Financial Performance Comparison: Astrazeneca Plc and GlaxoSmithKline Plc in Harvard Style - Case Study Example

Running Header: Financial Performance Comparison: Astrazeneca Plc and GlaxoSmithKline Plc Financial Performance Comparison: Astrazeneca Plc and GlaxoSmithKline Plc in Harvard Style by Student's Name Course Name University 1.0 Introduction An investment entails risks and returns. In order to gain from an investment, an investor chooses among a wide range of opportunities in the market where the expected benefits offset the inherent risks (Keown et al 2004). Currently, an investor is faced with various investment alternatives. With only a limited fund to invest, a prospective investor should utilize financial tools which will help him or her to compare the profitability of investing in between or among different alternatives. This report will consider the case of an investor contemplating invest either in Astrazeneca Plc (Astrazeneca) or GlaxoSmithKline Plc (GSK). It should be noted that both of these business organizations are important players in the global pharmaceutical industry. Astrazeneca is involved in the "discovery, development, manufacture, and marketing of prescription pharmaceuticals primarily for the cardiovascular, gastrointestinal, neuroscience, oncology, respiratory and inflammation, and infection areas in the healthcare sector worldwide" (Astrazeneca Plc Profile 2006). GSK is the major competitor of Astrazeneca as the former engages in the "creation, discovery, development, manufacture, and marketing of pharmaceutical and consumer health related products worldwide" (GlaxoSmithKline Plc Profile 2006). In comparing the profitability of investing in these pharmaceutical companies, financial ratio analysis will be conducted. 2.0 Financial Ratio Analysis Financial ratio analysis is a very essential tool in assessing the financial health of a business entity. It enables a financial analyst to spot trends in a business and to compare it with the performance of similar business enterprises within the same industry. This tool is currently utilized by business managers, investors, creditors, suppliers, and other decision makers in order to determine the financial performance and well being of a business organisation. Financial ratios are grouped into five categories, each showing a different aspect of a company's financial operations. These are profitability ratios, financial leverage ratios, liquidity/solvency ratios, efficiency ratios, and investor ratios. 2.1. Profitability Ratios Profitability ratios measure the ability of the company to generate income from its investments less the costs incurred (Fraser & Ormiston 2004). Return on capital employed is a variant of return on investment. Return on capital employed (ROCE) is a measure how well the company is utilizing its capital. The computed sales profit margin, which is the ratio of operating income to sales measures as a percentage of sales, the excess revenue from sales over cost of normal operation excluding financing. Asset turnover measures the amount of sales generated by every pound in the company's assets. Net profit margin, on the other hand, is the ratio of net income to sales showing the company's ability to efficiently manage cost and turn its revenue into profits (Fraser and Ormiston 2006). Logically, higher performance ratios indicate a healthier financial condition. Table 1. At first look, it becomes apparent that GSK is more profitable than Astrazeneca. GSK reports higher return on capital employed, gross profit margin, and net profit margin from 2003-2005. Astrazeneca only manages to overtake GSK in asset turnover ratio during 2005, implying that the former is more efficient in utilizing its resources to generate revenue. Looking at the ratios more closely, it can also be deduced that even though GSK shows higher profitability than Astrazeneca, this ability to make profits has been significantly declining over the years. From the ROCE of 78.28% in 2003, GSK's performance has slumped attaining an ROCE of 38.06 last year. Gross profit margin and asset turnover have also dropped from 78.28% and 2.48 times to 76 .32% and 1.22 times for the three year period, respectively. GSK's net profit margin has slightly improved from 20.45% to 22.23%. This decline in profitability is in direct contrast with uptrend experienced by Astrazeneca. All of the company's profitability ratios, though lower in comparison with GSK, have been increasing from the 2003 level. 2.2. Activity or Working Capital Efficiency Ratios Activity ratios are operating efficiency measures, which determine the ability of a company to maximise its output given a certain level of resources (Fraser and Ormiston 2004). These ratios significantly gauge the asset, investment, and cost management performance of the business entity. Ratios under this category are inventory, creditors' and debtors' ratio. The inventory ratio measures the number of days the inventories stay in the company's distribution center or warehouses. The debtors' ratio reveals the efficiency of a business organisation in collecting its account receivables while creditors' ratio shows the umber of days the company is able to pay its suppliers. Lower numbers are typically preferred in this ratio classification as they signify speed and efficiency of the business organisation in dealing with its different transactions (Fraser and Ormiston 2004). Table 2. Table 2 shows the computed activity ratios for Astrazeneca and GSK. It should be noted that the three ratios are expressed in days. During 2005, it can be seen that Astrazeneca reports lower figures which signifies its relatively higher efficiency in servicing its debts, collecting its receivables, and selling its products to customers. Astrazeneca is able to sell its goods 150 days on the average, far from the 232 days recorded by GSK. In terms of collection from debtor, GSK lags behind by four days. Astrazeneca's suppliers are being paid in 372 days compared to the 394 days for GSK's supplier. Similar to the observation in the previous section, GSK's efficiency is also in a decline while Astrazeneca's is improving. The year 2004 seems to be a very good year for GSK in terms of efficiency since most of its ratios has declined. However, the challenges faced by the business organisation becomes apparent in its lower efficiency. 2.3. Liquidity Ratios Liquidity or solvency ratios are used as measures of the company's ability to finance its short-term obligations by its cash and near cash items. Included in these ratios are current and acid test or quick ratios. Current ratio expresses the "working capital' relationship of current assets available to meet the company's current obligations" (Horngren 2000, p.153). The acid test is more indicative as it shows the company's ability to pay its current obligations without relying on the sale of its inventory. Higher ratios indicate more liquidity. Table 3. Throughout the three year period, Astrazeneca shows higher liquidity than GSK. It should be noted that both current and acid test ratios of Astrazeneca are far and above its competitor. It can also be observed that both pharmaceutical companies appear to be enjoying increasing liquidity over time. During 2005, Astrazeneca and GSK can pay off all their current liabilities through their liquid assets. In fact, Astrazeneca's total current asset is more than twice its current liabilities. However, it should also be noted that most of the company's liquid assets are tied up in inventory based on the wide gap between its current and acid-test ratios. 2.4. Financial Leverage Ratios Financial leverage ratios provide an indication of the long-term solvency of the firm. They indicate the extent of non-owner claims on the firm's profits as well as the firm's operating capability to meet its obligation. Gearing is the long-term debt to equity ratio which assesses the balance between liabilities and equity in the firm's long term resource structure. Another is the interest coverage ratio which measures the extent to which earnings cover the interest obligation of the company (Thomson 2002, p. C-6). Table 4. Table 4 shows the performance of the two pharmaceutical firms under consideration in terms of leverage for the three year period 2003-2005. It can be seen that the two ratios are closely related to each other. Based on its gearing, Astrazeneca Plc is more dependent on equity than on debt. It can be noted that even though the company is increasing its preference of financing its resources through liabilities, Astrazeneca still funds a larger percentage of its assets through equity. The company has a 55:45 equity debt structure during 2005. This seems to be a good indicator for Astrazeneca as equity is always less risky than debt (Keown et al 2004). Though it is highly dependent on equity, Astrazeneca has a high interest coverage ratio for its creditors. In contrast to its competitor, GSK is heavily leveraged with debt. Since 2003, GSK is highly dependent on its creditors in financing its resources. This dependence is furthered during the following years leading to a capital structure of 38:62 in favor of debt in 2005. Being highly reliant on its creditors, GSK allocates a large portion of its operating income to service its interest obligations. It should be noted that the company consistently maintained a significantly high level of interest coverage ratio. However, as the company's total liabilities mount implying that the pharmaceutical firm also needs to have a higher level of interest liability, GSK's interest coverage ratio is in a decline. 2.5. Investor Ratios Investor ratios are financial ratios especially designed to convey to investors the profitability of the company's stock as an investment. The company's return on shareholders ratio shows the income generated by the business organisation through its utilization of the shareholders fund. It can also be as the profit attributatble to each share of common stock in the company. Return on shareholders fund is a very important measure of financial performance because the main goal of a company is the maximization of shareholder value (Keown et al). Earnings per share ratio shows the return to common stock shareholder for each share owned (Fraser and Ormiston 2004). Table 4. Both investors of Astrazeneca and GSK are earning from the company's operation. Both of the pharmaceutical companies record higher than earnings per share signifying that they have generated more than a pound for its pound of investment in the firms' stocks. It should also be noted that both companies show increasing return on shareholder as well as increasing earnings per share. In absolute terms, Astrazeneca Plc creates more value for its stockholders than GSK. The company not only posted return on equity but also higher earnings per share. In fact, an investment in Astrazeneca yields more than 100% more return than that of its competitor. It becomes apparent that Astrazeneca is very much concern in satisfying its stockholders. It can be deduced that this is due to the company's higher dependence on its owners than its creditors as discussed in the previous section. 3.0. Recommendation and Conclusion This report has discussed that financial performance of two of the largest firms in the global pharmaceutical industry, Astrazeneca Plc and GlaxoSmithKline Plc. In order to fully assess their worth as stock investments, this report utilized financial ratio analysis. The ratios are classified according to what they measure: profitability; financial leverage; liquidity; working efficiency and investment potential. Based to the computations and interpretation conducted in the previous sections, this report asserts that an investment in Astrazeneca Plc deemed more profitable than an investment in its competitor GlaxoSmithKline. It can be recalled that in contrast to the dwindling profitability of GSK, Astrazeneca's ability to turn sales into profit as well as its efficiency in utilizing its resources to generate revenue makes its performance at par its competitor. Astrazeneca's working capital efficiency is also superior to GSK which has declining efficiency in managing its inventory, collecting its receivables, and paying its suppliers. Astrazeneca's liquidity is relatively higher than GSK. An investor should be cautioned though that excess liquidity may signify liquid resources which are not being put in profitable investments. Astrazeneca also shows preference for less risky financing, equity but very solvent to service its interest obligations. Lastly, Astrazeneca is chosen because it fully realizes its goal of creating value for its shareholders. For a prospective investor, the pharmaceutical firm generates higher returns making it a better choice than its competitor. It can also be seen that return on shareholder is the ultimate measure of a company's profitability as an investment. For an investor, what will matter most in the end is the company's ability to generate returns to common stockholders. References Astrazeneca Plc Profile 2006, Retrieved 23 November 2006, from http://finance.yahoo.com/q/pr's=azn Brealey and Myers 2005, Principles of corporate finance, McGraw-Hill, 8th Edition. Fraser, L. & Ormiston A 2004, Understanding Financial Statements, Pearson-Prentice Hall: Upper Saddle New Jersey GlaxoSmithKline Plc Profile 2006, Retrieved 23 November 2006, from http://finance.yahoo.com/q/pr's=GSK Horngren , C. et. al..'2000,' Accounting.'4th ed.' New Jersey: Prentice Hall Keown, A.J., Martin, J.D., Petty, J.W., and Scott Jr., D.F, 2005, Financial Management principles and applications, Pearson/Prentice Hall International Edition, 10th Edition. Thompson, A. & Strickland , J 2002,'Strategic Management.'3rd ed. New York McGraw- Hill Read More