Merck & Co Financial Analysis - Case Study Example

Merck & Co Financial Analysis Student’s Name Institutional Affiliation A. Industry Overview Merck &Co is an international health care firm that engages in the provision of innovative health related solutions through its prescription medicines; vaccines and animal-related product that it markets in a direct manner and through joint ventures (Merck & Co. Inc., 2016). It is important to note that the firm’s overall operations are fundamentally sustained on a product basis and is made up of four operating levels including; pharmaceutical; animal health; alliances and healthcare service segments (Merck & Co Inc., 2016). The focus of this paper is on examining the overall financial, accounting and strategic analysis of Merck & Co within the underlying pharmaceutical company. The pharmaceutical industry is currently at the hand of numerous key external drivers that include; first, the fact that there is extensive federal funding for Medicare and Medicaid. Nowadays, prescription drugs are being provided to the Medicare patients while Medicaid initiative allows for the coverage of both in and out-patient enrolments (IBIS World, 2016). Secondly, the industry is propelled by the median age of population as at now more than 90% and 58% of both seniors and adults are ascertained to be relying on daily prescription drugs. Consequently, the industry has been affected positively especially since the number of people that have been subscribed to private health insurance has continued to increase over time. It is expected that in the end of 2016, the number of patients with private health insurance would have increased by at least 20% (IBIS World, 2016). The current performance of the industry remains to be positive given that operators within the Brand Name Pharmaceutical Manufacturing Industry have all been contended with the overall loss of most once popular patents as a result of the patent hitch in 2012 (IBIS World, 2016). Due to this hitch, there has been increased number of generic versions of brand name drugs that have penetrated the market thus intensifying the level of competition for all industry operators. In essence, it is as a result of this level of intense level of competition that most of the pharmaceuticals have resorted to consolidation processes in order to cut down on operational costs and the immediate resources deemed to be fundamental in activities related to research & development (IBIS World, 2016). Research indicates that that for a period of five years ending 2016, the pharmaceutical industry level of revenues will certainly grow within an annualized percentage of 1.3% to a figure of 168.7B. In 2016, the level of revenues is expected to improve due to numerous factors that include; increased demand of biological drugs from patients while profits are expected to improve by 21.5% of industry revenues in the period ending 2011 to about 25% (IBIS World, 2016). The current industry structure is characterised by intense R&D costs together with an ever-increasing generic consumption rates that have indeed resulted to a continuous cut of the overall industry revenue growth and development. Notably, the industry has been compelled to cut down on its underlying product lines as well as R&D spending (IBIS World, 2016). On average terms, the number of in-house development product decreased in comparison to the R&D expenditures, which is an indication that there was a high per-drug development costs. In regards to the industry employment framework it is expected that by the end of 2016 operational year, the level of employment is set to increase to an annualised rate of 1.6% to more than 157,911 employees (IBIS World, 2016). In regards to the industry life cycle, the Brand Name Pharmaceuticals Manufacturing sector is deemed to be currently operating within the mature phase of its overall life cycle. In fact, the industry’s value addition that is directly engaged with the measurement of the of the sector’s underlying contribution is set to improve by 5.1% per annum in the next couple of years ending 2021(IBIS World, 2016). Most notably, within this period, the level of gross domestic product is set to also increase by 2.1%. In the next couple of operational years, the industry revenue growth levels will be attributed to most of the pharmaceutical companies engaging extensively in such activities as engaging in therapeutic classes; cutting down their overall workforce as well as engaging in the consolidation of their imminent overall operations. Despite the fact that the pharmaceutical industry has continued to be a profitable venture; it has effectively grown due to their cutting down on costs; formulation of even more efficient techniques for research & development as well as engagement in intense mergers and acquisitions (M&A) (IBIS World, 2016).The sector continues to rely on aspects related to the underlying sophistication in medical technology in order to come up with newer product that seeks to address the unmet needs of people. In contrast, improved scrutiny and growing safety concerns have also contributed to R&D productivity given that the industry is set to be contended with intense government relations. In the US, the sector is exposed to both internal and external competition. Internally, the sector competes in relation to product innovation mechanisms; capacity to engage in unique marketing processes such as direct-to-consumer advertising strategies and so on. In external competition, patent protection is deemed to be crucial platform for competition for average industry operators (IBIS World, 2016). As the sectorial products continue to lose the grip of their patent protection, brand name pharmaceuticals have continued to struggle with high levels of competition with generic pharmaceutical manufacturers. The major companies within the industry include; Johnson & Johnson with a market share of 11.4%;Amgen with 10.8%; Merck & Co. with 10.4%; AbbVie Inc. with a market share of 10.2% as well as Pfizer Inc. that enjoys a market share of 9.8% (IBIS World, 2016). Merck Corporation strategy relates to the provision of innovative products and services that would ensure to take care and improve on lives around the globe. To ensure that mission is achieved, the firm engages extensively in the attraction; retention and engagement with the most talented and thought leaders from around the world for the purpose of leveraging on its immediate diverse experiences and cutting-edge thinking model (IBIS World, 2016). Another way for which Merck ensures to stay afloat and beyond competition is through its overall commitment to exhaustive and all-inclusive corporate responsibility framework that seeks to formulate and provide innovative products and services that seek to save and improve people’s lives across the globe (IBIS World, 2016). In fact, the firm’s efforts to fight such tropical diseases as Malaria and, also a commitment to fully end maternal mortality rates in 30 African countries is a CSR activity that has ensured of its full and overall success in its operations over the years. B. Accounting Analysis Revenue Recognition The overall revenues that emanates from the sale of products are entirely recognised whenever the aspects related to both title and risks of loss is transferred to the end user or consumer; a process that ends at the time of delivery. It is important to note that the recognition of revenues is deemed to be subjected to reasonable assurances of collection of sales proceeds as well as the completion of all performance commitments. Sales executed within the local market are provided to customers as direct discounts at the immediate point-of-sale and indirectly through intermediary wholesaler that is known as chargebacks or in other cases as rebates. In addition to this, sales are effected with a restricted right of return under specific situations. Of particular interest to note, revenues are recorded net of provisions for sales discounts and returns that are determined at the exact time of the sale process. Furthermore, sales revenues are recorded net of time value of money that is discounted for customer in which collection of accounts receivables is deemed to be in surplus of one year only. The provision for aggregate indirect customer discounts is composed of both chargebacks and rebates. Chargebacks are stipulated to be discounts that happen whenever a contracted customer purchases in a direct manner through intermediary wholesaler. On the contrary, the provision of chargebacks is focused on expected sell-through degree by the firm’s wholesale customers to other contracted consumers and, also approximated inventory levels. It is worth noting that the firm adopts a historical customer mx that is certainly subjected to adjustments for other identified events for purposes of estimating the expected provision. Inventories Valuation Merck’s inventories are values at the lowest cost or market value. The firm ensures that the cost of substantial majority of locally sold pharmaceuticals as well as vaccines inventories is established and subjected to the LIFO technique for purposes of financial reporting and taxation. The costs of other inventories are established using the FIFO accounting technique. In essence, inventories are made up of marketed products and, also specific inventories that are generated in the course of product launches that are deemed to have a high probability of regulation. It is expected that there will be a likelihood of revenues being accessed from future sales of related inventory within the regulatory approvals. Depreciation Expense The firm ensures that depreciation is subjected over estimated useful lives of the underlying assets while still adopting the straight-line technique. In the case of taxation, accelerated tax techniques are easily adopted. For this case, the estimated useful life fundamentally stretches in the period between 25 and 45 years for buildings and 3 to 15 for plant, machinery and equipment. Goodwill Goodwill is made up of the surplus of the considerations that are shifted over the fair value of net assets of business operations that have been recently acquired. It is apportioned to all reporting units and thereafter; evaluated for impairment purposes on at least yearly basis or in other cases more often in the event that there is existence of impairment indicators. This is achieved by way of conducting an initial assessing qualitative aspects that are used to establish whether the reporting units could be less in comparison to the carrying amounts and in the event that it is established so; then a fair value test is conducted. C. Financial Analysis 1. Liquidity Ratios Year/Ratio 2014 2015 Current ratio= current assets/current liabilities 13,515/18,397=0.73 13,039/19,203=0.67 Quick Ratio= current assets-inventory/current liabilities 13,515-5,571/18,397 =0.43 13,039-4,700/19,203 =0.43 Taking a look at the current ratio it can be noted that it decreases from 0.73 to 0.67 in the period between 2014 and 2015 respectively. This is in contrast with GlaxoSmithKline rations that improve from 1.10 to 1.24 within the same period. The decrease in the ratio is an indication that Merck is slowly losing its overall capacity to meet its short term commitments as and whenever the fall due. The fall is attributed to the significant fall in short term investments from as well as inventories thereby reducing the overall ability of short term asset-base to counter current liabilities. The quick ratio stands at 0.43 within the two operational periods compared to GSK that shifts from 0.67 to 0.84 within a similar period. Considering the low ratio value; it can be noted that Merck‘s ability to pay off short term obligations continues to be unchanged over time. 2. Solvency Ratios Year/Ratio 2014 2015 Debt ratio= total liabilities/total assets 49,376/144,287 =0.34 57,012/144,582 =0.39 Times interest coverage= EBIT/Interest expense Cannot be computed because the company has not yet started paying off interests for its debt funds. Analysis The firm’s debt ratio increases slightly within the two periods from 0.34 and 0.39 in comparison to GSK’s ratios that stands at 10.45 in 2015. The firm’s low ratio means that it’s less leverages and less risky to potential creditors in comparison to GSK. This is probably because it has adopted a low debt funds policy that could support its underlying asset-base. 3. Efficiency Ratios Year/Ratio 2013 2014 2015 Inventory turnover=cost of goods sold/ inventories 16,954/6,226 =2.72 16,768/5,571 =3.00 14,934/4,700 = 3.18 Average Inventory Days=Inventory/ Cost of goods sold*365 6226/16954*365 = 134 days 5571/16768*365 days = 121 days 4700/14934*365 days = 114 days Accounts Receivable Turnover= sales/ accounts receivables 44033/7184 = 6.12 42237/6626 =6.37 39498/6484 = 6.09 Average Collection Period= accounts receivables turnover/ 365 days 7184/44033*365 days = 59 days 6626/42237*365 days = 57 days 6484/39498*365 days = 59 days Merck’s inventory turnover ratio increases within the three-year operational period from 2.72 to 3.18 in 2013 and 2015 respectively in comparison to GSK whose ratio decreases within the similar period from 2.18 to 1.98 respectively. In comparison to its major competitor, it can be noted that Merck has ensured to adopt effective strategies meant to translate inventories into sales revenues. The average inventory days for the firm decreases significantly within the three-year period from 134 days to 114 days in 2013 and 2015 respectively. The ratio stands way below that of GSK that is currently positioned at 184 days. This is an indication that Merck is able to convert its overall inventories into cash in a quicker way hence it is highly liquid as compared to its immediate competitor: GlaxoSmithKline. The firm’s account receivables turnover decreases slightly from 6.12 to 6.09 in 2013 and 2015 respectively in comparison to GSK’s ratio that currently stands at 6.48 in 2015. In overall all of the businesses collect credit sales in a similar number of times within the year. The average collection period remains steady at 59 days within the three-year period in comparison to GSK whose ratio currently stands at 56 days. This means that the two companies operate within a recommended industry averages hence collects credit sales in an efficient manner that would not cause cash resource shortage at any given moment in time. 4. Profitability Ratios Year/Ratio 2013 2014 2015 Rate of Return on Net Assets= net income/net assets 4517/49,326 =0.09 11934/48,791 =0.24 4459/44,767 =0.10 Asset turnover =sales/total assets 44033/151,100 =0.29 42237/144,287 =0.29 39498/144582 =0.27 Rate of Return on Equity= net income/total equity 4517/ 52,326 =0.09 11934/ 48,791 =0.24 4459/44,767 =0.10 The firm’s RONA improves slightly within the three periods from 0.09 to 0.10 in 2013 and 2015 respectively in comparison to GSK 0.18 in 2015. The ratio indicates that both of these companies are operating within the recommended industry averages hence ascertaining the fact that they are able to post enough profits while utilising their existing asset base efficiently. The asset turnover ratio decreases slightly within the period from 0.29 to 0.27 in 2013 and 2015 respectively in comparison to GSK’s 0.51. This means that in comparison to GSK, Merck is less efficient in utilising the existing asset base to effect total sales revenues altogether. The ROE of the company increases slightly within the period from 0.09 to 0.10 in 2013 and 2015 respectively in comparison to 1.09 for GSK in 2015, which is an indication that GSK is fairly positioned to utilise the existing equity base to effect substantial level of sales revenues. Conclusion From the discussion above, it can be noted that Merck operates under a very competitive pharmaceutical sector. While the firm’s solvency and efficiency ratios are positively way above its immediate competitor GSK, the profitability and liquidity ratios are still set below the rival. Thus, it is recommended that the firm seek to improve on its advertising and other pricing strategies for its drug related products in order to reduce the effects of direct competition especially from innovative-set companies within the same sector. References IBIS World (2016). IBIS World Industry Report: Brand Name Pharmaceutical Manufacturing in the US. Print Merck & Co. Inc. (2016). Annual reports 2013-2015. Accessed from http://investors.merck.com/investors/financial-reports/annual-reports-and-proxy-statements/default.aspx Morningstar. (2016). GlaxoSmithKline PLC ADR: Financials Key ratios. Accessed from http://financials.morningstar.com/ratios/r.html?t=GSK Read More