Financial Analysis Project

PFE and JNJ

Submitted by:

Michael Henry Francisco Laprada Haley Langmack

Submitted to:

Prof. Veena Srinivasan ACC 261

Economy The United States has experienced a positive albeit meager growth in economic activity over 2012 and the beginnings 2013 as indicated by the GDP (Gross Domestic Product) increasing by 3.1% in the 3rd quarter of 2012 and another 4% in the years 4th quarter. Much of this growth is contributable to an increase in personal consumption expenditures (PCE) (bea.gov)Personal income has been steadily increasing over 2012 as well, averaging around a .2% growth in disposable income per month. This peaked in the last quarter with a 3.7% increase in the months of November and December combined. Unfortunately however, this growth was halted with a 3.7% decrease in January, 2013 leaving personal income relatively unchanged throughout the year. In addition to this, the rise in PCE may be attributed to a decrease in unemployment over the past year, falling from 8.2% to 7.6% between the first quarters of 2012 and 2013. Between 2010 and 2013, inflation has risen approximately 6% however this is not a particularly alarming number. In regards to the impact of 2008s recession, it seems as though people are beginning to spend their money again. This should prove to be beneficial for many industries including the Pharmaceutical Industry. Pharmaceutical Industry The Pharmaceutical Industry as a whole has been growing exponentially beyond even the past ten years, with large to medium scale mergers being a common occurrence. This was largely in part due to the a total restructuring of Americas Food and Drug Association (FDA) allowing drugs to come to market far more quickly than before. (IRS Trends) This does not translate to positive results however as competition is becoming increasingly prevalent, specifically within the generic field. Following a large drop in share prices in 2007 to 2009, as much as $50 per share, prices have been steadily rising at an admittedly slow pace. This growth is likely attributed

to rising ages and price rises within the U.S. market over the past ten years, although this increase is countered somewhat by a slump in R&D development. (KPMG) Johnson and Johnson (JNJ) JNJ was founded in New Jersey and is currently headquartered in Brunswick. It currently employs around 128,000 individuals between itself and its family companies and is listed as a Fortune 500 company. On top of this, JNJs common stock influences the industry average as given by the Dow Jones. On top of drug manufacturing and sales, JNJ also has an extensive R&D background as well as a history of sponsoring clinical testing trials. In terms of sales, JNJ sells products in over 175 different countries across the globe and operates in 57. On top of this, JNJ has over 250 subsidiary companies and made over $6.5 billion in sales over the course of the 2011 fiscal year and $6.7 billion in 2012. JNJ owns many famous brands including but not limited to Band-Aid, Neutrogena, baby products, Tylenol, and Acuvue contact lenses. Many of these goods are distributed not only to private stores but hospitals both in the national and international market. While its reputation is relatively clean, JNJ has been involved in several serious recall scandals as well as internal settlements between its own stockholders. Pfizer (PFE) Pfizer is the worlds largest pharmaceutical company when looking at actual revenue. It is based in two different areas, its corporate branch in New York and its research branch in Connecticut. PFEs common stock is also listed as a critical component in the Dow Jones industrial average. Having grown exponentially over the past decade, Pfizer has made several very large-scale acquisitions including that of Warner-Lambert, Wyeth, and Pharmacia. Pfizer is primarily a research oriented company that deals in drugs relating to neuroscience, disease, pain, and cancer to name a few. Pfizer is well known for its products including the original penicillin,

Lipitor, Lyrica, Zithromax, and Viagra. The company is labeled as a repeat offender in the United States for being involved in several high-potency scandals. The company made $6.5 Billion in sales in 2011 and almost $6.8 Billion in sales in 2012. Liquidity It is quite interesting to see that PFEs current ratios (CR) and quick ratios (QR) followed a similar pattern of change from 2010 to 2012 going from 2.11 to 2.06 to 2.15 and from 1.51 to 1.44 to 1.58, respectively. The decrease in both the current ratio and the quick ratio is most likely the result of the cessation of operations in PFEs research and development facility in Kent, England. Although PFEs CR and QR are still relatively above the industry averages, 1.8 for CR and 1.0 for QR, (which show quite a positive trend) we can see that inventory makes up for a considerable part of their assets. When it comes to converting it products into cash through sales we see that their cash conversion cycle went from being 172 in 2011 to 162 in 2012. Even though this decrease in their CCC may appear to be an indication of something good at first sight, when comparing it to the industry average of 118 it leaves much to be desired. We see the opposite pattern when we see JNJs CR and QR from 2010 to 2012 as they go from 2.05 to 2.38 to 1.9 and 1.62 to 1.88 to 1.34, respectively. The fluctuation in these numbers may be the result the 2010 recalls of various childrens medicines (including Tylenol, Motrin, and Benadryl) and hip replacement prostheses as well as the 2012 introduction of the tuberculosis medicine Sirturo. JNJs CR and QR are also above the industry averages of 1.8 and 1.0 respectively. As with PFE, a big part of JNJs assets are inventory, as revealed by the QR. When examining their cash conversion cycle, however, we see that JNJ is doing quite well in turning their products into cash through sales with their CCC being 59 in 2011 and 77 in 2012.

Despite the increase in CCC from 2011 to 2012, these still remain far below the industry average of 118. Activity and Operating Efficiency Both PFE and JNJ experienced negative changes over the three-year period. By first looking at PFE, the companys A/R turnover ratio decreased from 4.94 to 4.64, which is lower than the company average of 4.86 and much lower than the industry average of 6.8. PFEs business operations deal with acquiring smaller companies to gain rights to drug R&D of the product, so they greatly profit through external relations with other companies. The low A/R turnover ratio indicates that PFE should be more efficient with timely credit collections, but they are not heading into trouble collecting credits from external accounts. The slight decrease in PFEs accounts receivables might be due to the slightly significant decrease in net sales in 2012. The company lost exclusivity of Lipitor in November of 2011, causing sales revenue to fall dramatically for the 2012 fiscal year. PFEs inventory ratio decreased from 1.89 to 1.66, which is still below the industry average but above the company average. Since Pfizer deals with reorganizing newly acquired companies, this low ratio could be a sign that they are still adjusting from the reformation. PFE experienced an increase in ROA, resulting from an increase in profitability despite the decrease in COGS. As for JNJ, the companys efficiency also experienced negative changes over the threeyear analysis. Due to recalls on OTC products and falling sales revenue, the A/R turnover ratio decreased from 6.39 to 6.14. Net A/R continued to increase, indicating that net sales were increasingly sold on account. As inventory increased, JNJs inventory turnover ratio fell from 3.49 to 3.14, falling below the industry average of 3.4. This suggests that the companys sudden increase in inventory is not being sold in an efficient and timely manner. The increase in A/R and

inventory thus caused JNJs ROA to decline, suggesting ineffective practices. Leverage While both PFE and JNJ would prove to be risky investments, PFE shows a significantly greater amount of stability, with their debt ratio staying in the higher portion of the fiftieth percentile between 2010 and 2012. JNJ shows a debt ratio of around 46.58% in 2012, which would make it a safer investment if it were not for the higher ratios in 2011 and 2010. A better item to look at would be the respective companies debt to equity ratios. JNJ has consistently stayed under a 1.0 ratio, indicating that they are in a safe position to pay their debts. Pfizer, conversely, is struggling to come under the 1.0 mark, starting at 2010 with a 1.22 ratio and raising in 2011 onward to 1.28. This is likely due to a variety of settlements that Pfizer was forced to pay in 2009 for accusations of marketing their arthritis drug Bextra illegally. This cost them almost $4 billion in damages. Pfizers status as a repeat offender in the eyes of the Department of Justice is also a potential cause for worry in the eyes of investors. In terms of industry averages, Pfizer is also around 13% over the average debt ratio. Both companies exceed the industry averages in terms of their current ratio, with JNJ averaging at around 1.9, .1 over the average, and Pfizer exceeding 2. However, when looking at the quick ratios, PFE rests consistently below the industry average of 1.0, being almost half of that in 2010 at .57 and slowly improving, now at .82 in 2012. JNJ is well over the industry average. One of the reasons for JNJs is due to the fact that their liabilities are much less than PFEs, almost half by 2012. Both companies have shown little change in their ability to pay interest, however they both also show a great ability to be able to pay back interest, JNJ being roughly ten times over the industry average ranging between a 38.25 in 2010 and 26.89 in 2012. PFE exceeds even this. It can be concluded then that between the comparison of their quick ratios as well as this difference in

liabilities, JNJ is financing most of its activities with its own money, mainly in the form of cash and marketable securities. All in all, in terms of leverage, JNJ has a noticeable advantage over PFE due to its ability to finance projects with its own equity instead of debt, as well as the fact that their assets are far more liquid than that of PFE. Profitability and Overall Efficiency Steady growth in PFEs operations is evident over the three-year period except for their net sales, which experienced a drastic decrease from the 2011 to the 2012 fiscal year. The growth rate for sales decreased from 0.14% to -9.61%. This can be attributed, again, to the loss of exclusivity of Lipitor in November of 2011 as sales for the drug fell 71% during that quarter. Despite the loss, the net profit margin (NPM) steadily increased from 12.67% to 24.70%. The company may have lost exclusivity on one product, but sales and income from other drugs including Celebrex Enbrel, Lyrica, and the Prevnar/Prevenar franchise attributed to the growth in profit. In addition, PFEs cost of goods sold (COGS) decreased due to economic factors such as healthcare reform and international price declines. With an increase in operating profit, it seems to suggest that operating expenses decreased as well. Furthermore, PFEs gross profit margin increased from 12.72% in 2010 to 17.97% in 2012. As for JNJ, their gross profit margin (GPM) experienced a decline, indicating declines in efficiency and profitability. Sales decreased from 6.03% to 3.37%, which can be accounted for by the signing of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010. However, operating profit (OP) and NPM experienced fluctuations by both increasing and decreasing. OP slightly increased from 2010 to 2011 but significant dropped in 2012. Conversely, NPM drastically decreased from 2010 to 2011 and only slightly increased in 2012.

Market Ratios PFE has experienced a hefty amount of growth in their EPS (earnings per share) starting at 1.0 in 2010 and doubling to 2.0 in 2012. A large result of this has been attributed to their operations overseas. JNJ in contrast, while their EPS is still considerably greater, has experienced loss a drop in EPC form 4.85 in 2010 to 3.94 in 2012. This is attributed mostly to legislation changes within the states that are having a negative impact on their ability to operate within the states. The contrast between the two companies is likely to the fact that while both companies participate in the international market, recent healthcare reforms are more likely to impact JNJ, who has a much stronger anchor in the U.S. market. The Net profit margins of both companies have remained relatively stable however over the past three years. Much like their EPS, JNJ has experienced a slight drop in their net profit, shrinking from 21.65% in 2010 to 15.64% in 2012. Likewise, PFE has experienced a similar increase in profits, doubling from 12.67% to 24.7% in the past three years. This change in PFE is concurrent with the change in their Net income since 2012. JNJs biggest strength on paper in the pharmaceutical market is their ability to remain stable. Due in part to their size, while they do experience fluctuations in their ratios the changes are often small. PFE is also large but also unstable, showing growth since 2010 but suffering from downtrends before that. While both companies have relatively consistent inventory and A/R turnover ratios, JNJ enjoys a higher rate in both aspects, roughly doubling PFEs low inventory turnover of 1.66 in 2012 with a ratio 3.14. The same applies for the companies A/R turnover which is 6.14 in 2012 compared to PFEs 4.64. Despite this, both companies sit below the industry turnover averages as of 2012, with PFEs turnover falling substantially below that of the averages.

Conclusion Looking at these ratios in an isolated manner and without any context to interpret then really limits what you can do and what you can say about the companies you are analyzing. However, by putting them together with those of previous years, you are able to see a trend and a story form that can more or less tell you what the company went through during those years. By doing this and comparing JNJ to PFE we were able to pick out certain trends to guide us in our decision of which company to invest in. For instance, by comparing the companies financial statements from 2010-2012 we could tell that JNJ did better in liquidity, activity and operating efficiency, and leverage than PFE. However, we could also tell that PFE did better in profitability and overall efficiency as well EPS when compared to JNJ. After some meticulous analysis of these two companies, we conclude by saying that JNJ would be the better company to invest in.

Appendix JNJ 2012 2011 2010 2012 PFE 2011 2010

Bibliography
BEA -http://www.bea.gov/index.htm BLS (Bureau of Labor Statistic) - http://data.bls.gov/timeseries/LNS14000000 IRS - http://www.irs.gov/Businesses/Pharmaceutical-Industry-Overview KPMG Future Pharma http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/Documents/futurepharma.pdf

http://csimarket.com/stocks/singleEfficiencyrt.php?code=PFE http://press.pfizer.com/press-release/pfizer-reports-third-quarter-2012-results http://www.philly.com/philly/blogs/phillypharma/Pfizer-revenue-falls-on-Lipitor-loss-but-net-incomejumps-25.html http://en.wikipedia.org/wiki/Pfizer http://en.wikipedia.org/wiki/Johnson_%26_Johnson FAP Documents in Blackboard