11 December 2006

KG: Analysis through Sept 2006

King Pharmaceuticals develops, manufactures, and markets a diverse array of pharmaceutical products. Over the last few years, KG has had its share of problems, including Medicaid overcharge allegations, inventory write-downs, financial restatements, and a proposed merger with Mylan Labs that fell apart after Carl Icahn raised objections.

Our analysis indicated that King turned the corner in the second and third quarters of 2005. The scores shown on the Overall gauge were in the upper 70's at the conclusion of both of these two quarters, after having been in the 20's three previous quarters. [The stock price on 30 June 2005 was $10.42, and it was around $17 most of 2006.] The scores then cooled off to around 50 points at the end of 2005 and beginning of 2006.

As will be shown below, the scores dropped further when we looked at King's results from the quarter that ended on 30 September 2006.

Cash Management: The Current Ratio was a solid 2.65, its highest level in about three years. Long-Term Debt/Equity was an affordable 18 percent; the debt ratio has been between 17 and 20 percent for most of the last several years. Accounts Receivable/Revenue have also been stable at around 50 days. The big news of the September quarter was that Inventory/CGS dropped to 179 days; this was the first time the Inventory level went below 200 days since March 2003. The Finished Goods percentage of Inventory was 30 percent, which was consistent with historical data.

Growth: Revenue growth decelerated to 12 percent year over year; the growth rate had been much higher the five previous quarters. Net Income dropped 30 percent over this period, but the results were skewed by special charges. Operating Profit was actually up 24 percent. Cash Flow from Operations was 19 percent less than during the previous year. Revenue/Assets was 58 percent, down a little from recent quarters, but much higher than the historic average.

Profitability: The ROIC was 16 percent, down from a strong 20 percent one year earlier. FCF/Equity was (coincidentally) also 16 percent, and it had also weakened from the year-earlier value. Operating Expenses/Revenue was 68 percent; this value had been going down, but might have stabilized. The Accrual Ratio was a nice -6 percent, suggesting high quality earnings, but King often has even better values for this parameter.

Value: It's not easy to establish a baseline for King's valuation metrics because its earnings have been on a roller coaster. At the end of September, the P/E was 26.3, about a 70 premium above the P/E for the S&P 500. We also don't get any insight from the PEG ratio, since negative earnings growth makes the PEG not applicable. Since Revenue is more stable than earnings, we can learn a more about the valuation from the Price/Revenue. At 2.18, it is inline with recent quarters and down quite a bit from the company's salad days.

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