Debt-Equity Ratio of Healthcare Industry - Example

Health Care Industry

Table of Contents

Introduction3

Macroeconomic country analysis3

Global industry analysis4

Selection and application of financial tools for analysis5

Comparison of Corporate Performance8

Profitability analysis8

Liquidity analysis10

Solvency analysis12

Conclusion and Recommendation13

Reference List15

Appendix16

• Introduction

The world is moving at a fast pace aided by technology, globalisation and innovation. One of the factors which determines long-term success or failure of companies is sustainable business operations. Many investors focus on qualitative aspects like CSR (Corporate Social Responsibilities) while others prefer quantitative aspects and fundamental analysis. The top-down approach starts with macroeconomic environment analysis followed by industry analysis and company analysis. Financial analysis of company can be conducted through various tools and one of the most popularly used techniques is the ratio analysis (Berry, 2009).

This assignment has selected publicly listed company Pfizer Inc. (ticker: PFE) which operates in the healthcare industry. The interpretation of financial analysis will be drawn upon on the basis of macroeconomic analysis and global industry analysis. The assignment will also conduct ratio analysis to interpret financial statements of the chosen company and compare corporate performance with peer groups and competitors. The analysis will help the existing and potential investors to take investment decision in the future.

• Macroeconomic country analysis

The global healthcare industry is expected to improve in next five years because if US Federal Reserve increases rates in 2016 it will stimulate growth in developed economies on which the revenues of healthcare companies was shrinking due to economic slowdown and after effects of global financial crisis. This however does not rule out possibilities in the emerging countries because interest rate hikes will be less than prevailing interest rates of developing countries. The continued drop in prices of oil in the past quarter helped healthcare industry to control cost of operation, because the companies operating in this industry have to transport medical devices and medicines to across the globe. Hence, transportation and logistics cost can become a burden for companies. While it is expected that consumption and employment in the US market will improve, the European market is also recovering. Demand of medicines in Germany will improve given favourable exchange rate effect. The emerging markets including Russia and Brazil have been underperforming and the same trend can follow in 2016 due to influence of global markets. In contrast, China and India have been performing well along with South Africa which is becoming an important market for healthcare companies (Crisp and Chen, 2014).

The healthcare industry evolves on progress of technological advancement hence, possibilities in strategic partnership of technology firms and healthcare companies can be a difference-maker. The government’s assistance is also required in order to improve access of affordable medicines to every section of the society. There are prevailing issues related to generic drug licensing and intervention of US Food and Drugs Authority (FDA) affecting company’s strategic decisions. On the social aspects, the world is growing and population is aging which is driving the global healthcare industry. Statistics show that global population will increase by 1 billion by 2040 and people above 60 years will increase in number, more than 600 million people will cross 60 years by 2030. These social and demographic factors will increase the demand for global healthcare industry (Kim, Farmer and Porter, 2013).

• Global industry analysis

The macroeconomic factors influencing the global healthcare industry may seem favourable but there are some industry-specific challenges.

• Licensing and Intellectual Property Rights (IPR) – Investments in healthcare companies depend on their internal capabilities, R&D and access to exclusive drug generating licenses and IPRs. Loss or expiry of license adversely affects profitability of drug manufacturers. Since, most of the portfolio of drugs has varying expiry dates for licenses and IPRs, companies will have to strengthen overall portfolio (Dafny, 2014).
• Government regulation – The drug authority and government can influence pricing strategies and accessibilities. As the distributors constantly seek discounts and demand price cuts of important drugs, continued reduction in drug prices affects profitability. The US government facilitates healthcare industry by allowing original manufacturers to sell and distribute drugs at low cost to countries like Japan, Canada, China, Europe, South Korea and some other international markets (Dafny, 2014).
• Regulatory environment – Healthcare companies will have to continue to develop existing products and introduce more innovative drugs. However, companies are regularly scrutinised by the drug authority for safe and efficiency of drugs. If the government finds any drug violating safety norms through independent research, then it can restrict its public distribution and also stop production (Dafny, 2014).
• Competition – The global healthcare industry is highly competitive in branded and generic drug segments. In the US, the generic drugs competition increased in 2015 which forces healthcare companies to lower prices of their products. In the emerging markets there is an immense competition from OTC (Over-The-Counter) drugs market (Dafny, 2014).
• Selection and application of financial tools for analysis

One of the most important sources of information about a company’s financial health and profitability is its financial statements. Publicly listed companies are required to file annual reports, quarterly earnings reports, Corporate Social Responsibility reports, etc. so that the investors can take informed decision. The balance sheet provides information on status of assets, liabilities and stockholder’s net worth, liquidity of cash flows and position of the company on a given date. The income statement provides detail regarding company’s core operational performance and profitability. In order to analyse the financial corporate performance of the company, it is required to interpret these financial statements and compare the results with peer groups or close competitors. This will assist the investor to compare the profitability and potential of target firm with other companies (Berman, 2008).

Once the source of information is selected (like annual reports, security filings, balance sheet, income statement, etc.), all relevant data needs to be collected. The next step is to select an appropriate financial tool for analysis which will help to organise information in such a way that it will highlight specific trends, underlying relationships and fundamental position of the firm (Berman, 2008).

The commonly used tool for analysis is financial ratios:

• Current ratio – This ratio analyses liquidity of assets and shows how soon the company will be able to convert receivables into cash and honour short-term obligations. This is calculated by dividing the total current assets by total current liabilities. High value of this ratio indicates that there is sufficient cash and equivalents available with the company to meet current obligations. For the global health care industry, a value over 1.5 is considered sufficient (Berry, 2009).
• Quick ratio – Inventory piling is not a very good sign because lots of cash is stuck in form of unsold goods. Hence, many analyst advices that stock should not be included in current assets because of its slow liquidity. The quick ratio eliminates stocks from total current assets and then divides it with total current liabilities to assess true liquidity (Brigham and Houston, 2009).
• Net profit margin – It is the ratio of net income to total revenues (often expressed as percentage). The high value of this ratio indicates higher profitability and investors looking for quality stocks in health care industry should consider minimum 20 percent net margin (Berry, 2009).
• Return on Equity (ROE) – The existing and potential investors would like to know how their capital is used and managed in the firm. This ratio helps to assess how owner’s capital is being utilised by management. It is calculated by dividing the net income by shareholders’ equity implying what part of their investment is translated into net earnings. Higher ROE is a good indication and it shows that current management is capable of increasing shareholder’s wealth (Berry, 2009).
• Debt-to-equity ratio – It is important to balance owner’s capital and borrowed money for maintaining long-term solvency of the firm. This ratio is calculated by dividing long-term debt by total shareholders’ equity. The relative proportion of debt and equity suggests financial leverage. Lower value of this ratio is very common in healthcare industry because it is not capital intensive industry like real estate (Brigham and Houston, 2009).
• Debt-to-asset ratio – The investors must be aware of solvency status of the firm because if assets of the company are not sufficient to cover debt then the company will have to file insolvency to repay creditors by selling assets. This ratio is computed by dividing the total debt by total asset (Brigham and Houston, 2009).
• Comparison of Corporate Performance
  • Profitability analysis

The target company, Pfizer Inc., has demonstrated satisfactory profit generating potential given the global economic turmoil. The company reported approximately US$49 billion revenues in 2015 which declined by 2% from previous year 2014. The decrease in profitability was mainly due to acquisition of Baxter vaccines for US$178 million (Pfizer, 2016). From the trends in net margin, it can be said that profitability drastically fell from 2013 to 2014. A critical analysis reveals that losses were mainly attributable to following factors:

• Loss of exclusive patent to use generic drugs of Celebrex in USA and also in certain emerging markets (approximate loss of US$1.7 billion)
• Underperformance of some drugs like BeneFIX in USA (loss of approximate US$369 million)
• Termination of Spiriva in some countries (approximate loss of US$98.9 million) and Enbrel in Canada and USA (approximate loss of $1.4 billion) (Pfizer, 2016).

Figure 1: Net Margin of Healthcare Companies

(Source: Author’s creation)

In contrast, the profitability of Novartis AG (NVS) increased from 2011 to 2015 by 23.14% followed by GlaxoSmithKline (GLAXF) which increased by 16% during the same period. The profitability of Bayer (BAYZF) was lowest compared to other global healthcare companies from 2011 to 2015 (Novartis, 2015; Bayer, 2014).

The ROE of PFE marginally decreased from 12% in 2011 to 11% in 2015 mainly due to declining profitability of the company due to factors discussed earlier. Since ROE is an indicator of how the company has been using owner’s capital in the firm, this ratio is an important decision making tool for the potential and existing investors (Berry, 2009).

Figure 2: ROE Analysis of Healthcare Companies

(Source: Author’s creation)

From the graph shown above, it is clear that while NVS, BAYZF and PFE had comparable ROE during 2011 to 2015, the ROE of GLAXF increased drastically from 0.65 in 2014 to 1.65 in 2015. This is more than the benchmark ROE in global healthcare industry showing outperforming investor’s expectations.

• • Liquidity analysis

The current ratio of PFE decreased from 2.06 in 2011 to 1.49 in 2015 mainly due to following reasons:

• Change in profit due to deferred sales of unsold inventory to third-party vendors
• Decrease in receivables as the company is minimising credit sales to avoid bad debts
• Increase in deferred income tax in 2014 and 2015 (Pfizer, 2016).

Figure 3: Current Ratio of Healthcare Industry

(Source: Author’s creation)

Figure 4: Quick ratio analysis

(Source: Author’s creation)

The liquidity of PFE steadily increased from 2011 to 2014 but then declined due to reasons cited above. In contrast, the liquidity of assets of other competitors in healthcare industry remained subdued from 2011 to 2015.

• • Solvency analysis

The debt-to-equity ratio is an important indicator of solvency because it helps investors to analyse the balance between debt and equity capital in balance sheet. This ratio for PFE increased from 0.43 in 2011 to 0.45 in 2015.

Figure 5: Debt-Equity Ratio of Healthcare Industry

(Source: Author’s creation)

The financing activities is essential for company’s growth and cost of debt is cheaper than cost of equity which makes debt capital preferable source of fund for companies. The selected company PFE utilised US$10.1 billion for financing in 2015. The company also repaid US$3 billion outstanding long-term debt in 2015 compared to US$1.7 billion in previous year. The company also purchased common stocks over US$ 6 billion in 2015 which increased the debt-to-equity ratio marginally. In contrast, the value of this ratio was highest for GLAXF from 2011 to 2015 mainly due to excess leverage. The debt level of NVS is negligible compared to other firms in global healthcare industry (GSK, 2015; Pfizer, 2016).

• Conclusion and Recommendation

This assignment conducted macroeconomic, global industry analysis of healthcare industry and financial ratio analysis of Pfizer Inc., Novartis AG, GlaxoSmithKline and Bayer for five years starting from 2011 to 2015. The findings of the study suggest that global macroeconomic conditions are favourable for healthcare companies which can further benefit if the US Fed increases interest rates. The developed markets in the European Union are recovering at slow pace but there is increasing demand for generic and branded drugs in these markets which will continue to grow. The industry can face challenges from regulatory bodies and competition can force companies to reduce prices of products which can impact profitability. The financial ratio analysis shows that financial position of chosen company, Pfizer Inc., is stable in terms of liquidity and operating efficiency. The working capital management policies of peer groups and close competitors of PFE are prudent and current assets are sufficient to cover current liabilities. The financial risk of PFE is very limited as the total long-term debt of the firm is manageable. Overall, the investors are recommended to consider the stocks of PFE in their portfolio.

• Reference List

Bayer, 2014. Annual Reports. [online] Available at: <http://www.bayer.com/en/integrated-annual-reports.aspx> [Accessed 12 May 2016].

Berman, H. J., 2008. Ratio analysis: a technique for financial management in hospitals. 6th ed. London: Prentice Hall.

Berry, A., 2009. Financial Accounting: an introduction. 4th ed. California: Random House.

Brigham, E., and Houston, J., 2009. Fundamentals of Financial Management. 5th ed. London: McGraw-Hill.

Crisp, N. and Chen, L., 2014. Global supply of health professionals. New England Journal of Medicine, 370(10), pp.950-957.

Dafny, L., 2014. Hospital Industry Consolidation—Still More to Come? New England Journal of Medicine, 370(3), pp.198-199.

GSK, 2015. Annual Report 2015 and 20-F. [online] Available at: <http://www.gsk.com/en-gb/investors/corporate-reporting/annual-report/> [Accessed 12 May 2016].

Kim, J.Y., Farmer, P. and Porter, M.E., 2013. Redefining global health-care delivery. The Lancet, 382(9897), pp.1060-1069.

Novartis, 2015. Annual Report 2015. [online] Available at: <https://www.novartis.com/news/annual-report-2015> [Accessed 12 May 2016].

Pfizer, 2016. Pfizer Financial Reports. [online] Available at: < http://www.pfizer.com/investors/financial_reports/financial_reports > [Accessed 12 May 2016].

• Appendix

Table 1 – Ratio analysis

CURRENT RATIO ANALYSIS

2011

2012

2013

2014

2015

PFE

2.06

2.15

2.41

2.67

1.49

NVS

1.04

1.16

1.16

1.39

0.96

GLAXF

1.08

0.99

1.11

1.10

1.24

BAYZF

1.50

1.45

1.36

1.43

1.40

Benchmark

1.42

1.44

1.51

1.65

1.27

QUICK RATIO ANALYSIS

2011

2012

2013

2014

2015

PFE

1.78

1.90

2.14

2.41

1.23

NVS

0.78

0.88

0.88

1.17

0.70

GLAXF

0.82

0.70

0.83

0.79

0.88

BAYZF

1.02

0.92

0.85

0.89

0.90

Benchmark

1.10

1.10

1.18

1.31

0.93

DEBT-EQUITY ANALYSIS

2011

2012

2013

2014

2015

PFE

0.43

0.38

0.40

0.44

0.45

NVS

0.21

0.20

0.15

0.19

0.21

GLAXF

1.52

2.53

2.21

3.72

3.00

BAYZF

0.37

0.35

0.23

0.87

0.66

Benchmark

0.63

0.86

0.75

1.30

1.08

DEBT-ASSET ANALYSIS

2011

2012

2013

2014

2015

PFE

0.56

0.56

0.56

0.58

0.61

NVS

0.44

0.44

0.41

0.44

0.41

GLAXF

0.80

0.86

0.83

0.90

0.90

BAYZF

0.64

0.64

0.60

0.71

0.67

Benchmark

0.61

0.63

0.60

0.66

0.65

PROFIT MARGIN ANALYSIS

2011

2012

2013

2014

2015

PFE

0.15

0.25

0.43

0.18

0.14

NVS

0.15

0.17

0.16

0.19

0.35

GLAXF

0.19

0.17

0.21

0.12

0.35

BAYZF

0.07

0.06

0.08

0.08

0.09

Benchmark

0.14

0.16

0.22

0.14

0.23

ROE ANALYSIS

2011

2012

2013

2014

2015

PFE

0.12

0.18

0.29

0.13

0.11

NVS

0.14

0.14

0.12

0.14

0.23

GLAXF

0.66

0.79

0.78

0.65

1.65

BAYZF

0.13

0.13

0.15

0.17

0.17

Benchmark

0.26

0.31

0.34

0.27

0.54