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Schering-Plough Corp.
SGP Valuation

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By admiraltroll
July 31, 2003

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Hi guys,

SGP came up on the Value Investing board and so I decided to do a quick valuation as I thought that I might be interested at $15+ - I'm definitely not!

I agree with BOBERT that this stock is overvalued now by a significant amount. One thing though the full 2003 estimate is not $0.68 as that is the 2004 estimate. This year's estimate is just $0.53, some 15c lower than the per share dividend.

So here is my simplistic valuation:

I used the SEC Filings and then calculated a simplified DCF and a Discounted earnings for SGP.

First I looked at the 10Q to find the net cash from ops and capex for the last quarter and the year ago quarter.


                       2002      2003
Net Cash from Ops      441m*    509m
Capex                  119m     148m
FCF                    322m     361m


On the surface this looks pretty good that despite a huge drop in earnings the FCF has not dropped much. Until you check accounts receivable and payable. Accounts receivable decreased $208m more than Accounts Payable and thus 65% of the FCF came from this change alone. Without it the FCF would have been $114m, a drop mirroring the drop in earnings.

Annual Figures for 2002


Net Cash from Ops $1,980m
Capex               $770m
FCF               $1,210m


So TTM FCF is $1,210m - $361m + $322m = $1,171m

But without the benefit of the one time improvement the TTM FCF would be $963m

Zacks analyst estimates give a 5 year growth of 10% consensus, the high was 20% and the low 1%. I would probably go with 5% but I'll calculate 10% as well.

I chose a discount rate of 11% as I would give Pfizer, Glaxo & Merck just 9%. If I chose a higher discount rate the valuation would be even lower.

So with FCF of $1,171m, discount rate 11% and growth rates 5% for 10 years and 3% terminal rate after that the IV is just $12. Subtract a 20% margin of safety and I get a buy price of $9.60

If I use growth rates of 10% first 5 years, 7% second 5 years and 3% terminal rate the value is $15 and the buy price is $12.

But then if I subtract out the one time gain from reduction in accounts receivables the IV's become $10 and $13 and the buy prices become $8 and $10.40

If I were calculating based on discounted earnings I would ignore the TTM earnings (perhaps I should have ignored the TTM free cash flow too!) and try and figure out what the likely earnings base is as we know that earnings are not going to be $400m per quarter going forward this year.

The full year estimate for 2003 is $0.53 per share and with 1.469m shares this translates to $778.6m in earnings for the full year. 2004 estimates are $0.68 per share or $998.9m. Incidentally the P/E on the 2003 full year estimate is 32.8 and on 2004 is 25.6 so I think that we can banish all thoughts that the current P/E of 16.9 gives any indication of value in this stock

A discounted earnings calculation will therefore give even lower figures than the above DCF calculation. Using 2003 full year estimates the IV's for the same discount rate and growth figures are $10 and $8 and the buy prices with the same 20% margin of safety $8 and $6.40.

If I'm more generous and use 2004 estimates as my base then the IV's are $10 and $13 with buy prices of $8 and $10.40

So there you have it my buy range is $6.40 to $12 at the most.

And here is another prediction: the dividend will likely be cut. It is currently 68c per share with a payout ratio of 65%. With earnings projected at 53c a share (FCF will probably be close) the payout ratio will jump to 128%, which can't be sustained for long.

As I said this is a simplistic valuation and a quick one but I do not think the range of values is far off the mark

Regards
Philip


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