22 May 2010

KG: Financial Gauge Analysis for the March 2010 Quarter

King Pharmaceuticals, Inc. (NYSE: KG) earned $0.02 per diluted share on a GAAP basis in 2010's first quarter, a result which improved on a loss of $0.04 per share in the same quarter of 2009.  Non-GAAP "adjusted" earnings fell from $0.26 to $0.14 per share.

In our earlier review of King's Income Statement, we compared the actual results to our "look-ahead" estimates.

We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.  This post reports on the metrics for King Pharmaceuticals and the associated financial gauge scores.  The metrics were calculated using data from King's current and historical financial statements, including the latest 10-Q report.

King Pharmaceuticals develops and sells various brand-name prescription pharmaceuticals and other products.  In a $1.6 billion deal completed in December 2008, King obtained new pain-relief medicines and animal-health products by acquiring Alpharma.  Additional background information about King and the business environment in which it is currently operating can be found in the look-ahead.

In summary, King's latest quarterly results produced the following changes to the gauge scores:

 The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.  Readers are encouraged to verify these figures and calculate others as they see fit using the filings available at the SEC's web site and elsewhere.

Cash Management31 Mar 201031 Dec 200931 Mar 20095-Yr Avg
Current Ratio3.
Debt/CFO (years)
Inventory/CGS (days)133.0141.2140.7165.3
Finished Goods/Inventory64.1%69.5%72.8%53.5%
Days of Sales Outstanding (days)45.746.046.645.2
Working Capital/Revenue39.1%37.6%70.5%47.3%
Cash Conversion Cycle Time (days)118.7119.1132.3147.1
Gauge Score (0 to 25)147614

King took on additional Long-term Debt when it paid $1.6 billion in cash for Alpharma at the end of 2008.  However, it soon repaid much of the debt, and the current debt amount is lower than before the acquisition.

It did so without impairing the company's liquidity, as far as we can tell.   Working Capital -- the difference between Current Assets and Current Liabilities -- was $705 million on 31 March 2010, not much lower than the $742 million it was one year earlier.

One modest liquidity concern might be that King held, as of 31 March 2010, tax-exempt auction rate securities having a par value of $264 million.  Poorly functioning credit markets have led to failed auctions that make it difficult for security owners to recover the full value of their investments, although interest payments usually continue without interruption.  During the first quarter of 2010, King sold auction rate securities associated with student loans with a par value of $8 million for $7.36 million.

King's Inventory expanded last year to include the products it acquired from Alpharma and new products.  The company has since been working with its customers to normalize the inventory levels across the product base, and the inventory level (as measured by days of Cost of Goods Sold) has recently decreased.  The Finished Goods ratio has also recently edged down, a positive development in our view.

Growth31 Mar 201031 Dec 200931 Mar 20095-Yr Avg
Revenue growth10.6%13.5%-23.9%-0.4%
Operating Profit growth-23.8%-17.6%-11.1%-18.5%
CFO growth3.8%-12.3%-39.5%-2.3%
Net Income growthN/AN/AN/A31.2%
Gauge Score (0 to 25)1514011
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.

The last five quarters occurred after King's acquisition of Alpharma, and King's financial statements for the these periods reflect the results of the combined company.  The financial statements for earlier periods were not revised to show how the combination would have performed if the acquisition had taken place earlier. 

This provides an artificial boost to the trailing-year growth rates, which greatly degrades their utility.  Trailing-year growth rates compare the last four quarters to the four previous quarters.

It was discouraging that Revenue in the March 2010 quarter was 11 percent less than in the March 2009 quarter.  Both of these quarters occurred after the Alpharma deal.  Unfortunately, we can't compute meaningful the quarter-on-quarter Cash Flow and Net Income Growth rates because the former was negative in the recent period, and the latter was negative in the earlier period.

Profitability31 Mar 201031 Dec 200931 Mar 20095-Yr Avg
Operating Expenses/Revenue83.6%81.1%73.4%73.3%
Free Cash Flow/Invested Capital15.5%16.2%16.9%23.7%
Accrual Ratio-15.7%-13.0%2.4%-3.2%
Gauge Score (0 to 25)87714

King's Operating Margin has suffered as a result of declining sales of branded pharmaceutical products, new sales of lower-margin Animal Health products, and special charges. 

Cash Flow from Operations and, thus, Free Cash Flow were negative in the March 2010 quarter.  However, it's noteworthy that CFO totaled over $400 million in the three previous quarters.

Value31 Mar 201031 Dec 200931 Mar 20095-Yr Avg
P/E vs. S&P 500 P/E 1.51.7N/A1.2
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)00911
Share Price ($)$11.76$12.27$7.07-

The latest Value gauge score in the table above was calculated with the closing share price, $11.76, when the first quarter ended.  This is our standard practice.

However, the share price has now fallen 27 percent to $8.56.  At this price, the trailing-year P/E comes down to 20, Price/Sales is reduced to 1.2, and the EV/CFO ratio becomes 4.7 (cash flow yield >20 percent).  The Value gauge score would be 6 points -- better than zero, but hardly sensational.

King's share price rallied more than 70 percent over the last nine months of 2009.  Part of the recovery can be attributed to overall market conditions, but there was also optimism that products emerging from the King/Alpharma pipeline would be able to replace those losing patent protection.  Investors are more uncertain now.

Overall31 Mar 201031 Dec 200931 Mar 20095-Yr Avg
Gauge Score (0 to 100)27212750

The Cash Management gauge rose as King paid off debt without compromising liquidity and trimmed its inventory.  The Growth and Profitability gauges also inched up, but the difficulties in comparing periods before and after the Alpharma acquisition makes these scores unreliable.  The Value gauge sank because optimism that was temporarily inflating the share price wasn't matched with stellar operating results.

The shares are now less expensive, and the Cash Flow metrics are the most appealing.  However, the first quarter 2010 results increased skepticism that organic growth is imminent.  To justify a P/E of 20, better results are needed.

Full disclosure: Long KG at time of writing.

No comments:

Post a Comment