Assignment Title:
Strategic and financial goals of Hikma PLC to enter FTSE100 listing
INTRODUCTION
1.1 Company Overview
Hikma PLC is a UK based pharmaceutical company that specialises in manufacturing and distributing generic and specialised therapeutic medicines. Hikma’s business revenue contribution per region is:
US- 62%
MENA- 33%
Europe/others – 5%
Hikma products are generally categorised into Generic medicines that represent 31% of the revenues, Injectables as 40% of the revenues, and branded drugs as 28% of the revenues. However, Injectables form Hikma’s core competency as this category has witnessed the most growth in Hikma operating history (MarketLine, 2017). Hikma started as a small pharmaceutical in Jordan in 1978, formed by the now deceased Samih Darwazah who had transformed the company into a multinational corporation.
Hikma’s entered the UK stock market in 2005, with less than anticipated performance for a few years until 2015 where it gained its prowess by entering into the top FTSE 100 Index (Ward, 2015). The company currently competes in the FTSE250 index, but its current course is aligned to regain its position at the top FTSE index.
Although, with its current positioning is in the FTSE250, some of its top competitors are AstraZeneca, and GlaxoSmithKline that are currently ranked in the FTSE100 index.
This report will analyse Hikma PLC’s current performance, followed by exploring its current position in the FTSE market.
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KEY FINANCIAL RATIOS
2.1 Profitability (200)
Hikma PLC has shown one of the most promising and reliant performances in Pharmaceuticals industry. Revenues growth has been continuous over the last eight financial periods, with the exception of the periods 2014-2015. Hikma’s stronghold over the MENA region contributes 33% towards the overall business income (Hikma, 2017 A). These declines in revenue were particularly associated with the political instability across the MENA region, such as Algeria, Iraq, and Libya, that had a detrimental effect on the revenues.
However, Hikma has been able to sustain a higher GPM throughout 2014, and 2015 despite the slump, when compared to 2012. It may be noted that Hikma’s GPM has been higher (2013 onwards) than the industry average of 49.32% (Gurufocus, 2017 E), yet it is much lower than its close FTSE250 rival Indivior that operates on an average of 92.68% GPM over its 6 recent financial years (Orbis,
B). However, this could somewhat be explained by Hikma’s reliance on trading branded drugs that contribute 40% of Hikma’s revenues, hence as a measure Hikma has been performing a string of acquisitions to boost its own brand portfolio, particularly Injectables, which has been increasing revenue contribution consistently.
The company had set targets for 2014, and 2015 to reduce operating costs by increasing their efficiency and eliminating tail products from their product portfolio, along with pursuing targeted acquisitions of speciality drug manufacturing companies around MENA and US (Hikma, 2014).
Year 2009 onwards has witnessed volatile market competition, coupled with the increased scrutiny by US FDA that has led to a consecutive decline of prices (estimated to have dropped by -20%) for generic and branded drug prices for common medical conditions(LaMattina , 2016), thus reducing GPM across Hikma’s branded drug trade. As such, the US being a major export market for Hikma will remain to be a concern, as the pressure on lower drug prices for common medical conditions will continue to deter favourable margins. In a 2017 interim financial report published by Hikma, the generic price depression factor has already been considered and the company has a clear strategy set to focus on strengthening their differentiated product portfolio (Hikma, 2017 B). While trade on generic and branded drugs will continue in the US market with Hikma’s US market share of 6%, the focus is clearly on boosting revenues through its Injectables product line.
ROCE had been climbing steadily until 2014, with continued positive ROCE until 2016. This indicates that, despite the downward pressure on prices of some of Hikma’s drug portfolio, profits have been enough to continue returns on capital invested in the
company. WACC of HIKMA indicates that, it costs them 2.14% as the cost of raising capital, while Hikma’s returns are average to 7.34% (Gurufocus, 2017 F). These, compared to Hikma’s competitor (with similar market cap) states that returns are better than most including its FTSE250 competitor Indivior PLC.
A number of reasons have attributed to the fall in ROCE in 2015, 2016. Firstly, the economic and political turmoil in some of the countries in MENA has drastically affected the ROCE due to, due to the devaluation of the currency (net assets). The areas particularly were Somalia, Algeria currency in 2015 (Hikma, 2015), and further devaluation of Egyptian, Algerian, Moroccan, and Sudanese currency, against US dollar that led to loss of up to 67 million USDs in 2016 (Hikma, 2016, p. 36), leading to directly realised losses in currency translation.
A further decline was caused by Impairment charges caused by divestment in Unimark Limited in 2015 that, having viewed, as a potential opportunity during the pre-investment did not work out well due to Hikma’s interest in acquiring Roxane, a US-based drug manufacturer. This divestment was necessary to comply with the US Federal Trade Commission condition that would avoid Hikma PLC to hold a market monopoly as a sole trader of a particular set of drugs (FTC, 2016) for a particular period of time in future, preventing competition for producing the same. Hikma completed the divestment in 2016 and absorbing the related losses of 2 million USDs in 2015, and further anticipated losses of 7 million USDs in 2016 (Hikma, 2015). This along with the losses absorbed from currency translation, has had significant decline in ROCE and shareholders income.
High-interest rates paid as finance expenses for key acquisitions made during 2014-2015 such as Bedford-2014, Roxane in 2015 that required funds to be raised on an interest basis. Nonetheless, the Hikma group revenue has grown by a good 35% in 2016, compared to the previous year. Whole 2015, 2016 have been challenging years for Hikma due to various activities, the board of directors seem to have a confident outlook on 2017 performance. With the current expansion of assets from the acquired companies, newly added drug-producing plant and machinery, decommissioning of outdated assets and discontinuing declining/loss making product line, it would be interesting to note is that how the ratios change by the end of 2017.
2.2 Efficiency
(MarketLine, 2017)
Hikma sets the credit period for receivable according to the individual market practices where Hikma operates, by cautiously aggregating the risks and keeping a provision for any impairment, to a certain extent. So far, the maximum trade receivable limit is set for MENA region, at 360 days (Hikma, 2016, p. 182). Although there has been a spike in 2016, where the receivables touched 130* days, the same has been brought down to 106* days during 2017 as indicated by GuruFocus (2017 G). This is a bit more than the industry standard (set at 73.92 days) however, Hikma’s policy of setting higher days could be linked to competitive advantage, which would have helped them boost their sales by offering higher credit period to their customer. However, this comes with a caution as Hikma’s FTSE 250 competitors Vectura, Dechra pharma credit their customers between 40 – 60 days (GuruFocus, 2017 G).
Trade Payables are close to the industry average of 68.69 days, which indicates that suppliers would have sufficient trust in Hikma’s payment system.
2.3 Liquidity
(MarketLine, 2017)
Hikma’s current ratio significantly drops in current ratio were expected due to the string of acquisitions (and the unfortunate divestment incident) from the year 2013 onwards to 2016. The biggest slump is witnessed in 2016 with Roxane’s onboarding, while still absorbing the liabilities (as recognised losses) from Unimark’s divestment.
The slump in 2016 is also largely due to recognising the costs of funding the acquisition of Roxane, the biggest deal for Hikma in its 38 years. Long-term debt (LTD) recognised in 2016 stood at (mainly interest & noninterest bearing borrowings) at 1034 million USDs, a good 58% increase from 2015 LTDs. Nonetheless, with no other significant concerns disclosed in Hikma’s 2016 annual report
on this regard, it can be expected the current ratio should improve as the benefits from acquisition started flowing in effectively in 2017, and the sharp focus on restructuring the product portfolio according to their highest contributions.
Despite the fluctuation, investors should have a positive outlook considering the going concern. Both current ratio and quick ratio indicate that Hikma is able to meet the maturing obligations.
2.4 Financial Gearing
Hikma’s gearing is not significantly different than its FTSE100 competitor AstraZeneca despite Hikma’s market share inferior to the former. However, when compared to Hikma’s FTSE250 competitor Indivior, it is noticeable that the latter has a significant amount of gearing. Highly geared companies have both, an advantage and the opposite. (Atrill & Mclaney, 2015) notes that highly geared companies return better ROSF due to the fact that owners finances are not held up as capital assets, which further leads to lucrative returns on shareholder funds. This is if the cost of borrowing (i.e. interest) is lower from the returns generated by the business. The opposite is true as well; high gearing has a higher negative impact on deteriorating returns to shareholder’s funds.
Some authors argue that optimal levels of gearing are industry and the required capital sensitive. Companies that are not significantly geared must be cautious in their choices, and ensure that their alternative means of borrowing provide similar benefits as gearing ( Ogier, et al., 2012).
Cited in (GuruFocus, 2017 H)
However, looking at Hikma’s interest cover it is understood that the company has decent backups to facilitate interest payments. In order to boost lending confidence, it would be Hikma’s interest to improve this ratio in 2017, for further borrowings to facilitate Hikma’s expansion plans.
2.5 Investment
Hikma’s Earnings per Share (EPS) peaked in 2014, thereby declining year on, as with the ROCE. One major issue affecting the Shareholder returns was the devaluation of currency from Hikma’s major earning regions (i.e. MENA), apart from the unexpected losses from Unimark’s divestment. As such, when analysing Hikma 2017 annual interim report, there is growth across Hikma’s current assets. However, clear understand of Hikma’s performance would be subject to analysis of their 2017’s financial year.
P/E ratios have shown sturdiness and growth despite the setbacks. With the current strategic plans of Hikma, market confidence is positive, as investors hold a positive outlook on future earnings. With the much-anticipated acquisition of Roxane, the US-based drug manufacturer, Hikma’s PE ratio had already improved over its FTSE100 rival AstraZeneca, whose PE ratio has been declining over the years. This indicates that investors may be keen and interested in Hikma’s future performance. This presents as both, an opportunity and challenges for Hikma. The anticipated benefits from Roxane’s acquisition must reflect upon Hikma’s yearly performance in order to have the investors ready to lend funds. Investors would be keen on ensuring that it would be a safe and worthwhile return on funds.
This means that Hikma’s current ratios, interest cover, and gearing must improve and controlled tightly in order to lure investors, as an alternative to raising funds via syndicated bank loans. Further, adventurous investors may be interested in higher earnings on shares, a quick comparison of EPS of AstraZeneca shows that its
EPS has consistently and historically been higher than Hikma’s (i.e. by 318% higher).
Dividends cited in (GuruFocus, 2017 A) (MarketLine, 2017) (Orbis, 2017 A)
Dividends paid to shareholders have been climbing over the years (i.e. 25% in 2013, 10% in 2014, 45% in 2015, and 3.13% in 2016) even though the revenues decreased 2014 onwards. 2015 witnessed the highest decrease in revenues as discussed in the chapter of profitability; however, the dividends paid were about 45% higher than the previous year. This may be considered unwise according to finance principles (Atrill & Mclaney, 2015, p. 218), nonetheless it could be considered that Hikma would want to reward its investors with healthy income despite the revenue slump, and that it could be a strategy to keep investors interested in Hikma, as deductible from its current PE ratio. As a forward-looking comparison, the 2016 Yields for AstraZeneca stood at 2.51%, while Hikma’s FTSE250 competitor Indivior PLC’s yield stood at 13.04%, though it may be noted that Indivior is a high stake investment due to their volatile ratios.
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