WPI: Financial Gauge Analysis for the June 2009 Quarter

In an earlier post, we examined Watson Pharmaceuticals' (NYSE: WPI) Income Statement for the June quarter and compared the figures to our "look-ahead" estimates.  Second-quarter earnings fell from $0.51 to $0.46 per share, primarily because of the costs to launch the RAPAFLO® and Gelnique products and to acquire Arrow Group.


We have since mined Watson's financial statements in its 10-Q to update the metrics we use to assess Cash Management, Growth, Profitability and Value. This post reports on these metrics and the Financial Gauge scores.

In summary, Watson's latest GCFR gauge scores are as follows:

• Cash Management: 12 of 25 (up from 10 in March)
  
• Growth: 11 of 25 (unchanged)
  
• Profitability: 10 of 25 down from 11)
  
• Value: 8 of 25 (down from 10)

• Overall: 39 of 100 (down from 43)
  

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.

Cash Management	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Current Ratio	1.4	1.4	2.9	3.7
LTD/Equity	6.7%	11.6%	41.8%	35.5%
Debt/CFO (years)	2.1	2.1	2.1	2.0
Inventory/CGS (days)	117.0	120.4	130.6	124.7
Finished Goods/Inventory	59.2%	62.4%	67.7%	57.1%
Days of Sales Outstanding (days)	45.3	44.4	44.2	50.6
Working Capital/Invested Capital	20.3%	17.1%	32.6%	39.5%
Cash Conversion Cycle Time (days)	67.2	70.4	67.8	86.0
Gauge Score (0 to 25)	12	10	13	13

We noted after the first quarter that Watson's total debt had not changed significantly, but much more debt was due within one year.  Looming debt payments increases Current Liabilities, depresses the Current Ratio, and reduces Working Capital. 

We guessed incorrectly that Watson would refinance the debt before the end of the second quarter.   However, the Balance Sheet for 30 June 2009 shows $726 million in short-term debt and $150 million in Long-term Debt, which is an unusual ratio. The liquidity situation is made more complicated by the "expectation that the Company will redeem the outstanding amount of the [convertible contingent senior debentures] CODES for cash within the next 12 months"

The downward trend in Inventory is encouraging.  The company might have been building up inventories for products they just recently made available for sale.

Growth	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Revenue growth	6.5%	5.1%	5.8%	13.8%
Revenue/Assets	71.7%	71.6%	70.8%	64.0%
Operating Profit growth	37.9%	34.6%	16.5%	19.7%
CFO growth	4.4%	3.4%	-16.9%	11.9%
Net Income growth	24.8%	48.0%	N/A	21.7%
Gauge Score (0 to 25)	11	11	4	10

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.


Revenue picked up in the latest quarter.  Net Income, hurt by some one-time factors, still shows a potent growth rate.  Cash Flow from Operations, however, still appears tepid.

Profitability	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Operating Expenses/Revenue	86.7%	86.2%	87.7%	87.5%
ROIC	9.2%	9.4%	7.3%	7.2%
Free Cash Flow/Invested Capital	14.1%	14.3%	12.6%	14.7%
Accrual Ratio	-2.1%	-2.4%	-4.4%	-0.7%
Gauge Score (0 to 25)	10	11	12	9

Operating expenses as a percentage of Revenue were reduced a full percentage point over the last year, and the results are seen in the improved return on invested capital.  The rise in the Accrual Ratio, relative to its value 12-months ago, suggests some degradation to Earnings Quality.  To be specific, it indicates that less of the company's Net Income is due to Cash Flow from Operations; therefore, more is due to changes in non-operational Balance Sheet accruals.

Value	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
P/E	17.4	15.5	17.4	23.2
P/E vs. S&P 500 P/E	0.8	0.8	0.9	1.3
PEG	0.5	0.4	1.1	1.5
Price/Revenue	1.5	1.4	1.3	1.7
Enterprise Value/Cash Flow (EV/CFO)	10.3	9.5	9.5	9.0
Gauge Score (0 to 25)	8	10	14	10

Shares of Watson Pharmaceuticals increased 8.3 percent during the second quarter, from $31.11 to $33.69.  This rise put some pressure on the contrarian Value gauge, especially since earnings fell.

Overall	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Gauge Score (0 to 100)	39	43	49	40

The gauge scores basically held steady in the second quarter.  They would increase after a successful debt refinancing, the winding down of some non-recurring costs, and the realization of higher cash flows from the new products now emerging from the development pipeline.




Full disclosure: No position in WPI at the time of writing.