Drip Portfolio Report
Wednesday, September 3, 1997
by Jeff Fischer (TMF Jeff)
ALEXANDRIA, VA (Sept. 3, 1997) -- On the simplified eight-point guidelines that we use to initially measure our investment possibilities, SCHERING-PLOUGH (NYSE: SGP) comes out shining; in fact, it may prove to look the best out of our four healthcare possibilities, the three others being Abbott, Pfizer, and Johnson & Johnson.
1. Schering-Plough has the strongest balance sheet, with $760 million in cash, $46 million in long-term debt, and a debt-to-equity ratio of 0.3. The company expects to spend about $800 million on research and development this year, while operating cash flow should top $1.5 billion. (Schering-Plough has spent about 13% of sales on research and development over the past years. Of our choices, Pfizer spends the most on research and development as a percentage of sales.) Cash and cash equivalents have increased from $115 million in 1994, to $321 million the next year, to $535 million in 1996, and then to $760 million in the latest quarter. Long-term debt has decreased from $753 million in 1991 to the current $46 million.
2. For the past eleven years, the company has achieved double-digit earnings growth. Earnings increased 16% last year as revenues increased 11%. The company grows earnings through increased sales volume, more efficient operations resulting in better margins, and by repurchasing shares, which reduces the shares outstanding and increases the earnings per share.
3. As earnings per share have grown, so has return on equity. Return on equity is:
One year's earnings ROE = ------------------------------- Shareholder's Equity
The higher the return on equity, the more each dollar invested in the company is "rewarding" shareholders. Since 1991, the company has increased return on equity from 37% to 65%, crushing the return on equity achieved by its peers. Two other companies that we're considering offer return on equity in the 20% range, and Abbott's stands at 40%.
4. Schering-Plough also has higher margins than its peers, with 29% operating margins and 21% net profit margins. For every dollar in sales, 21 cents is pure profit. Johnson & Johnson has 13% profit margins, Abbott and Pfizer, 17%.
5. The company and management is one of the most respected in the industry, as is true with our other choices, too. They recruit and retain top industry people.
6. Schering-Plough has consistently repurchased its own shares, and it plans to continue doing so. Since 1991 the average shares outstanding decreased from 806 million to 732 million (stock splits included). Since 1983 the company has bought back $3.9 billion worth of stock (now valued at over $12 billion). In 1996 management repurchased $500 million more in company stock and authorized a new $500 million share buyback plan for this year. Also, in 1996 the company announced the 13th dividend increase since 1986.
7. "Industry dominant" is our seventh criteria. Schering-Plough mainly sells pharmaceuticals. In the U.S. it has twelve major products that rank number one in their class. In international markets, it has six products as number one category sellers. Its pharmaceutical division has been growing at competitor-beating paces in most markets. You can't say Schering-Plough is industry dominant in the same sense that you can say Coca-Cola or Intel is dominant. This is a different story. It certainly is doing very well in what it does, though, and management knows how to capitalize on a sale, bringing dollars to the bottom line more efficiently than does the competition.
8. Is all of this sustainable? It's likely that the company will continue to lead the industry in several niches over the coming two decades. The barriers to entry in the industry are high, and once you have a product lead, as with most industries, it often takes at least a few big mistakes -- or a paradigm shift -- to lose it. Arguably the largest risks here, as with technology, are new solutions to old ailments. Let's see where Schering-Plough is making its money.
Ninety percent of the company's sales are in the pharmaceutical business. Pharmaceutical sales rose 13% in 1996 to $5.0 billion, meaning only the remaining $700 million came from other products. Within pharmaceuticals, the largest selling product is CLARITIN, with $1.2 billion in 1996 sales, a 46% increase. CLARITIN is the world's leading antihistamine, and last year it was sold in all Schering-Plough markets except Japan. Japan sales begin this year.
The number two product is INTRON A, an antiviral/anticancer, genetically engineered agent. Sales grew 21% last year to $524 million. Eleven other pharmaceutical products topped $100 million in sales in that year. Rather than break down revenues by each product (which are granted 17 years of patent protection), let's look at pharmaceutical sales by ailment. All of these niches have enjoyed increasing revenues over the past three years.
1996 pharmaceutical product sales Allergy & respiratory $2,100,000,000 Anti-infective & anticancer 1,135,000,000 Dermatological 560,000,000 Cardiovascular 533,000,000 Other pharmaceutical 512,000,000 ------------------- apprx. $5,000,000,000
Schering-Plough is considered a leader -- if not the leader -- in the dermatological and allergy and respiratory markets, while it is making great strides in the anti-infective and anti-cancer markets.
Schering-Plough's remaining $700 million in 1996 revenue is derived from:
Animal health $196,000,000 OTC 210,000,000 Foot care 261,000,000 Sun care 123,000,000 Other health care 13,000,000 ------------------- apprx. $700,000,000
What these numbers alone don't show is the growth (or lack of) in each product division. Over the past three years, Coppertone sun care revenues have remained flat, drifting from $129 million in 1994 to $123 million last year. Foot care sales (Dr. Scholl's) have increased slightly, up from $248 million in 1994, to $261 million last year. OTC sales, which include the popular Afrin nasal spray, have declined from $264 million in 1994 to $210 million last year. Finally, sales of animal health products have improved by $30 million since 1994.
It's obvious that the vast majority of the company's growth is coming from its pharmaceutical business, which is a good and logical thing, of course, as that business comprises 90% of Schering-Plough's sales. What ails the consumer products?
Generic and store-brand competition is hurting OTC sales. To counter this, Schering-Plough has begun its own generic labels, which have helped soften the blow but haven't led to overall growth. To further counter the competition, management is working on cost cutting by consolidating manufacturing and distribution, focusing on the company's better brands, and reducing overcapacity. Some production is also being moved to less expensive facilities.
Consumer and OTC products aren't the only items under attack, though. Many of the company's pharmaceutical products are replicated by generic brands as well. To counter this, in 1993 Schering-Plough introduced its generic Warrick Pharmaceuticals subsidiary, which has seen increasing sales since inception and has helped stem the impact of cheaper competition. (Hot tip for today: if you're buying "generic" pharmaceuticals, buy Warrick. You're really buying Schering-Plough.)
The company has consistently made record profits while facing increased competition. Its strong leadership in several markets and good management have led to improved margins even as competition has increased. We'll have to compare it to Abbott, Pfizer, and Johnson & Johnson -- on the eight-item checklist and on the overall business -- before we can begin to quantify how strong management and the business are, comparatively, and then move to decide which stock we want to buy.
THANK YOU. We thank all of you who sent in radio show recommendations. Hopefully some of them will pan out, and we'll announce right here any shows ahead of time. If anyone else has a talk show radio program that they think would carry this portfolio and Foolish investing as a topic, please send email to Chris Hill, at TMF Wizard.
Also, a final thank you to everyone who sent in name suggestions for the portfolio. There were some very inventive names. For now, we've claimed Drip. Others have DRP, DRIP, or DRiP. We have Drip.
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