Introduction
The credit analysis to judge the credibility and the capacity of the firms to pay interest on the loans they take, and also for the repayment thereof have been done based on key financial and accounting ratios of the firm worked out based on the historical accounting statements and reports. The analysis had a single focus on the default risk of the interest payments on the bonds and other credit instruments issued by the company. Because of the single objective, the analysis concerned itself primarily with the calculation of ratios that are associated with fixed-income investments. The ratios that are normally considered include the ratios which cover the interest coverage, capital leverage and funds flow to total debts of the company. The approach of using the ratio analysis was considered adequate and appropriate when interest rates were stable and the bonds were purchased by the investors with the object of holding for longer terms till maturity. However, there have been changes in the purposes for which the bonds are being purchased by the investors in the last two to three decades. The major purpose for which the bonds are purchased is to trade in them to take advantage of the changes in the interest rates or changes in the credit quality of the bonds. This necessitated a closer analysis of the financial standing of the company by basing the analysis on more key financial ratios dealing with the profitability and long-term liquidity like return on equity, operating margin, and assets turnover that are normally associated with the common stock of the company. In the case of analysis undertaken to assess the financial status of the company for dealing in corporate bond purposes, both the ratios calculated for judging the capacity of the company for interest payments and the other ratios which facilitate the trading in the common stock of the company should be used. By using both the dimensions of credit analysis, the analysts can form their opinion on both the purpose of bond holding; security of interest payments and repayment of the principal, and also improvement in the credit quality of the bond during the tenure of the bond.
With this background, this paper attempts to make a credit rating analysis of the US Pharmaceutical company Bristol-Meyers Squibb Company based on the available information.
Bristol-Meyers Squibb Company – an Overview
The company was incorporated under the Delaware State in the year 1933 under the name Bristol-Meyers, succeeding another company started in the year 1887. After a merger, the company’s name was changed to Bristol-Meyers Squibb Company. The main business of the company includes discovery, development, licensing, manufacturing, marketing, distribution, and sale of pharmaceuticals and other healthcare-related products. The company has three operational divisions in Pharmaceuticals, Nutritionals, and Other Health care. The pharmaceutical division covers the global pharmaceutical and international consumer medicine business. The company undertakes major research and development activities and competes with other research-based pharmaceutical companies. The company has manufacturing facilities in the US and various other foreign locations. The company had approximately 43,000 people as at the end of the year 2006. (Investor guide.com)
The financials of the company for the years 2005 and 2006 are:
Industry Outlook
There is international pressure on the pharmaceutical companies like Bristol-Meyers to adjust their patterns against generic drug manufacturers from countries like India. This has put some of the products of the company under heavy pressure to make as much profit as possible within a shorter time frame before the manufacturers of generic medicines eliminate these products from the market.
Inefficiency is another issue that the industry has to address in light of the reduction in the number of sales representatives due to heavy staff costs. “Employing so many thousand sales representatives is not seen as an economical solution in the long-term, and it is expected that companies will start trimming this sales force in an effort to cut costs.”
Such sales representatives are given only very little time to present their products to the Doctors. It is but true that the rising costs on the sales force and other similar costs in the pharmaceutical industry can be curtailed so fast. This phenomenon has put companies like Bristol-Meyers Squibb on the auction block.
Under the industry considerations, the following are the factors that need consideration for making a proper credit rating analysis.
Economic Cyclicality
The economic cyclicality implies whether the growth of the company is following the GDP growth of the nation. The quality of the industry in resisting the recessionary tendencies also needs consideration. The Earnings per share (EPS) of the company should be compared with the EPS of the industry. “The global pharmaceutical market is projected to increase between 5 and 6% in 2008 to reach $735–745 billion, according to IMS Health (Norwalk, CT). This pace is down from growth of 6–7% in 2007. In the US and the five largest European markets, sales growth in 2008 is projected at 4–5%, marking a historic low for the US market, according to IMS.” (Patricia Van Arnum, 2007).
Against this growth rate of 6 to 7 percent expected for the year 2007 BMY has reported a negative growth rate of EPS for 2006 as compared to the year 2005 and there is no sign of any improvement in the EPS growth in the year 2007 due to the reported loss for the year 2007.
Growth Prospects
The second aspect that needs consideration is the growth prospects of the industry in a global context. As per the report from IMS Health the industry is expected to slow down in the year 2008 as compared to the growth rate in the year 2007. This also gives a negative rating for the credibility of the company.
Research and Development Expenses
The research and development expenditure incurred by the industry is another factor that determines the growth prospects of the industry. “Research and Manufacturers of America (PhRMA) reported even larger expenditures and faster growth. Spending by its member organizations rose more than six-fold between 1980 and 2004, from about $6 billion (in 2005 dollars) to $39 billion.” (CBO, 2006) Though there had been a growth of research and development expenditure during the last two decades the growth in the industry is more than affected by the growth in generic drugs. Due to the impact of generic medicines, the industry is expected to face a decline in the order of $ 370-380 billion for the primary care-driven drugs during the year 2008 which implies the companies would reduce the level of their expenditure in the area of research and development. This again attributes a negative value to the credit analysis.
Competition
The competition in any industry is based on many factors. In general, the price and the quality are the two factors that determine the competitive environment of any industry. But the US pharmaceutical industry is facing competition from the generic products being manufactured by emerging countries and for the first time in the industry, these economies will contribute a major share of the industry during the year 2008. “For the first time, the seven largest markets will contribute just half of overall pharmaceutical growth, while seven emerging markets will contribute nearly 25% of growth worldwide. These seven emerging markets (Brazil, China, India, Mexico, Russia, South Korea, and Turkey) are expected to grow 12–13% next year to $85–90 billion, according to IMS.” (Patricia Van Arnum, 2007). Therefore it appears that the US pharmaceutical industry is facing stiff competition which reduces the credit rating of the BMY.
Sources of Supply
The market structure of an industry and its competitive forces have a direct impact on the sources of supply of major production components. The continued growth in the pharmaceutical industry in the emerging nations will have an impact on the availability of generic components for manufacture in the US and this may hit the production of the pharmaceutical industry in the US. This is because countries like Bangladesh and India who were the main sources of generic components have started captive consumption of the generic components and this may to some extent affect the US pharmaceutical industry.
Degree of Regulation
The next element to be considered in a credit rating analysis is the impact of regulations on the industry. “Pharmaceutical companies have to operate in a highly regulated environment; the degree of regulation to a significant extent depends on the country and type of the product.
In the United States – the largest and the most attractive pharmaceutical market – currently there is no direct price control for non-government drug sales. At the same time, it is expected that Medicare Prescription Drug Improvement and Modernization Act will potentially increase downward price pressure”. (Larry Davidson and Gen’nadiy Greblov, 2005). Given this, the company BMY’s credit rating suffers.
Labor and Accounting
The labor situation and the special accounting practices are the other elements that affect the growth of any industry. The accounting requirements in general after the passing of the Sarbanes – Oxley Act 2002 have put an enormous burden on any manufacturing companies and this also applies to the pharmaceutical industry which affects the performance of the companies though not seriously. The labor situation in the industry does not pose any serious issues that hinder the growth of the industry.
Financial Analysis
Having considered the industry outlook and the factors affecting the growth of the industry the next stage is to proceed with the financial analysis of the company. This phase of the analysis takes into account the traditional ratio analysis. The ratios to be considered will include Interest coverage, leverage, cash flow to total debt, return on equity, working capital, intangibles, pension liabilities and age and conditions of the plant, etc.
Company Outlook
Bristol-Meyers Squibb made announcements that due to falling sales revenues the company is expected to make major losses for the last quarter of 2007. This is due to the loss of sales revenue from one of the top-selling products of the company ‘Plavix’ which faced stiff competition from the generic drug manufactured by Canada-based Apotex Inc. BMY has to restrain the Canadian competitor by an order from the Court but the sales of the company were badly affected in the meantime. Due to a fall in the sales revenue, the company’s net income also declined from $ 3 billion in the year 2005 to $ 1.5 billion in the year 2006 which is nearly a drop of 50 percent. (Investor guide.com)
As part of an overall strategy, the company had sought the assistance of several investment firms to assist the company in case if the company is handed a buyout offer from any potential suitor. Some of the analysts think that the buyout price could be in the region of $30 to $ 40 which price includes a premium over the current price of the company’s shares. GlaxoSmithKline and Novartis and Sanofi-Aventis have been identified to be the potential suitors for the buyout of Bristol-Meyers Squibb. These companies are considerably larger and stable than the target company. Out of the two one of the possible contenders is Sanofi. The familiarity of Sanofi with the prime product of BMY Plavix might facilitate a smooth transition between the companies. With so many speculations around it is quite likely that the Bristol-Meyers may soon be the candidate of a potential buyout. (Investor guide.com)
Ratio Analysis
The following are the key financial ratios that have a bearing on the credit rating of the company.
Profitability Ratios
Liquidity Ratios
Long–Term Solvency Ratios
Based on the industry analysis and the key financial ratios the credit rating of A+ given to the company Bristol-Meyers Squibb by Standard & Poor’s is justified.
“Standard & Poor’s recently reviewed the rating and negative outlook on Bristol-Myers, electing to leave both unchanged. We recognize the company’s recent improvements, including settling its shareholder litigation, launching significant new products (such as Orencia), and settling its patent litigation on Plavix. However, we remain concerned over the loss of Pravachol sales and its impact on free cash flow, especially since current cash flows are inadequate to cover the company’s hefty $2 billion annual dividend.” (Standard & Poor’s, 2006)
References
- CB0 (2006) ‘Research and Development in the Pharmaceutical Industry’.
- Investor Guide.com ‘Bristol-Meyers Squibb’.
- Larry Davidson and Gennadiy Greblov, (2005) ‘The Pharmaceutical industry in the Global Economy’.
- Patricia Van Arnum (2007) ‘Global Pharmaceutical Industry Growth to Slow in 2008’ Pharmtech.com.
- Standard & Poor’s (2006) ‘A Better Prognosis for Big Pharma’ Business Week.
Appendix
Calculation of Ratios
Profitability Ratios
Liquidity Ratios
Long – Term Solvency Ratios
PROFITABILITY:
1.1 Gross profit Margin
Gross profit * 100
Sales
- Net profit Margin
P.B.I.T * 100
Sales
- Return on capital employed (R.O.C.E):
P.B.I.T * 100
Capital Employed
P.B.I.T = Finance income + operating profit + Share of post tax of joint ventures
Capital employed = (L/T Liability + Shareholders funds) or (share
capital + reserves + long term debt)
LIQUIDITY:
- Current Ratio:
Current Assets
Current Liabilities
- Quick Ratio:
Current Assets – Stock
Current Liabilities
LONG TERM SOLVENCY:
- Gearing Ratio
L/T Liab * 100
Capital Emp
- Interest Cover
P.B.I.T
Interest Payable
(In the absence of break up of interest paid and interest income earned in the case of Starbucks this ratio could not be calculated)