RMBS, waaaaay to early, sorry. Check out WPI: "WATSON PHARMACEUTICALS INC. (L-T NEUTRAL/S-T NEUTRAL)
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MIKE KRENSAVAGE (212) 493-8272
WPI: FOURTH-QUARTER EARNINGS ARE LESS THAN THEY APPEAR
EPS ANNUAL P/E Dividend
Price --------------------- ------------ ----------- 3-Yr. 52-Wk
2/15 12/99 12/00E 12/01E 12/00 12/01 Rate Yld. Grwth Range
------- ----- ------ ------ ----- ----- ----- ---- ----- ------
WPI $40 3/4 $1.67 $1.95* $2.39* 20.9 17.1 $0.00 NM 20% $63-27
WPI 2000E* Q1 $0.42E* Q2 $0.46E* Q3 $0.52E* Q4 $0.56E*
1999 Q1 $0.41 Q2 $0.43 Q3 $0.38 Q4 $0.46
* Represents change in estimates
Q4 1999: $0.46 vs. $0.40; up 15%
Earnings Restatement, Lower Tax Rate Help Results
Investment Summary Watson Pharmaceuticals Inc. reported fourth-quarter
earnings of $0.46 per share before a one-time gain, exceeding First Call
consensus by $0.01 and our estimate by $0.03. A restatement of year-ago
earnings and decreased tax rate, however, make growth appear stronger than
it is. We are maintaining our rating of long-term Neutral, short-term
Neutral as regulatory problems continue to keep Watson Pharmaceuticals from
introducing new drugs.
Receivables Balloon On the surface, Watson Pharmaceuticals' fourth-quarter
results are robust. Earnings, as the company trumpets in the headline of
its press release, increased 52% from year-ago net of $0.30 per share. The
company, however, arrives at such a rate by comparing its performance to
year-ago results that it restated lower because of an acquisition. Using
the $0.40 that it actually reported in the year-ago period, growth is a
more modest 15%.
An unsustainably low tax rate further aided fourth-quarter earnings,
boosting them between $0.03-0.06. It declined to 32.8% in the quarter from
a year-ago rate of 36.5% on an as-reported basis or 41.6% on a restated
basis.
If Watson Pharmaceuticals' tax rate remained constant, fourth- quarter
earnings would have been not $0.46 per share, but $0.43 at last year's
reported rate, or $0.40 based on last year's pro forma rate. In other
words, Watson Pharmaceuticals' earnings growth of 15% drops to either to 9%
or nothing, depending on the tax rate you choose.
The tax windfall, the product of accounting for tax-loss carryforwards, is
temporary. In 2000, its tax rate is likely to rise to between 37-38% from
34.4% in 1999 and a pro forma 37.3% in 1998.
(If our musings on reported and pro forma numbers confuse you, you probably
are not alone. One reason almost every acquisitive health care company has
suffered an earnings disaster, in our opinion, is acquisitions make it
difficult to measure real growth. Investors do not know until it is too
late.)
Watson Pharmaceuticals' revenue growth also merits scrutiny. It increased
24% to $189 million, compared with pro forma revenue of $152 million. That
is a gain of $37 million. Yet some of the increase reflects acquisitions,
not real growth.
Acquisitions include Alora, a hormone-replacement patch acquired in
October, 1999; Androderm, a hormone-replacement patch acquired in May,
1999; and three birth control pills acquired November 18, 1998. Revenue
growth would have been something less without these acquisitions.
Further, Watson Pharmaceuticals' receivables ballooned in the quarter,
raising the possibility-and only a possibility-it borrowed sales from 2000
to meet its fourth-quarter target. While fourth- quarter sales increased
$17 million compared with the third quarter, receivables jumped $55
million, reaching $180 million. Days of sales in receivables, in other
words, increased to 73.7 from 67.7 in the third quarter.
Watson Pharmaceuticals attributed the increase to customers' Y2K
stockpiling and pledged to reduce receivables to historical levels.
Increased receivables contributed to negative operating cash flow in the
quarter, by our estimate, of about $2 million.
Watson Pharmaceuticals Needs New Drugs
Receivables would become a problem only if its fails to introduce drugs.
Indeed, a court ruling that would allow a launch of a generic version of a
nicotine gum could come any day. Watson Pharmaceuticals hopes to introduce
the product, with potential sales of $20 million per year, this quarter.
Prompt introduction of nicotine gum, already delayed for months, is no sure
thing. Nor are launches of any of the 19 generic drugs awaiting approval at
the U.S. Food and Drug Administration. It refuses to approve products that
Watson Pharmaceuticals wants to make at its Corona, California, factory
until the company resolves quality issues.
As part of its fourth-quarter earnings release, the company warned that it
might have to wait until the second half of the year before product
approvals resume at Corona. Watson Pharmaceuticals had hoped to pass FDA
scrutiny at the end of last year. Our experience indicates FDA problems
take more time to resolve than many people expect.
FDA woes are particularly troubling for Watson Pharmaceuticals' Dilacor XR,
a hypertension medicine of which fourth-quarter sales of $10 million
accounted for 5% of revenue and perhaps 10% of earnings. Watson
Pharmaceuticals' supplier has ceased making the drug, leaving the company
with inventory that would last through the first quarter.
During a conference call, Watson Pharmaceuticals said it hopes to win
approval to make the drug in Corona or find an alternate supplier. It
discounted the threat of interrupted Dilacor XR supply, saying the medicine
would account for less than 4% of revenue in 2000.
Fortunately for Watson Pharmaceuticals, its efforts to replenish Dilacor XR
inventory will have the help of Allen Chao, chief executive and founder.
Mr. Chao has returned to Watson full time after taking a hiatus to battle
stomach cancer. He said during a conference call that a follow-up
examination after surgery and chemotherapy has turned up no signs of
cancer.
Mr. Chao's return perhaps has instilled enough confidence in investors to
make them overlook declining earnings estimates. The consensus earnings
estimate for 2000 has fallen by about $0.05 in three months, according to
Zacks Investment Research. First Call consensus stands at $2.04 per share.
During a conference call, the company endorsed a range of $2.00-2.06.
We agree with the analysts who have cut their numbers. We are reducing our
2000 earnings estimate to $1.95 from $2.08, implying 17% earnings growth.
That means WPI shares trade at 20.9 times estimated 2000 earnings, or a 15%
discount to the S&P 500. Unless the company launches new drugs, its
earnings and price/earnings multiple are likely to contract.
Watson Pharmaceuticals Inc. is a Corona, California-based drug company with
1999 revenue of $689 million. Branded drugs generate about two-thirds of
gross profit, and generics account for the remainder. Specialties include
female healthcare and dermatology." |
