Thursday, June 11, 1998
by Phil Weiss
Towaco, NJ (June 11, 1998) -- We interrupt this portfolio report to make an announcement. Over the weekend, your C-K managers (Al, Phil, Rob and Tom) will be spending time in the message folder trying to determine which five stocks to include in the Cash-King Poll next week. After determining which five go in, we'll be relying 100% on the poll to determine which stock makes it into the portfolio. We'll see you in the Web Cash-King Companies folder. Fool on!
Ok, tonight Im going to finish up the discussion about Pfizers balance sheet that I started yesterday by walking through the Liabilities section. I hope that by the time youve finished reading this series of reports youll have a better understanding of the wealth of information that is available from a companys financial statements. Once you understand the information in these statements, which doesn't take much sophisticated thought (I think I've proven that with this Foolishness!), youre ready to start drawing conclusions about a company.
No high-level math is required to understand this information, as in Step 6 of our 11 Steps to Cash-King Investing, evaluating all of the data demands nothing more than a calculator and sixth-grade training. In fact, I'm just echoing a Fool there. I recently read an article on The Motley Fool in my local newspaper in which Tom was quoted as saying something like, "Its all elementary mathematics."
So, far and away the biggest obstacle that most of us face when looking at financial statements is the language. How many of our friends and family believe they could never ever read financial statements with any competence? It can be intimidating. It shouldn't be. And that's the drive behind this week's Cash-King articles on income statements and balance sheets.
Again, Pfizers balance sheet is available from the companys website (click here: Pfizer's Balance Sheet). If you have a copy of the companys annual report, you can find the balance sheet on page 42. Please read it along with us.
The Liabilities section of the balance sheet starts out with current liabilities -- all bills that the company will have to pay in the next year. In current liabilities, the first entry that we encounter is Short-Term Borrowings. Pfizer's short-term borrowings of $2.25 billion looks, wow, rather high to me, so I want to figure out what interest rate Pfizer is paying on all that short-term debt. Did the company just go out and borrow $2.25 billion on credit cards charging interest rates between 18%-22%? What a disaster that would be (what a disaster it is for any Fool to borrow any money at those rates, but don't tell your friendly neighborhood banker that we told you).
A quick glance at Note 5B tells us that in 1997, Pfizer only paid interest at a rate of 2.9% on these amounts, making for an extremely inexpensive way to borrow money. For me, any concern that I might have had about this balance is lessened because of that low interest rate. (Note: I also know from a prior conversation with Pfizers Investor Relations Department that a lot of Pfizers short-term loans are in Japan, which explains the low interest rate. It pays to make these phone calls on occasion.)
Next up under current liabilities is Accounts Payable. This entry generally represents payments that the company owes to its suppliers. Often these amounts do not incur any interest charges. So, we actually dont mind if this balance runs high. After all, if Pfizer owes money and its supplier doesn't charge interest on that debt, then we're just looking at an interest-free loan.
Below accounts payable, we see that Pfizer has deferred about $785 million in income taxes, has unpaid compensation-related fees of around $477 million, and has a slew of other current liabilities of around $1 billion. Now many investors think these are real negatives for the company. After all, add up all the current liabilities and the company will have to make payments of $5.3 billion over the next 12 months. On the flip side, it only has $1.5 billion in cash & short-term investments today.
Our inversion of that thinking is one of the things that makes Cash-King thinking special. Time will tell if we got this all wrong, but our thinking is that when you extract the cash from current assets, all that remains is a listing of the company's inability to turn its efforts into rewards. Accounts receivable -- we wish they'd already been collected. Inventory -- we wish it'd already been finished and sold. Current assets minus the cash are, for us, current liabilities.
On the flip side, these current liabilities that we speak of today are examples of our company legally and fairly dragging out the process of giving up its cash. The deferred tax payments, the deferred payments to suppliers, the other deferrals -- so long as our company isn't paying high interest rates and is meeting the requirements of its contracts -- we love these delays. Current liabilities are items that provide us cash; current assets less cash are items that deny us cash.
And therein lies the origin of our Foolish Flow Ratio, as described in Step 7 of our 11 Steps to Cash-King Investing. The Flow Ratio is calculated by taking current assets less cash & short-term investments then dividing this figure by current liabilities. Again, we're subtracting cash from that which denies us cash, and dividing by that which provides us cash. Pause for a second and you'll see that we want the Flow Ratio to run as low as possible. We want current assets less cash to run much lower than current liabilities. If you don't understand this, please drop us a note in the Cash-King Folder.
Let's check out Pfizers Flow Ratio at the end of 1997:
PFE Flow = (current assets - cash) / current liabilities
PFE Flow = ($6.8 billion - $1.6 billion) / $5.3 billion
PFE Flow = $5.2 billion / $5.3 billion
PFE Flow = 0.98
Pfizer's Flow Ratio of 0.98 meets our standard of looking for Flow Ratios below 1.25. What this means to us is that Pfizer is in a powerful position in its industry, able to hold off payments to suppliers longer than it must wait for payments from its distributors. I hope that sentence is clear to you, because it means an awful lot in our investment approach.
Now, we can also calculate what we refer to as the Unleveraged Flow Ratio, which was offered up in the Cash-King folder a few months back by Fool News writer Dale Wettlaufer (TMF Ralegh). The only difference in this calculation is that we exclude interest-bearing liabilities from the denominator of the fraction. After all, if our company is paying interest, it doesn't represent a true staving off of obligations.
That means that in Pfizer's case, we take the same $5.2 billion on the harmful asset side and we divide it by current liabilities less short-term borrowings ($5.3 billion minus $2.3 billion=3.0 billion). So, we'll be dividing $5.2 billion by $3.0 billion, which gives us an Unleveraged Flow Ratio of 1.77. Generally, we look for Unleveraged Flow Ratios below 1.5. Pfizer's is on the high side. Now, for us, because Pfizer's interest rate on those short-term borrowings is a paltry 2.9%, we're not overconcerned about its Unleveraged Flowie. Were that interest rate up between 7% to 10% or higher, we'd be concerned.
Ok, the remaining liabilities on the balance sheet are those of the non-current variety -- those that are due and payable in more than a year. The one non-current liability that is of the most interest to Cash-King investors is Long-Term Debt. What is certainly the strongest company in the Cash-King portfolio today, Microsoft, carries not a dollar of long-term debt. It is fueling its entire business out of internal cash flows, out of the money it is making on product and service sales. In Pfizer's case, we see that it is carrying $729 million in long-term debt.
Note 5C gives us a lot more information on that debt. The weighted-average interest rate on the debt, as of year-end 1997, was only 6.0% a pretty low rate if you ask me (you did ask, right?). Companies the size and stature of Pfizer are able to borrow money at lower costs than smaller, lesser-known companies -- like Tony's Tree Service. Such is life. Now, Note 5C also provides us with the maturity date of this debt as well as the fact that it is primarily in the form of unsecured notes.
Once we know how much long-term debt a company has we like to calculate the simple ratio of cash-to-debt. In Pfizers case it has that $1.6 billion of cash and short-term investments and it has this $729 of long-term debt. Divide the former by the latter and you come up with a cash-to-debt ratio of 2.2. In other words, Pfizer has 2.2x more cash than long-term debt. And that's better than our standard of 1.5x cash-to-debt. Nice job, Pfizer.
Pfizers other non-current liabilities are not of significant concern to us in our company analysis, so Im going to skip over these items in this report. And, what's more, I'm going to skip the remaining section of the balance sheet, Shareholders Equity, due to time and space constraints. We'll be coming at you with that in the weeks ahead.
For now, that concludes our walk through Pfizers income statement and balance sheet. In addition to today's article, I offered up these preceding two articles:
I hope you'll take the time to read these three articles and that you'll gain something of value from them. Again, if you have any questions or comments or points to contest, please don't hesitate to bring them up in the Cash-King message folders linked below.
Thats it for tonight. Time to take my wife to dinner in celebration of our anniversary (Yyyyes! I remembered! And so did she!). We'll back tomorrow with more details about our search for the Foolish Cash-King Five... and the road to the vote next week.
Stock Change Bid ---------------- AXP -3 5/8 104.06 CHV -1 3/8 78.06 KO -1 3/8 79.69 GPS - 3/4 61.75 EK - 7/8 69.38 XON - 3/4 68.06 GM -2 7/16 70.25 INTC --- 68.56 MSFT - 11/16 85.31 PFE -1 15/16 107.06 TROW + 1/8 35.00
Day Month Year History C-K -1.28% 0.85% 6.66% 6.66% S&P: -1.59% 0.34% 9.32% 9.32% NASDAQ: -1.33% -1.64% 5.86% 5.86% Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 22 Pfizer 82.30 107.06 30.09% 5/1/98 37 Gap Inc. 51.09 61.75 20.87% 2/27/98 27 Coca-Cola 69.11 79.69 15.31% 2/3/98 24 Microsoft 78.27 85.31 9.00% 2/6/98 56 T. Rowe Pr 33.67 35.00 3.94% 5/26/98 18 American E 104.07 104.06 0.00% 2/13/98 22 Intel 84.67 68.56 -19.03% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 63.15 69.38 9.86% 3/12/98 20 Exxon 64.34 68.06 5.79% 3/12/98 17 General Mo 72.41 70.25 -2.98% 3/12/98 15 Chevron 83.34 78.06 -6.34% Cash-King Stocks Rec'd # Security In At Value Change 2/3/98 22 Pfizer 1810.58 2355.38 $544.80 5/1/98 37 Gap Inc. 1890.33 2284.75 $394.42 2/27/98 27 Coca-Cola 1865.89 2151.56 $285.67 2/3/98 24 Microsoft 1878.45 2047.50 $169.05 2/6/98 56 T. Rowe Pr 1885.70 1960.00 $74.30 5/26/98 18 American E 1873.20 1873.13 -$0.08 2/13/98 22 Intel 1862.83 1508.38 -$354.46 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 1262.95 1387.50 $124.55 3/12/98 20 Exxon 1286.70 1361.25 $74.55 3/12/98 17 General Mo 1230.89 1194.25 -$36.64 3/12/98 15 Chevron 1250.14 1170.94 -$79.20 CASH $2037.63 TOTAL $21332.26 *The year for the S&P and Nasdaq will be as of 02/03/98