Hope springs eternal in those waiting for
miracle cures, reflected in the high stock prices of those companies despite less-than-average profitability. This makes J&J's
fourth-place ranking all the more impressive, despite its mediocre profit margin, which is offset by relatively high asset
productivity and modest usage of debt in its capital structure.
US presence. By itself, this is not a performance metric. But to the extent that more of a company's business is in the United States,
the most profitable market, that presence affects other metrics. Every company in this report aims to increase its US presence
for this reason. The United States does not regulate prices, so the value of a drug can be reflected in better prices and
profit margins. Therefore, companies such as Forest, Amgen, and Genentech, which get revenue primarily from within the United
States, tend to have higher profit margins. On the other hand, a company like Novartis, at about 43 percent US penetration,
has a goal to increase that ratio to improve profitability.
US sales per rep. This metric reflects the productivity of the sales force. With the general consensus that the industry's sales force productivity
is diminishing, this metric separates the more productive sales forces from the less productive. Total drug sales were adjusted
by the ratio of US presence, and that figure was divided by the number of US reps to arrive at sales per rep. J&J, with a
broad presence in the US market, topped the list for this metric.
Sales per employee. This is a new metric for the report. In addition to sales per rep, the overall productivity of a company's employees is worth
noting. Is the com-pany top heavy? How efficient is the firm in terms of its entire employee base? This ratio is similar to
sales to assets in that employees are assets.
Biogen-Idec's productivity, at over$1 million in revenue per employee, sets the pace. The three biotechs and Forest, all smaller-scale
operations in niche markets with high margin/high value products, outperform the rest of the pack. All the more impressive
is BMS's placement in fifth place as a major pharma in terms of employee productivity. Both BMS and Schering-Plough are experiencing
tough times, but BMS seems to be pulling out while Schering-Plough is still mired in not getting more out of its employee
Investment in R&D. As in last year's analysis, there does not seem to be any correlation between investing in R&D and its payoff. (See "R&D
Spend: Does It Pay?" page 86.) Biogen-Idec, with the greatest percentage of sales invested in R&D (38.9), languishes in unprofitability
for 2003 and has virtually no revenues from new products.
In Amgen's case, the question is: Why spend on R&D? Amgen in-licenses everything, and it was only marginally profitable for
2003. The same can be said for Genentech. Forest is another in-licensing machine that is stingy with R&D yet is very profitable.
GSK, the most profitable pharma in terms of return on shareholder equity, ranks 12th in its percentage R&D spend, yet its
new-product revenue percentage is very impressive (22.2).
Pfizer outspends everybody in abso-lute dollar amounts in R&D but has little to show for new-product revenue (12.5 percent)
and scores low in all the profitability metrics.
There are a few metrics that directly measure whether a company has added to its shareholders' value. In other words, if a
shareholder invested X dollars at an earlier point in time, what can that shareholder take out of the company today?
Brand power: knowledge capital equity (KCE). This metric has to do with the value of a company's brands after the influence of cash or cash equivalents, property, plant,
and equipment have been factored out of net earnings. This year, instead of calculating absolute dollar value, the total dollar
value of a drug company's brands was divided by enterprise value to arrive at the percentage of a company's total value accounted
for by its intellectual property.
The methodology to perform the calculations was established by Baruch Lev, an accounting professor at the Leonard N. Stern
School of Business at New York University. (See "Accounting Gets Radical," Fortune, April 16, 2001, for an explanation of Professor Lev's methodology.) Brand power as a per-centage of enterprise value could
not be calculated for Biogen-Idec and Schering-Plough for 2003 because both firms were unprofitable.
Return on shareholder equity. This important profit metric measures the return to shareholders for investing in the firm. Shareholder equity is net profit
divided by the sum of all capital stock and retained earnings. (See "Fortune 500: Notes and Explanations," Fortune, April 16, 2001.)
In this acid-test metric, GSK's percent is almost double that of the second-place company, Merck (62.7 percent and 39 percent,
respectively). J&J and Lilly are within a percentage point of each other. As noted earlier, Pfizer's low ranking is a result
of the charges taken related to the purchase of Pharmacia. But the surprise is the low numbers for Genentech (10.2 percent)
and Amgen (11.9 percent). Despite their relatively lackluster performance in this metric, the market places value on these
two biotechs for the future.
Executive pay to performance 2001-2003. The relationship between executive compensation and shareholder value return between 2001 and 2003 raises the question of
how the CEO was compensated versus how the shareholders fared. Business Week's 54th annual Executive Pay Scoreboard compares an executive's total compensation with the company's total return to shareholders
in stock appreciation and dividends during the last three years. That compensation is com-pared with the value of $100 invested
in the firm's stock over the three years.
Of the 10 companies in this audit that were detailed in Business Week's study, only three added to shareholder value: Abbott, J&J, and Genentech. A passing note: Last year Pharm Exec reportedthat Howard Solomon, CEO of Forest, took home a modest income despite the company's outstanding performance in 2002.
He made up for that in 2003. Solomon was the top pharma earner, pulling down a total one-year compensation of $36.1 million.
(See Forbes, May 10, 2004; Business Week, April 19, 2004.)
Patent productivity. Data from Fortune on research productivity for selected pharma companies are interesting. Patents are the first thing that come to mind in sizing
up who is an innovator in the industry. Merck is the most efficient pharma at getting patents; it acquires more than its peers
and is more efficient in doing so. Difficult as it is to look 8-12 years out, it seems reasonable to anticipate that Merck's
efficiency in research productivity will pay off sooner rather than later.
In a presidential election year in which the pharma industry will come under intense scrutiny, placing high in an admired
and respected company survey is no mean feat. In the latest list of "Fortune's Most Admired and Respected Corporations in the United States," J&J comes in at seventh out of all Fortune 500 companies.
The reputation attributes used in the study are:
- financial soundness
- employee talent
- quality of management
- use of corporate assets
- long-term investment
- social responsibility
- quality of products/services.
Rounding out the analysis of this year's pharma performers, a couple of research items are worth noting. The Harvard Business Review invited G. Bennet Stewart III, of the consulting firm Stern Stewart, to comment on the global companies that were best at
adding market value for shareholders. For North America, the two pharmas were J&J and Pfizer, ranking fourth and eighth, respectively.
In Europe, the only pharma to place was GSK, which ranked first in market value added. (See "Champions of Profitable Growth,"
Harvard Business Review, July-August 2004.)
A very interesting final point comes from Fortune's recap of the Fortune 500 (April 5, 2004) between 1954 and 2004. Of the companies that were on the list for all 50 years,
six out of 10 with the highest return to shareholders were pharmas: J&J (third), Merck (fifth), BMS (sixth), Pfizer (seventh),
Abbott Labs (ninth), and Eli Lilly (10th).