Pharm Exec's 10th Annual Industry Audit - Pharmaceutical Executive

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Pharm Exec's 10th Annual Industry Audit


Pharmaceutical Executive


Sales Rank: Table 1 simply ranks from top to bottom our 23 companies in terms of total sales revenues.


5: Net Income
Sales Growth: Table 1 also shows which companies grew sales revenue more than others. Growth is a critical metric: Grow or you're sunk. You can only cut costs to grow profits for so long. Eventually, sales need to grow. But what kind of growth? The most qualitative growth is organic: sales that come from the company in-house. Mergers and acquisitions will always be a growth avenue, but the market recognizes that this kind of growth is not as desirable as organic growth. As Procter & Gamble CEO Bob McDonald puts it: "It's my ... responsibility to figure out how to get our growth goals without an acquisition," as reported recently in Business Week.

Pfizer and particularly Merck exhibited substantial growth in 2010, but this was due mainly to the post-merger integration of Wyeth and Schering-Plough businesses, respectively. Other avenues to growth can come from price increases. Gilead and Celgene are examples of the latter route to growth.

The average sales growth of our lineup for the period 2010 – 2009 was 22.1 percent. A handful of companies did not grow sales: Johnson & Johnson, GlaxoSmithKline, Sanofi-Aventis, and Forest. Clearly, Johnson & Johnson had a difficult year, with manufacturing problems, OTC recalls, lawsuits, and regulatory attention directed to its medical devices strategic business unit. Notwithstanding these travails, Johnson & Johnson still managed to rank as the 17th most admired corporation in Fortune's annual Most Admired Corporations survey (March 2011).


6: Net Income to Sales
Given the ability to merge and acquire, the strength of this metric is tempered by a weight of three.

Enterprise Value: Enterprise Value is a firm's market capitalization (total shares of common stock outstanding times the price of the stock on a given day) plus cash minus debt. Enterprise Value reflects the value of a firm in terms of what it would cost to buy it. Enterprise Value also reflects the future income of the company discounted to present value. The goal is to increase or create shareholder value versus what it would take to destroy shareholder value. This important metric merits a weight of five.

The higher the Enterprise Value, the more impressive the company is in delivering to shareholders. An increase in Enterprise Value is a sign that shareholder value is being created. But there is a link between size or scale of operations and Enterprise Value. There will be a correlation between sales volume and Enterprise Value.


7: Sales to Assets
This leads to our next critical metric: Growth in Enterprise Value. Average Enterprise Value growth for the top 23 companies was 9.6 percent. Substantial growth was seen by Pfizer, Novartis, Sanofi-Aventis, Novo Nordisk, Biogen-Idec, Allergan, and Endo. A substantial part of this growth was associated with anticipated mergers, raising stock prices.

Enterprise Value to Sales (EV/S): As noted, the higher sales volume is, the higher absolute Enterprise Value tends to be. We need a ratio that normalizes or neutralizes the absolute size factor. That ratio is Enterprise Value to Sales. The higher the ratio, the implication is that sales growth and earnings growth will continue to rise. The lower the ratio, the implication is that a company will maintain steady, if not spectacular, sales as well as earnings growth. Celgene and Novo Nordisk lead the pack with ratios of 7.39 and 6.27, respectively. Novo Nordisk's EV/S increased whereas Celgene's decreased.

The average EV/S for our companies in 2010 is 3.18; in 2009 it was 3.24. The decrease suggests that our companies are facing strong headwinds relegating them to "value" stocks, with the exceptions noted. Better prospects can be found with hamburger, soda, and cigarette stocks such as McDonald's (4.05), tobacco company Altria (3.79), and Coca-Cola (4.50).

A large base isn't an excuse for diminished growth: Apple, for example, has a substantial sales base, but has still been able to demonstrate amazing growth. With revenues of $65 billion, the tech giant grew 60 percent last year, as reported Forbes magazine in March. With a market capitalization of $324 billion, this results in an approximate EV/S ratio of 5.0, indicating that Apple is just getting started.

Patent expiration cannot be gainsaid. Everyone knows how vulnerable many of the major pharmas are regarding key blockbuster drugs going off patent. This patent vulnerability takes its toll on the valuation of pharmaceutical companies. According to analysts at Bernstein Research and reported in The New York Times, Eli Lilly and AstraZeneca are most vulnerable, with GlaxoSmithKline, Novartis, and Bristol Myers-Squibb showing good prospects.

Gross Margin: Gross Margin reflects pricing power, and represents the difference between sales revenue and cost of goods sold on the profit and loss statement or income statement. The greater the difference, the more money is left to cover operating costs and contribute to profit before taxes. Biogen-Idec and Celgene set a nosebleed pace with price markups over 91 percent. That is, for every $1 in revenues, only 9 cents goes to the cost of the physical ingredient making up the drug. Average Gross Margin for 2010 for our lineup is: 72.1 percent. This indicates that (branded) pharma is a high-price sector. The key to Gross Margin is to be able to maintain its reflecting pricing power. Increasing Gross Margin is good, but if you are at the stratospheric levels of Biogen-Idec or Celgene you are bumping up against infinity.


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