17 August 2009

KG: Financial Gauge Analysis for the June 2009 Quarter

In an earlier post, we examined King Pharmaceuticals' (NYSE: KG) Income Statement for the three months that ended 30 June 2009.  Second-quarter earnings fell from $0.17 last year to $0.15 per share.  Non-GAAP earnings per share slipped from $0.35 to $0.32.

Headquartered in Bristol, TN, King Pharmaceuticals, Inc., manufactures and sells various brand-name prescription pharmaceuticals for neuroscience and other markets.  Medications for treating acute and chronic pain are becoming increasingly important to the company.

King acquired Alpharma on 29 December 2008.

We have now mined the financial statements in King's 10-Q to update the metrics we use to assess Cash Management, Growth, Profitability and Value.  This post reports on these metrics and the Financial Gauge scores.

In summary, King's latest GCFR gauge scores are as follows:
  • Overall: 18 of 100 (down from 28)
The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.

Cash ManagementJun 2009Mar 2009Jun 20085-Yr Avg
Current Ratio2.
Debt/CFO (years)
Inventory/CGS (days)129.3156.9105.8186.0
Finished Goods/Inventory69.4%72.8%63.8%50.2%
Days of Sales Outstanding (days)42.948.441.247.2
Working Capital/Invested Capital25.8%27.9%67.4%47.0%
Cash Conversion Cycle Time (days)132.6155.388.2168.6
Gauge Score (0 to 25)771416

Two quarters have now elapsed since King paid $1.6 billion in cash for Alpharma.  The acquisition certainly had an effect on the company's cash balances, but the ratios related to liquidity and debt are now settling down.  Neither appears to be a concern. 

The drop in Inventory held, as measured by days of Cost of Goods Sold, is welcome.  However,  a further decrease would be required to lift the CM gauge.  We're beginning to accept that the Inventory buildup in the prior couple of quarters reflected temporary adjustments and also preparations for the rolling out of new products.  We would consider a further cut in the Finished Goods ratio to be a positive development.

The Days of Sales Outstanding, which is based on the Accounts Receivable, also came down nicely.  We had fretted that the first-quarter increase might have been signaling relaxed payment terms for customers to boost sales.

GrowthJun 2009Mar 2009Jun 20085-Yr Avg
Revenue growth-15.6%-23.9%-7.6%2.8%
Operating Profit growth-12.7%-11.1%23.7%11.1%
CFO growth-43.7%-38.6%20.1%-6.9%
Net Income growthN/AN/A-58.2%20.0%
Gauge Score (0 to 25)00610
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.  The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.

As unsettling as the decline in trailing-year Revenue appears, it would have been significantly steeper if the last two quarters had not included sales of products developed by Alpharma.  Branded prescription pharmaceuticals have been the weakest area in the product lineup.

Because Net Income was thrown deeply in the red by special charges, we have to look elsewhere for signs of growth.  Cash Flow from Operations offers no relief.

ProfitabilityJun 2009Mar 2009Jun 20085-Yr Avg
Operating Expenses/Revenue75.1%73.4%74.4%71.9%
Free Cash Flow/Invested Capital14.9%17.2%31.2%24.3%
Accrual Ratio6.1%2.5%-26.4%-0.1%
Gauge Score (0 to 25)671514

Profitability has suffered as a result of falling sales of branded pharmaceutical products and numerous acquisition-related charges.  The rise in the Accrual Ratio, which is the opposite of what we like to see, is a consequence of declining Cash Flow relative to (modest) earnings.

ValueJun 2009Mar 2009Jun 20085-Yr Avg
P/E vs. S&P 500 P/E N/AN/A1.11.3
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)391012

The price of King shares increased a remarkable 36 percent during the second quarter, from $7.07 to $9.63.  The price movement seemed to be due to optimism about the prospects for new products and a normal bounce after the steep drop earlier in the year.

With earnings negative, our attention must shift to valuation metrics involving Revenue and Cash Flow.  If anything, the June values for the metrics might raise some concerns.

It's not shown above, but we did exclude the $610 million of special charges recorded in the December 2008 quarter.  The Price/Earnings multiple, with the exclusion in effect, is 13.7.

OverallJun 2009Mar 2009Jun 20085-Yr Avg
Gauge Score (0 to 100)18284853

Each gauge score is relatively weak, but Value was the only gauge that moved significantly in response to the second quarter results.  The Value gauge disapproved of the big share price rise in this period, when earnings and cash flow were hardly stellar.

Full disclosure: Long KG at time of writing.

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