Merck vs Pfizer

Evaluating Merck & Co. , Inc vs. Pfizer, Inc. Amy Lan Lan Liu Connor Buestad Raghul Subramanian Natalia Cosa ACCT 831 March 16, 2011 Table of Contents: Part 1: History, Background and Core Business ……………………………………………………………. 2 a. Merck & Co. , Inc. ………………………………………………………………………………………………….. 2 b. Pfizer, Inc. ……………………………………………………………………………………………………………… 2 c.
Core Business …………………………………………………………………………………………………………. 3 Value Chain ………………………………………………………………………………………………………. 4 Porter’s Five Forces ……………………………………………………………………………………………. 6 SWOT Analysis ……………………………………………………………………………………… ………. 8 Part 2: Financial Analysis ………………………………………………………………………………………….. 5 a. Profitability Analysis …………………………………………………………………………………………….. 15 b. Liquidity Analysis …………………………………………………………………………………………………. 18 c. Solvency Analysis ………………………………………………………………………………………………….. 19 Part 3: Valuation Analysis ……………………………………………………………………………………….. .. 20 a.
Residual Income ……………………………………………………………………………………………………. 20 b. Cost of Equity ……………………………………………………………………………………………………….. 21 c. Valuation ………………………………………………………………………………………………………………. 22 d. Sensitivity analysis …………………………………………………………………………………………………. 23

Part 4: Recommendations ……………………………………………………………. ……… 23 Appendix: …………………………………………………………………………………………………………………. 25 Appendix A: Profitability Analysis…………………………………………………………………………………. 25 Appendix B: Liquidity Analysis …………………………………………………………………………………….. 25 Appendix C: Solvency Analysis …………………………………………………………………………………….. 6 Appendix D: Residual Income and Cost of Equity……………………………………………………………… 26 Appendix E: Sensitivity Analysis…………………………………………………………………………………….. 27 References ………………………………………………………………………………………. 28 Part 1: History, Background and Core Business a. Merck & Co. , Inc. : History and Background Information Merck is headquartered in Whitehouse Station, New Jersey. According to its website, the company was originally established in 1891 as a US subsidiary of the Merck KGaA German company. Merck became an independent company in 1917.
In 1963 Merck launch the first measles vaccine, and, in 1967 launched a mumps vaccine. In 2009, Merck acquired Schering-Plough and now represent the world’s third-largest pharmaceutical company by market share. Today, the company has over 94,000 employees worldwide (2012). Merck is the third largest global healthcare company in the world. The company specializes in prescription medicines, vaccines, animal health, and consumer care products, that are marketed directly and through its joint ventures. The company operates four segments namely Pharmaceutical, Animal Health, Consumer Care, and Alliance segments (merck. om, 2012). Starting 2011, in order to drive future growth, Merck started focusing on reducing costs, making strategic investments in new product launches, and improving its research and development pipeline. Merck’s sales worldwide reached $48 billion in 2011, which was a 4% increase from 2010. With two drugs under review with the FDA, the company has 19 other drugs in the Phase III of development. b. Pfizer Inc. : History And Background Information Found by Charles Pfizer and Charles Erhart in 1849 Pfizer, Inc. is the largest pharmaceutical company in the world.
Their main goal was to discover new drugs that would help improve the healthcare around the world. Both Pfizer and Erhart were born and raised in Germany before descending upon Brooklyn, New York, where Pfizer first opened its doors as a fine-chemicals business. The first product launched by Pfizer was used to intestinal worms, a disease that was prevalent in mid-19th century America (Pfizer. com, 2012). According to their website, in 1880, Pfizer shifted its focus to manufacturing citric acid which was the raw material for soft drink products such as Coca-Cola, Dr. Pepper, and Pepsi-Cola.
In 1944, Pfizer succeeded in producing penicillin with was also called “the miracle drug. ” By 1980, Pfizer was manufacturing an anti-inflammatory drug called Feldene (piroxicam), which was the first product to generate revenue of one billion dollars from sales around the world. Today, Pfizer is known for its creation of drugs such as Lipitor used for cholesterol, Viagra used for erectile dysfunction, and Celebrex used as an anti-inflammatory (2012). The range of products sold by Pfizer has many applications in the health industry that serves in wellness prevention and treatment of a wide variety of diseases.
Some of its promises drugs that are under review are potential cures for Alzheimer’s disease and cancer. c. Core Business: Merck and Pfizer share the same core business model of researching, developing, and marketing pharmaceutical products. As with any business, Merck and Pfizer are facing increasing competition and challenges, not the least of which is the expiration of patent protections on key products. There are three tools that are increasingly useful in analyzing the core business and economic characteristics of an industry. These include the value chain analysis, Porter’s Five Forces Model, and the SWOT analysis.
The Value Chain The first tool, the value chain analysis, represents the chain of activities involved in the development, manufacturing, and distribution of products and/or services of a company. The value chain of pharmaceutical companies usually consists of research and development of drugs, drug approval by government regulators, manufacturing of drugs, creation of demand for drugs, and marketing to consumers. The analysis of each stage of the value chain can reveal the central focus and competencies of the firm, and can point to the activities that drive profit.
According to Fortune 500, the leading pharmaceutical firms in 2011 were Pfizer, Johnson & Johnson, Merck, and Abbott Laboratories (CNN. com, 2011). The two companies we discuss in this paper, Merck and Pfizer, have similar value chains. Merck and Pfizer position themselves as companies that provide innovative and effective drugs and medical solutions globally. Due to the increasing threat of patent expiration and generic drug competition, both pharmaceutical companies focus extensively on research and development and new drug approval value chain activities.
Both companies devote considerable internal resources on R&D, and continue to expand through acquisitions or by entering into agreements with other companies that focus on the discovery and development of new drugs. In 2009, Pfizer acquired Wyeth for $68 billion, an acquisition that is considered the largest pharmaceutical merger in nearly a decade (Hoover’s Company Records, 2012). In addition, Pfizer acquired Excaliard Pharmaceuticals in November 2011, and in September 2011 it gained 70% ownership of the outstanding shares of Icagen, Inc.
Merck is also constantly seeking out collaborations, licensing, and outsourcing agreements in the area of Research and Development (Datamonitor, 2011). In November 2009, it acquired Schering-Plough for $41 billion (Hoover’s Company Records, 2012), and in May 2011 it acquired Inspire Pharmaceuticals. Pfizer and Merck focus heavily on the new drug approval process. In 2011, Merck had 2 drugs under review by government regulators and 19 drugs in last trial phase, and it also planned to file 5 major products for approval between 2012 and 2013.
Pfizer had 19 drugs submitted for FDA for approval, and 5 already approved for 2011. Both Merck and Pfizer benefit from using sophisticated and efficient manufacturing and supply chains. Both companies create, move and sell tremendous amounts of product each year and therefore must rely on a dependable manufacturing system. Their manufacturing network consists of numerous manufacturing sites and distribution networks around the world. In addition to their internal manufacturing, pharmaceutical firms work with networks of external partners to produce lines of product, packaging, and active ingredients.
To create demand for their products, both companies market extensively in multiple media outlets and encourage consumers to ask their doctors about different drugs. Merck markets its products in over 140 countries through direct sales forces and international distributors. Its customers are drug wholesalers, retailers, government agencies, and healthcare providers (Hoover’s Company Records, 2012). Pfizer sells its products through wholesale distributors like McKesson and Cardinal health and it markets its products directly to doctors, hospital, nurses, employer groups, and patients.
Porter’s Five Forces The pharmaceutical industry is a highly dynamic with new technologies emerging in the market quite often. Michael Porter’s Five Forces model can be used to study and verify the factors affecting the market performance of Merck & Co and Pfizer. This model focuses on the external forces that the companies must pay attention to in order to maintain their profitability. The five forces of the pharmaceutical industry are analyzed below. 1. Threat from new entrants is predicted to be low in this industry due to the following reasons.
The pharmaceutical industry is a high-tech industry and involves high capital costs. Economy of scale is required to keep the costs down and the established firms (Merck & Co and Pfizer) are well known for excelling in this area. The existing drugs are safe-guarded by patents at least for a particular period of time before the generic drugs hit the market. This gives companies like Merck and Pfizer a considerable leg up on competitors. However, these patents do eventually expire, thus opening the door to more competition from generic drug makers. Product differentiation is necessary in order to attract new customers.
In the field of pharmaceuticals, it is very hard to bring a differentiated product to market. New drugs undergo extensive testing by the FDA before entering the market. The drugs by the established firms get easily passed when compared to new entrants whose credibility is still uncertain. 2. Rivalry among established firms is high in the industry among players like Johnson & Johnson, Merck & Co, Pfizer, Abbott Laboratories etc. The pharmaceutical industry is high revenue industry and there is a tough competition to obtain more market share. No company owns more than 6-10 % of the market share.
In addition, high costs of R and marketing are incurred by all the firms involved in this competition. 3. Buyer power would be classified as low to moderate in this industry due to the following reasons. The concentration of buyers relative to overall industry size is low. The demand for chronic and lifesaving drugs is high due to the ageing baby-boom population. The buyers have little knowledge about the industry cost structure and hence the pharmaceutical companies use this advantage to price their products higher. The patents protect the drugs from lower priced competitor drugs, but many patents are expiring. . Supplier power is considered medium to low in the industry. The supplier switching costs incurred by pharmaceutical companies like Merck and Pfizer is low. The threat of forward integration by suppliers is low due to lack of knowledge and expertise. Differentiation of the supplier products is low because they have a wide range of applications, with the biotech firms being one of them. 5. Substitute products always present a challenge to companies operating in the pharmaceutical industry. This can be attributed to the following factors.
Biotech firms like Amgen are beginning to market their own products, unlike the traditional method of selling them to pharmaceutical companies like Merck and Pfizer. This presents a new segment of competitors that can provide substitutes. Increasingly, patients can use medical alternatives such as surgery, homeopathic remedies, acupuncture and herbal medicines. The overall healthcare industry is very dynamic and always changing. New products and healing methods are constantly being developed, some of which could serve as substitutes to existing treatments offered by Merck and Pfizer.
SWOT Analysis Merck & Co. SWOT Merck is the third largest healthcare company in the world. Over the years, a large investment in R has enhanced the company’s top-line growth. However, new competitors and large cost of drug development could affect their revenue growth. | Strengths |Weaknesses | |Leading market position; third largest healthcare company in |Generic brand competition | |the world. High litigation cost | |Successful launches of new products | | |Merger with Schering-Plough strengthens their industry | | |position | | |Opportunities |Threats | |Cost savings from internal restructure |US regulatory setbacks | |Expansion in emerging markets |Healthcare reform of US | |Strong pipeline | | Strengths Leading Market Position; Third Largest Healthcare Company in the World Merck is a well-known and respected company worldwide. One of their greatest strengths is their leading market position. Merck’s worldwide sale totaled $48 billion in 2011, an increase of 4% compared to 2010.
The increase of revenue is mainly due to the company’s signature products such as Singulair, Januvia, Remicade, Zetia, Vytorin, Janumet, Isentress, Nasonex, Gardasil, and Temodar (Datamonitor, 2011). Successful Launches of New Products Merck has a proven success record for launching new products. Since 2006, it has successfully launched 10 new therapeutics, including Victrelis, a treatment for chronic hepatitis C (2011), Elonva, a corifollitropin alpha injection (2010), Janumet, a treatment for diabetes, Isentress, an HIV integrase inhibitor (2007), Gardasil, a drug that could prevent diseases caused by HPV, and Januvia, a cure for type 2 diabetes (2006) (Datamonitor, 2011). Merger with Schering-Plough Strengthens Their Industry Position The merger with Schering-Plough has certainly strengthened Merck’s industry position.
Schering-Plough owned many popular pharmaceutical drugs such as allergy drugs Claritin and Clarinex, anti-cholesterol drug Vytorin, and a brain tumor drug Temodar. Schering Plough had 1. 4% market share in the U. S. , 17th in the top 20 pharmaceutical corporation by sales (Datamonitor, 2011). Weaknesses Generic Brand Competition Merck pharmaceutical products have traditionally accounted for most of their total sales. One weakness is the competition Merck faces with generic brands. Due to the current economy, we tend to estimate people will shift to more inexpensive and generic brand products. This can cause sizable losses for Merck’s total revenue. High Litigation Costs
Merck continues to face litigation related to their Vioxx recall, a drug that is used to cure arthritis and acute pain. In 2004, Merck withdrew Vioxx off the market because it cased potential cardiac attacks among the patients who took it regularly for a period of 18 months or longer. During 2010, Merck was forced to spend around $140 million in legal defense costs (Datamonitor, 2011). Opportunities Cost Savings from Internal Restructure Merck has emphasized the idea of decreases costs in order to drive greater efficiencies within the company. According to Datamonitor’s SWOT analysis, Merck hopes to reduce costs by $3. 5 billion annually beyond 2011 (2011). Expansion in Emerging Markets
Merck has strengthened its international market share by signing exclusive agreements with other established companies to co-promote and distribute a number of products. For example, Merck and Johnson & Johnson agreed to govern the rights to distribution of Remicade and Simponi. Remicade is a treatment for nasal allergy and Simponi is an asthma treatment for patients above the age of three. According to the agreement with Johnson & Johnson, Merck is allowed to market Simponi and Remicade in Asia, Canada, Africa, The Middle East, and Central and South America as of July 1, 2011. In addition, Merck exclusively markets these products in Turkey, Russia, and Europe.
These two products brought in 70% of Merck’s revenue from 2010 (Datamonitor, 2011). Strong Pipeline Datamonitor expects that Merck’s 20 new products will add combined annual sales of more than $7 billion to its top-line by 2015 (2011). “While Merck retains its internal focus on pipeline productivity, half of its new launches were obtained in the company’s merger with Schering-Plough. Recently Merck has had considerable success with a number of new launches since moving into its core portfolio. It will look to replicate this success with the pipeline programs it has inherited from Schering-Plough as well as with those it has been developing prior to the merger. ” Threats US Regulatory Setbacks
US regulatory setbacks include terminations of Merck’s treatments such as for Tredaptive for atherosclerosis, and Taranabant for obesity. The potential for further setbacks and termination can be a concern for Merck’s brand image during the drug development stage. There could also be threats for the clinical and regulatory failures with developing Saphiris (schizophrenia), boceprivir (hepatitis C) and TRA (Datamonitor, 2011). Healthcare Reform of US The recently enacted US Healthcare Reform could decrease Merck’s profit margins. According to Datamonitor, Merck incurred additional expenses from increases in Medicaid rebates, which increased from 15. 1% to 23. 1% for the branded prescription drugs.
Being in the Medicare Part D coverage gap, Merck was required to pay a 50% discount utilization required by law in 2011. In addition, Merck expects to Also, beginning in 2011, Merck expects that it will pay an additional annual health care reform fee, which will be calculated as a percentage of the industry’s total sales of branded prescription drugs to specified government programs. The fee was $2. 5billion for 2011 (2011). Pfizer Inc. SWOT Pfizer is the world’s largest research-based pharmaceutical company and still remains the strongest industry player in terms of sales and marketing capability. However, Pfizer relies on a large-scale M&A structure and lacks some key aspects of an organic sales growth model. Strengths |Weaknesses | |M&A to gain economies of scale |Difficulty in gaining market share due to already | |Strong advertising capabilities |established position in the market | |Acquisition of Wyeth in 2009 |Heavy reliance on Lipitor franchise | |Opportunities |Threats | |Acquisition of King in 2010 |Difficulties in achieving organic sales growth | |Enhancing established products in emerging markets |Development setbacks of Sutent and Chantix/Champix | |Decreasing cost structure | | Strengths M&A to Gain Economies of Scale Pfizer has used large-scale acquisitions to establish and maintain its position as the biopharmaceutical industry’s leading player. Since 2000, Pfizer acquired four big pharmaceutical companies: Warner-Lambert, Pharmacia, Wyeth, and King Pharmaceuticals. Pfizer acquired Wyeth in 2009. Wyeth was known for manufacturing over-the-counter drugs such as Robitussin and Advil, around $3 billion in sales annually. The acquisition of Wyeth enhanced Pfizer’s position as the industry’s largest prescription pharmaceutical manufacturer.
According to an article from MarketWatch, Pfizer’s large economies of scale growth also enhanced the company’s ability to implement restructuring programs designed to reduce costs and drive profitability, while maintaining a steady increase in R expenditure (2012). Strong Advertising Capabilities According to MarketWatch, Pfizer has a strong marketing and sales infrastructure that helps grow sales for new products as well as mature product that face strong competition from generic competition. According to MarketWatch, “The most visible illustration of Pfizer’s sales and marketing capability is the significant revenue stream recorded by Pfizer attributable to third party products marketed under-license in selected geographic markets. In short, Pfizer remains a marketing partner of choice for many medium and smaller sized prescription pharmaceutical players” (2012). Acquisition of Wyeth
The acquisition of Wyeth gives Pfizer an immediate access to many well-known biologic and vaccine products such as Enbrel, an anti-inflammatory product and Prevnar, a vaccine. Pfizer’s financial statement 2011 stated the worldwide revenues from biopharmaceutical products in 2010 were $58. 5 billion. This was increase of 29% from 2009, primarily attributed to the addition of operational revenues from Wyeth products of approximately $13. 7 billion (Datamonitor, 2011). Weaknesses Difficulty in Gaining Market Share Given Pfizer’s current market share (world’s largest research-based pharmaceutical company), it will be difficult for the company to continue to grow at the historical rate of sales without further use of large-scale M&A.
According to MarketWatch, “Pfizer’s 15 established blockbuster products in 2010, only a few products, including the neuropathic pain therapy Lyrica (pregabalin), are forecast to deliver a positive sales growth contribution through to 2015 (2012). All other products, including Lipitor, will deliver net negative sales growth, primarily due to generic exposure. ” Heavy reliance on Lipitor franchise According to the analysis of MarketWatch, “Pfizer’s blockbuster portfolio is dominated by the Lipitor franchise, which generated global sales of $10. 7 billion in 2010 (2012). However, Lipitor revenue growth slowed substantially since mid-2006 due to the ‘indirect generic impact’ of therapeutic substitution via loss of patent exclusivity for Merck & Co. ‘s rival statin Zocor.
With the Lipitor patent expiration set to occur in mid-2011, exposure of this one product to generic competition will have a significant impact on the overall performance of the company. ” Opportunities Acquisition of King in 2010 Pfizer acquired King Pharmaceuticals on Oct 12, 2010, the world’s 39th largest pharmaceutical company that focuses on pain management. Its product includes Altace for heart attack prevention, and Sonata, a sleeping aid. According to MarketWatch, “the acquisition of King represents the latest stage in a diversification strategy implemented by Pfizer over the past two years, as it seeks to prepare for the loss of patent exclusivity on its best-selling prescription pharmaceutical product Lipitor (atorvastatin) in late 2011.
King is a leading developer of analgesics and its integration will broaden Pfizer’s pain offering to include opioid drugs with anti-abuse technologies (2012). Datamonitor currently forecasts that King’s total revenues will increase at a CAGR of 11. 3% during 2010-15, from $1. 2 billion to $2 billion” (2011). Enhancing Established Products in Emerging Markets Pfizer established two independent business units, one focused on established products and the other focused in emerging markets. The goal is to bridge emerging markets with established products. Pfizer, like Merck, plans to expand to the emerging markets by collaborating with local players to source branded generic products. Decreasing Cost Structure
Pfizer’s aim to grow profit will be depending on its continued use of a decreasing cost structure. According to MarketWatch, Pfizer forecasted the acquisition of Wyeth will save $3 billion by the end of 2012 (2012). Pfizer’s reason for the large-scale M&A is to cut cost substantially (by not having to invest in R&D and the development of new drugs) to drive increased profitability (by leveraging what other companies have developed). Threats Difficulties in achieving organic sales growth Pfizer success relies heavily on large-scale M&A and lacks organic sales growth. Datamonitor believes that further large-scale M&A activity will be undertaken by Pfizer because of growing competition of generics (2011).
Pfizer’s own R operations will find it difficult to keep up with the historical M for its organic growth. Development setbacks of Sutent and Chantix/Champix Sutent, a treatment of advanced renal cell carcinoma, experienced development setbacks. Sutent’s revenue growth depends partially on approval in additional tumor types; the termination of clinical trials in both colon cancer and breast cancer indicates that the product’s performance in the marketplace could suffer. In addition, Pfizer also experienced setbacks in Chantix/Champix, smoking cessation therapy. Revenue declined mainly due to the updated labeling to warn of neuropsychiatric symptoms.
As DataMonitor pointed out, “further failures in clinical trials of Sutent and other products could significantly affect Pfizer’s sales growth” (2011). Part 2: Financial Analysis a. Profitability Analysis (Appendix A) Using return on assets (ROA), return on common equity (ROCE), and earnings per share (EPS), one can properly illustrate the profitability of Merck and Pfizer. Merck’s ROA decreased significantly from 2009 to 2010, dropping from 16. 8% to 1. 29%. This decrease was attributed to a decline in net income and profit margin. After their acquisition of Schering-Plough, Merck was left with higher costs, such as an 88% increase in R expense and a 55% increase in Marketing and Administrative Expenses. Total costs increased by 265%, while sales increased by only 67%.
Net income also decreased in 2010 due to an increase in Other Expenses attributable to the Schering-Plough merger, an exchange loss of $200 million due to two Venezuelan currency valuations, and a $950 million charge for the Vioxx Liability Reserve. The disaggregated ROA showed a decrease in profit margin as well, from 48. 9% in 2009 to 3. 06% in 2010. A year after the merger, Merck’s ROA bounced back to 6. 7%, which is closer to the industry average of 11% (CNN. com, 2011) by decreasing some expenses (R, Materials & Production) and an increase of $2 million in sales. Pfizer’s ROA shows a similar decreasing trend for 2010. Its ROA decreased from 9. 03% in 2009 to 4. % in 2010 due to deductions related to asset impairment charges that were $1. 3 billion higher in 2010 than in 2011, due to the Wyeth acquisition in 2009 and litigation related to their subsidiary Quigley Company, Inc. The ROA has increased in 2011 to 5. 83% because the costs and expenses decreased by $3 million. The disaggregated ROA shows both the decrease of asset turnover and profit margin from 2009 to 2010, and the increase in both for 2011, showing that the operation profitability is getting stronger. However, we believe that both firms’ profit margins are healthy when compared to the industry average of 16. 7% (yahoofinance. com, 2012)
After comparing the Asset Turnover, Profit Margin, and ROA for both companies, we can conclude that both are starting to improve in regards to profitability, after their acquisitions in 2009. However, Merck seemed to be using its assets more efficiently to generate sales than Pfizer in 2011. Merck also had a higher ROA. However, both companies are below the industry average ROA of 11% and below the ROAs of competitors (Johnson & Johnson ROA is 8. 5% and Abbott is 7. 8%) (CNN. com). Return on common equity helps to explain how well a company uses its investment dollars to generate profits. ROCE can be very important to shareholders as it informs common stock investors how effectively their capital is being reinvested.
Merck’s ROCE decreased significantly in 2010 due to the acquisition of Schering-Plough, which led to a decrease in Net Income due to the cost of acquisition (increase in R, and increase in marketing, administration, materials and production expenses), and an increase in Shareholders’ Equity. Pfizer’s ROCE declined marginally in 2010 as well, due to the acquisition of Wyeth. However, both companies were back to normal operations in 2011 and had similar ROCEs, around 11%, which is considered the average percent for publicly traded companies in the US. This means that both companies have healthy ROCEs and are generating healthy returns to shareholders.
The desegregated return on common shareholders’ equity reveals a decrease in the financial leverage of Pfizer from 2. 29 in 2010 to 2. 25 in 2011. Merck’s financial leverage is constant, 1. 92 in 2010 and 1. 93 in 2011. We conclude that both companies are not heavily leveraged by short and long term debt, which shows that they are less risky financially. The disaggregated ROCE also reveals low asset turnover ratios for both companies and this is not uncommon for companies with high profit margins in the pharmaceutical industry. Finally, Earnings per Share is also used to assess a company’s profitability. EPS allow us to compare the companies’ power to make a profit. This means that Merck’s Price Earnings Ratio performs better than that of Pfizer’s.
Whereas Pfizer’s EPS has been constant for the last three years (around 1), Merck experienced a significant decrease in 2010 to 0. 36 for diluted. The notes of their financial statements list the following reasons for the decrease: R impairment charges, restructuring and merger with Wyeth (had to recognize a full year of amortization of intangible assets and inventory set-up), legal reserve deductions related to Vioxx, and the US healthcare legislation reform. Non GAAP results were evaluated as well, and we believe these results give a better understanding of the performance of the company as they exclude the non-recurring costs mentioned above. b.
Liquidity Analysis (Appendix B) The following section analyzes the short term liquidity risk of Merck and Pfizer. The Current Ratios for both companies are healthy, above 1, which means that they both have substantial cash and near-cash assets available on their Balance Sheet to repay their obligations within the next year. The Quick Ratios for both companies is also healthy, above 0. 5, which means that both companies have liquid assets on hand to repay their short term obligations. The Operating Cash Flow ratio is similar for both companies, above 0. 4, which means that both companies generate enough cash flow from operations after funding working capital needs.
According to the notes of the financial statement, Pfizer’s lower rate in 2010 was attributed to certain tax payments made in connection with the increased tax costs associated with the Wyeth acquisition and therefore, the decrease in net cash flow from operations. From analyzing the Revenue to Cash and Days Revenue Held in Cash ratios, it is noticeable that Pfizer has less cash on hand. Pfizer has less cash because they are more focused on M. Pfizer spent 3. 3. billion on acquisitions in 2011, while Merck spent just 3. 7 million. Merck has a healthy ratio for accounts receivable turnover. Merck’s accounts payable turnover is almost double that of Pfizer.
These findings show that Merck is paying their supplier twice as fast as Pfizer. Pfizer’s lower ratio might be due to the fact that its creditors allow more time to pay off its debt. The Accounts Receivable and Inventory Turnover ratios are also pretty high and pretty similar for both companies. This means that both firms are selling inventory and turning accounts receivable into cash relatively quickly. However, it looks like Merck is collecting money from customers faster and turns inventory over quicker than Pfizer. Overall, we believe that both firms have healthy short term liquidity. c. Solvency Analysis (Appendix C) The following section analyzes the long term solvency risk of Merck and Pfizer.
The Liabilities to Asset Ratio reveals that both Merck and Pfizer finance their companies with approximately 50% debt and 50% equity. However, Merck’s ratio is a little lower, with around 45% debt and 55% equity financing. As can be noticed in the table, the Liabilities to Shareholders’ Equity, Long Term Debt to Long Term Capital, and Long Term Debt to Shareholders’ Equity ratios are healthy, which means that both companies will have no problems meeting long term obligations and are not heavily financed by debt. The Interest Coverage ratios for 2011 reveal that both companies are able pay interest on outstanding debt and can carry additional debt as well.
Therefore, their credit risk is considered low. The Operating Cash Flow to Total Liabilities ratios are around 20% or higher, which means that both firms generate enough cash flow from operations to service debt. Both firms experienced a lower ratio in 2010 due to increased tax costs for the acquisition of Wyeth for Pfizer and due to increased costs associated with the Schering Plough merger and the Vioxx impairment charges for Merck. The liquidity and solvency analysis revel that both firms are not experiencing any financial distress. However, we consider Merck less risky that Pfizer because Merck relies less on debt and more on equity financing. Part 3: Valuation Analysis
As outlined above, profitability, liquidity, and solvency all go a long way in providing analysts with viable information used to measure the performance of a firm. In addition to these measures, residual income, cost of equity, and valuation can also be used when analyzing companies such as Merck and Pfizer. a. Residual Income (Appendix D) We started our valuation analysis by calculating the residual income for both Merck and Pfizer. In order to achieve this, we used the companies’ 10K reports from 2009-2011 to project the forecast for 2012-2016, a five-year time frame. The method we used for this forecast was the same method used to project the residual income. Pfizer’s residual income for 2012 was $82,621million while Merck’s was $54,517million.
Please note that all numbers in our calculations are in millions. Our valuation was based on the assumption that both companies will grow by an average rate in the following years. We took into consideration three factors: the current growth rate, past growth rate and macroeconomic factors. Both Merck and Pfizer are in the maturity phase of their growth cycles and show steady growth figures. Residual income growth for Merck was negative for 2010, however we believe this was due to Merck’s merger with Schering-Plough Corporation. In 2007 and 2008, Merck showed a positive double-digit growth. In 2011, residual income growth was virtually flat, at 0. %, however we believe this is also due to the Plough acquisition. For Pfizer, residual income growth figures for the previous three years averaged approximately 3%. Based on these values for residual income, we choose to be conservative and assume a 1% long-run growth rate for residual income for years 2012 to 2016 for both Merck and Pfizer. We chose this modest growth number because both companies are still adjusting to recent large-scale M activity. On a macroeconomic level, both Merck and Pfizer’s growth may be stunted by an overall down economy, the health care policy restructuring in the United States and the expiration of long-standing patents. b. Cost of Equity (Appendix D)
After determining the 5 year forecast for each company, we next calculated the cost of equity. The capital asset pricing model was used to calculate the cost of equity. We used the yield on a ten-year Treasury Bill as the risk free rate which was 1. 98% (US Department of Treasury, 2012). The betas we used to calculate these numbers were retrieved from a financial website index (yahoofinance. com, 2012). The beta for Pfizer was 0. 71 and for Merck it was 0. 8342. The return on market was set at 14. 50% for both companies (NYSE, 2012). Using the Camp Model, the cost of equity for Pfizer was determined to be 10. 869%, while for Merck it was 12. 424%. Therefore, stockholders of Merck require a larger return than stockholders of Pfizer.
Given that Pfizer is the number one pharmaceutical company in the world, it is implied that investors require more return from Merck than from Pfizer. c. Valuation (Appendix D) Using the growth rate of 1%, we forecasted 2012’s residual income by multiplying the growth rate by 2011 residual income. We performed the same calculation for the next five years until 2016, and then discounted it to get the present value. From 2016 on, we assumed a perpetuity growth rate, which means we assumed this company would grow forever. Therefore, we needed to calculate the current value for the company as if it were to grow at a rate of 1%, forever. We first calculated next year’s residual income by multiplying 2016’s residual income by 1%, then dividing by 2.
The reason we divided by 2 was to account for the fact that the firm might not grow at a rate of 1% forever. In fact, in some cases, there might be negative growth, as Merck experienced from 2009 to 2010. Therefore, to be conservative, we divided the residual income in half, and then we discounted the value by the discount factor to get the present value. After we calculated the present values, we added all the values together and divided by the current number of shares outstanding to obtain the value per share. For Pfizer, the value per share was $79. 39 and for Merck $114. 93. The value we calculated is three times the amount of what the stock is currently trading at.
We believe this number is high, but not unreasonable. Around the year 2000, Pfizer was trading near $50 and Merck was trading near $100. We think the current low share value is due to the overall weak economy and we believe that the share price will grow in the future. Please note that all the values of the calculations are in millions except for value per share and current share value. d. Sensitivity Analysis (Appendix E) We performed a sensitivity analysis based on changing horizon growth factors and discount rates (cost of equity) to show the value per share. This gives investors the value per share for a different discount rate or growth factor. Part 4. Recommendations
After a thorough analysis of both Merck and Pfizer based on profitability, liquidity, and solvency evaluations, we found that both companies are preforming well financially. We found that both companies use assets and investments effectively to generate profit and their profitability growth seems to be steady. The analysis of short term and long term liquidity of both firms shows no risk in their ability to generate cash to meet working capital needs, and satisfy short term and long term debt. From the valuation analysis, we can predict that the future share values of both Pfizer and Merck seem to grow at a steady rate, assuming that both companies grow at a rate of 1% each year.
From an investor’s point of view, we consider that the earning per share, the price/earnings ratio, and the leverage are important factors to consider before making an investment. |Company |EPS |Price/Earnings Ratio |Leverage | |Pfizer |2. 14 |10. 47 |2. 25 | |Merck |3. 25 |11. 95 |1. 93 | After analyzing both companies, on the basis on earning per share, the price/earnings ratio, and the leverage, we have the following recommendations for potential investors. Comparing these values for both companies (table above), we found that Merck outperforms Pfizer marginally.
We believe that investment in both companies is safe, however, investment in Merck will bring a higher earnings return than a similar investment in Pfizer in the future. In addition, the financial leverage shows that the financial risk investment in Merck is lower than Pfizer’s, which makes it an even better choice for investment. However, the investor should keep in mind that the pharmaceutical industry involves high risk due expiring patents and threats from generic drugs and their profitability can be highly impacted by these events. According to a recent article on Dailyfinance. com, we found that the patents for major drugs like Pfizer’s Lipitor and Protonix, and Merck’s Singulair, which make up a large portion of the companies’ revenues, are about to expire(2011).
These patent expirations cause uncertainty in the future growth of the companies and might have a substantial impact on their stock prices. Appendix A |ROA |Pfizer |Merck & Co | | |2009 |2010 |2011 |2009 |2010 |2011 | |Asset Turnover |0. 46 |0. 32 |0. 35 |0. 34 |0. 42 |0. 45 | |Profit margin |19. 50% |14. 60% |16. 50% |48. 90% |3. 06% |14. 70% | |ROA |9. 03% |4. 80% |5. 38% |16. 80% |1. 29% |6. 70% | ROCE |Pfizer |Merck & Co | | |2009 |2010 |2011 |2009 |2010 |2011 | | |10. 28% |9. 21% |11. 53% |33. 47% |1. 73% |11. 74% | |EPS |Pfizer |Merck & Co | | |2009 |2010 |2011 |2009 |2010 |2011 | |GAAP |$1. 24 |$1. 09 |$1. 10 |$5. 65 |$0. 36 |$2. 01 | |Non GAAP | | | |3. 77 |3. 42 |3. 25 | Appendix B Pfizer | |Merck | | |2011 |2010 | |2011 |2010 | |Current Ratio |2. 0566461 |2. 1306398 | |2. 0425362 |1. 8581932 | |Quick Ratio |1. 438099 |1. 4454533 | |1. 4301631 |1. 2496004 | |Opr. CF to Current Liab. |0. 7210802 |0. 399986 | |0. 7622653 |0. 6918995 | |Revenue to Cash |19. 051992 |38. 649568 | |3. 5508832 |4. 2189908 | |Days Revenues Held in Cash |19. 158102 |9. 438314 | |102. 79133 |86. 51358 | |Accounts Payable Turnover |1. 67 |2. 11 | |3. 77 |3. 89 | |Days Accounts Payable |218 |173 | |97 |94 | |Outstanding | | | | | | |Accounts Receivable Turnover|5 |4. 79 | |6. 16 |6. 59 | |Days Receivable Outstanding |73 |76 | |59 |55 | |Inventory Turnover |1. 88 |1. 53 | |2. 78 |2. 4 | |Days Inventory Held |194 |238 | |131 |138 | Appendix C | Pfizer | |Merck | | |2011 |2010 | |2011 |2010 | |Liabilities to Asset Ratio |0. 560 |0. 540 | |0. 458 |0. 463 | |Liabilities to Shareholders’|0. 583 |0. 555 | |0. 300 |0. 290 | |Equity Ratio | | | | | | |Long Term Debt to Long-Term |0. 297 |0. 303 | |0. 220 |0. 220 | |Capital Ratios | | | | | | |Long Term Debt to |0. 422 |0. 435 | |0. 284 |0. 84 | |Shareholders’ Equity Ratio | | | | | | |Interest Coverage Ratio |8. 600 |6. 180 | |10. 900 |3. 480 | |Operating Cash Flow to Total|0. 190 |0. 099 | |0. 300 |0. 120 | |Liabilities Ratio | | | | | | Appendix D | | |10 year |Merck’s Beta|Merck’s Rm | | | | | |Treasury Bill | | | | | | | |1. 98% |0. 8342 |14. 50% | | | | |CAPM |12. 2% | | | | | |Merck |2012 |2011 |2010 | | | | |Beginning SE |54,517 |54,376 |59,058 | | | | |Comprehensive Loss |3,132 |3,216 |2,767 | | | | |Income Available to Com. |57,649 |57,592 |61,825 | | | | |Shareholders | | | | | | | |Required Income |-222 |-222 |-221 | | | | |Residual Income |57,427 |57,370 |61,604 | | | | |Changed in Residual Income | |0. 10% |-6. 7% | | | | | | | | | | | | | |2012 |2013 |2014 |2015 |2016 |CV | |Projected Residual Income |57,427 |58,001 |58,581 |59,167 |59,759 |30,178 | |Discount Factor |1. 12424 |1. 2639156 |1. 420944 |1. 5974826 |1. 795954 |0. 2051731 | |Present Value |51,081 |45,890 |41,227 |37,038 |33,274 |147,086 | | | | | | | | | |Total Value |355,596 | | | | | | |# of Share Outstanding 3,094 | | | | | | |Value per Share |114. 93 | | | | | | |Current Share Value (5/4/12) |38. 84 | | | | | | | | |10 year Treasury|Pfizer’s |Pfizer’s Rm | | | | | |Bill |Beta | | | | | | |1. 98% |0. 71 |14. 50% | | | | |CAPM: |10. 7% | | | | | |Pfizer |2012 |2011 |2010 | | | | |Beginning SE |$82,621 |$87,813 |90,014 | | | | |Comprehensive Loss |-4,129 |-3,440 |552 | | | | |Preferred Dividends |45 |52 |62 | | | | |Income Available to Com. |$86,705 |$91,201 |89,400 | | | | |Shareholders | | | | | | | |Required Income |3,142 |4,520 |4,510 | | | | |Residual Income |$89,847 |$86,681 |84,890 | | | | |Changed in Residual Income | |3. 65% |2. 1% | | | | | | | | | | | | | |2012 |2013 |2014 |2015 | |CV | | | | | | |2016 | | |Projected Residual Income |89,847 |90,745 |91,653 |92,569 |93,495 |47,215 | |Discount Factor |1. 10869 |1. 22919352 |1. 3627 |1. 5109 |1. 6751 |0. 1653 | |Present Value |81,039 |73,825 |67,254 |61,267 |55,813

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