ACCA Thesis Approved

Table of Contents

Part 1: Project Objectives & Overall Research Approach

• 1.1 Introduction
• 1.2 Selection of Topic
• 1.3 Reasons for Choosing Ferozsons Laboratories Limited (FSLL)
• 1.4 Research Objectives
• 1.5 Research Questions
• 1.6 Research Approach

Part 2: Information Gathering and Tools for Analysis

• 2.1 Data Gathering
• 2.2 Sources Used for Data Gathering
• 2.3 Limitations in Gathering Information and Ethical Issues
• 2.4 Analysis Models and Techniques
  • 2.4.1 Business Analysis
    • 2.4.1.1 PEST Analysis
    • 2.4.1.2 SWOT Analysis
  • 2.4.2 Financial Analysis
    • 2.4.2.1 Profitability Ratios
    • 2.4.2.2 Liquidity Ratios
    • 2.4.2.3 Gearing Ratios
    • 2.4.2.4 Investor’s Ratios

Part 3: Results, Analysis, Conclusions and Recommendations

• 3.1 Business Analysis
  • 3.1.1 PEST Analysis
  • 3.1.2 SWOT Analysis
• 3.2 Ratio Analysis
  • 3.2.1 Profitability Ratios
  • 3.2.2 Liquidity Ratios
  • 3.2.3 Gearing Ratios
  • 3.2.4 Investor’s Ratio
• 3.3 Conclusions
• 3.4 Recommendations

Part 1: Project Objectives & Overall Research Approach

•  Introduction:

In this research project I analyzed and evaluated both the financial and business prospective of Ferozsons Laboratories Limited (FSLL) for the three financial years from 1 July 2013 to 30 June 2016. The comparison of FSLL’s financial performance in relation to its competitor, The Searle Company limited (SCL) along the three year period under study is the prime focus of this research report. I have also carried out Business to enlighten the future prospectus of the company.

This research report is compiled as a requirement of part of OBU BSc degree.  The nature of research is Secondary. Citation of sources used is done using Harvard reference system. No liability or legal claims as on use of analysis done and conclusions withdrawn.

• Selection of Topic:

I have selected the project topic area and title of which is Topic# 8 an analysis and evaluation of The Business & Financial performance of a company over a three year period for my research and analysis project. Financial and corporate reporting papers (Papers F7, P2) and Financial Management Papers (F9, P4) have always been my personal interests during my ACCA studies. After passing P4-Advanced Financial Management, my interest in financial analysis got deepened and enrolled myself for CFA (Chartered Financial Analyst) studies. Currently, I am preparing myself for CFA level III Exam. I believe that a project on such analysis will not only satisfy in exploring my personal interest but it will further enhance my knowledge. Moreover, I am also working as investment analyst in leading industrial group in Pakistan, where my day to day work is to analyze the group financial and business performance and to identify any business opportunity for the group.

Furthermore, as I selected Public Limited Company (PLC) for my RAP it will be easy to access the required information as the PLCs are required to publish their annual reports.

Reasons for Choosing Ferozsons Labortries Company Limited (FSLL):

Although the sectors on which RAP has to be prepared is limited by ACCA but Pharmaceuticals and Biotechnology sector is the one that I am currently working on. As Pharmaceutical is a fast growing industry in Pakistan, my employer is currently analyzing any investment opportunity in the sector. I am also one of the team members that are working on the project. It does not take a time for me to opt for the sector. However, before finalizing the sector I have consulted with my mentor who encouraged me to select this sector.

Pakistan’s pharmaceutical industry is the world’s sixth largest, with a total market size of PKR220 billion. It directly employs 70,000 people and indirectly employs 150,000. It is able to meet 70% of Pakistan’s demand for pharmaceutical products, in terms of volume, by domestically producing analgesics, anti-depressants, herbal and homeopathic medicines, and penicillin. Other needed pharmaceutical products, such as cancer drugs, are produced in other countries and then imported. (Worldfolio, 2016) {Ref# 1}

FSLL is a public limited company listed on the Pakistan Stock Exchange. FSLL possesses leadership brands in the areas of gastroenterology, herpetology, cardiology and oncology, with an emerging presence in the diabetes space. FSLL is maintaining exclusive agreements with a number of international partners for distribution, selling and co-manufacturing of products including the Bagó Group in Argentina, BioGaia of Sweden, Biofreeze of Hygienic Corp., PanTheryx, Boston Scientific and Gilead Sciences, Inc. in the USA.
With Bagó Group of Argentina, FSLL set up a world class biotech cGMP compliant facility through a joint venture, BF Biosciences Limited. FSLL is also the exclusive partners for Gilead Sciences Inc. for their range of branded products in HBV, HCV and HIV, and additionally hold an in-country license to manufacture authorized generics of Gilead’s products for HCV (Ferozsons-labs.com, 2016) {Ref#2}.

Research Objectives

The objective of this research is to analyze the financial and business prospective of FSLL over the three year period from 1 July 2013 to 30 June 2016. For financial analysis purpose focus is on ratios analysis including profitability, liquidity, gearing and investors ratios. The financial result of FSLL has also compared with that of competitors, SCL.

For business analysis, SWOT and PEST analysis techniques has been used. The purpose of business analysis is to better understand the internal and external environment of the company. It will also be helpful to understand the long term profitability and existence of the company.

• Research Questions

1. What is the financial performance of FSLL over three year period from July 2013 to June 2016, comparing with its competitors?
2. What is the nature of the environment in which the FSLL is operating?
3. What is the key to obtain long term growth and profitability?

• Research Approach

In order to conduct a successful research I have done the following:

• Detailed study of Financial Statements of FSLL from 2014-2016.
• Detailed study of Financial Statements of SCL from 2014-2016.
• The research has been obtained from other sources as well i.e. the data that is not primarily compiled for this purpose but has been published somewhere else. However, before relying on the data, efforts have been made to confirm accuracy and sources is also mentioned.
• Obtaining knowledge of pharmaceutical industry as a whole including FSLL.
• Understanding pharmaceutical industry and its environment.
• An understanding of SCL in order to better compare the financial and business performance of FSLL to that of SCL.
• An understanding of the ratios, their formulas and interpretations of the formula.

Part 2: Information Gathering and Tools for Analysis

• Information gathering

First of all, thoroughly go over the official website of FSLL to obtain knowledge about the company, its product brands etc. After that SCL has been identified as a competitor of FSLL and overview the website of SCL too.

After understanding company and its competitor, internet is used for further understanding and data collection. Business journals, national newspapers and other relevant websites were also used. Before relying on data, efforts have been made to verify the accuracy and credibility of the data by cross checking the data from different sources.

Data has been obtained from both primary and secondary sources.

• Primary Sources

Most of the information was gathered from the official web sites of FSLL (Ferozsons-labs.com, 2016) {Ref#2} and SCL (Searlecompany.com, 2016) {Ref#3}. I also got insights from ACCA and CFA curriculum during industry and business analysis. All these can be categorized as a primary source of information.

• Secondary Sources

“A secondary source interprets and analyzes primary sources. Secondary sources may have pictures, quotes or graphics of primary sources in them.”

Secondary sources for data collection also played a vital role in my research project, because not all the relevant information was available at the company website and financial reports. So I had also visited the websites like (https://www.google.com/ ) {Ref#4} many times for my project.

• Sources used for gathering information

Internet was the first and basic source of information for me. However, I have also consulted back to my ACCA and CFA curriculum whenever I needed more explanation. I made a separate folder in my laptop for the project and started downloading information which I thought could be useful for the project and saving it in my personalized folder.

All the necessary information required for the project about FSLL and its environment, regulatory and other general economic  condition were gathered from:

• Different websites
• Business newspaper and journals
• Research articles
• Annual Financial reports
• Data from government sources like (Finance.gov.pk, 2016) {Ref#5}
• Statistical Data had gotten from Pakistan Bureau of Statistic website (Pbs.gov.pk, 2016) {Ref#6}.

The knowledge that I had gotten from my ACCA and CFA studies was also very helpful. This was attained through:

• ACCA Study Text, Exam Preparation Kits and lectures by teachers etc.
• CFA curriculum and learning outcomes
• Kaplan Schweser and Finquiz

Limitations of gathering Information and Ethical Issues

I know accuracy and reliability of the data is the key for my research project. I tried my best to get the data from most reliable source. But still numerous problems were being faced by me during my research project.

Some of the common problems faced during the research were as follows:

• It was difficult to find the exact competitor because there are more than 700 pharmaceutical plants in the country (Ppma.org.pk, 2016) {Ref#7}.
• It was also difficult to predict the marker share splits between different companies because of different in focus, target market and segment etc.
• Sometime same information were quoted with different stats in different websites
• It was difficult to contact with management of FSLL to insert their comments and get benefits from their experience.
• Throughout my research work I remain afraid of plagiarism.

However, up to the best of knowledge and judgment, I tried to overcome the limitations as much as I can.  Whenever I found conflicting stats between two different sources, I always prefer the information that are presented by government or semi government and other multination sources like world bank (World Bank Group, 2016) {Ref#8} and world health organization (World Health Organization, 2016) {Ref#9}. But I regularly discussed with my colleagues and senior about the data source and their reliability. I was also in continuous touch with my mentor who guide and direct me about the problem.

Based on my continuous efforts and cross checking the data from different sources, I can safely say that the data is reasonably fair and accurate.

Analysis Models and Techniques:

I have analyzed the organization through both financial and business techniques. Following business and financial techniques has been performed for my analytical work.

Business Techniques

Understanding the company and its environment is the key for the analyses. The first step to build a research work is to understand the business of the company. There are various methods, techniques and models for this purpose. However, I will carry out my work through very common and known models PEST and SWOT analysis.

These models are a part of ACCA paper P3 (Business Analysis) and are as follows:

• PEST Analysis

PEST analysis is a technique use to understand the broader business environment of an organization. It covers the external business environment of the company.

The acronym PEST stands for the following factors along with examples:

Political:

The political factors refer to the change in government policy that may directly or indirectly impact an organization and its operation. It also refers to change in government due to political unrest and uncertainty. An example includes monetary and fiscal policies, trade and commerce polices minimum wages etc.

Economic:

This factor examines the outside economic issues that can play a role in company’s long term success. An example includes economic growth, exchange and inflation rates, economic stability and credit availability etc.

Social:

This factor analyzes the demographic and cultural aspects of the company’s market. These factors help businesses examine consumer needs and determine what pushes them to make purchases. An example includes population growth rate, age distribution, attitude towards work and job market etc.

Technological:

This factor takes into consideration technology issues that affect how an organization delivers its product or service to the marketplace. An example includes technological advancements, government spending on technological research and the life cycle of current technologies. (PEST Analysis: Definition, 2016) {Ref#10}

Limitations of PEST

However, being such an important tool for analyzing external environment, PEST technique has some limitations too:

• The external factors considered during PEST analysis are dynamic and they change at a very fast pace.
• PEST analysis is insufficient for the purpose of strategic planning, since it only covers the external environment and completely ignoring the internal factors.
• The selection of critical factors is a subjective task and it requires high level of skills and strong observations to be demonstrated by concerned management personnel.

(Brighthub Project Management, 2016) {Ref#11}

SWOT Analysis

“SWOT analysis is a process that identifies the strengths, weaknesses, opportunities and threats of an organization. SWOT is a basic, analytical framework that assesses what an organization can and cannot do, as well as its potential opportunities and threats. A SWOT analysis takes information from an environmental analysis and separates it into internal strengths and weaknesses, as well as its external opportunities and threats.

• Strengths and Weaknesses

Strengths describe what an organization excels at, allowing decisions on how to gain a competitive advantage. For example, a hedge fund may have developed a proprietary trading strategy that returns superior results in comparison to its competitors

Weaknesses stop an organization from performing at its optimum level. An organization needs to minimize weaknesses and analyze how they can be improved. An inadequate supply network or lacks of capital are example of weaknesses.

• Opportunities and Threats

Opportunities refer to favorable external factors that an organization can use it its advantage. If utilized effectively, opportunities have the potential to create a competitive advantage. For example, a car manufacturer may be able to export its cars into a new market if tariffs in a country are substantially reduced.

A threat refers to factors that have the potential to negatively impact an organization. For example, a drought is a threat to a wheat-producing company, as it may destroy or reduce the yield of a wheat crop (Investopedia, 2016) {Ref#12}

Limitations of SWOT

• SWOT analysis may cause organizations to view circumstances as a very simple because of which the organizations might overlook certain key strategic contact which may occur.
• Identification of factors as a strength, weakness, opportunity and threats may be too subjective and difficult to identify.
• Lack of required skills and efficient labor etc.

(Managementstudyguide.com, 2016) {Ref#13}

Financial Techniques

During financial analysis of FSLL, main focus will be on ratio analysis. While there are various ratio analysis tools, profitability, liquidity, leverage and investor ratios will be analyzed primarily. Understanding about the ratios has already been built during ACCA studies. CFA studies further polish my analytical techniques and abilities.

The ratio analysis will be helpful to identify the financial prospects of the company compared to that of competitors and industry.

• Profitability Ratios

This is the ability of the company to generate earnings compared with its expenses and other relevant costs incurred during a specific period. Three main profitability ratios are Gross Profit Margin, operating profit margin and return on equity.

• Gross Profit (GP) Margin:

GP is the profit company makes after deducting the directly attributable costs associated with manufacturing the goods or rendering the services. (Investopedia, 2016) {Ref#12}

It can be calculated by following formula:

GP Margin (%) = Gross Profit/Revenue x 100

• Operating Profit (OP) margin:

Operating profit is the profit earned from a firm’s normal core business operations. It does not include any profit earned from non-operating sources.

It can be calculated by following formula:

OP Margin (%) = Operating profit/Revenue x 100

• Return on equity:

It measures organization’s ability by revealing how much a profit generates with the money shareholders have invested.

It can be calculated by following formula:

ROE (%) = Net Income/shareholder’s equity

• Liquidity Ratios

These ratios measure the ability of the company to pay off its short term obligations as they fall due. It is helpful in working capital management. Two liquidity current and quick ratios will be analyzed during the research project. (Readyratios.com, 2016) {Ref#14}

• Current Ratio:

The current ratio measures a firm’s ability to pay off its short-term liabilities with its current assets. The current ratio is an important measure of liquidity because short-term liabilities are due within the next year.

Current Ratio = Current Assets/Current Liabilities

• Quick Ratio:

It measures how many liquid assets are available to pay off its short term liabilities. It differs from current ratio because it generally excludes inventory from current assets. (AccountingCoach.com, 2016) {Ref#15}

It can be calculated by following formula:

Quick Ratio = (Current assets-inventory)/Current Liabilities

• Gearing Ratios

It is a measure of financial leverage demonstrating how much firm’s activities are funded by long term debt compare to owner’s equity.

• Debt Ratio

It is the measure of total long term and short term debt to total assets of the company. It can be interpreted as the proportion of a company’s assets that are financed by debt. (Investopedia, 2016) {Ref#12}

It is calculated as follows:

Debt Ratio (%) = Total Debt / Total Assets x 100

• Interest Coverage Ratio

The interest coverage ratio (ICR) is a measure of a company’s ability to meet its interest payments. (Readyratios.com) {Ref#14}

It is calculated as follows:

Interest Coverage Ratio (%) = EBIT/Interest expense x 100

• Investor’s Ratios

Investor ratios are used to measure the ability of a business and its management to earn an adequate return for the owners of the business. (Plan Projections, 2016) {Ref# 16}

• Earnings per Share (EPS)

EPS is a market prospect ratio that measures the amount of net income earned per share of stock outstanding.

            EPS (Rs.) = Net income-Preferred Dividend

Weighted average common shares outstanding

• Dividend Payout Ratio

The dividend payout ratio is the amount of dividends paid to stockholders relative to the amount of total net income of a company. (Financeformulas.net, 2016) [Ref#17}

It can be calculated by following formula:

Dividend Payout Ratio (%) = Dividends paid and proposed/Net Profit x 100

Limitations of Ratio Analyses

The ratio analysis is the most basic and wider used tool to analyze the financial performance of the company. However like others financial and business techniques, it has some limitations listed as bellow:

• Different organizations use different accounting policies (E.g. depreciation, research & development costs, inventory valuation method etc.) so it is difficult to compare the ratios.
• Window dressing or creative accounting techniques have made Ratio Analysis less effective.
• Year end figures can be manipulated into ones favor (E.g. Intentionally delaying payments to suppliers to provide a strong cash position).
• Ratio analysis only considers the quantitative data and ignores qualitative factors.
• The ratios entirely depend on the quality of the information being provided by the financial statement. In case of faulty figures, the ratios would be meaningless.

Part 3: Results, Analysis, Conclusions & Recommendations

Business Analysis

PEST Analysis

Political Factors

FSLL is operating in Pakistan where political system is not much mature. In the past military had intervened several times in the government and regulatory structure. (Auken, 2016) {Ref#47} Besides the military intervention, the current ruling party has also faced couple of times long sit-ins and protests by opposition parties. (DAWN.COM, 2016) {Ref#48} However, despite the political unrest and system limitation, the ruling party has a business friendly repo in the country.

After getting in power in the year 2013, the new government has emphasized on the business and made industrial reforms, including pharmaceutical industry.

A new drug policy was introduced during March 2015, where sale price hikes were linked to national inflation rate and should be calculated through specific formula. (Anon, 2016) {Ref#18}

However, the price hike procedure according to new drug policy was violated by several pharmaceutical companies including some multinational as well. (DAWN.COM, 2016) {Ref#19}

Later on honorable Sindh high court verdict went in favor of price hike. However, the federal government challenged the high court decision in the Supreme Court of the country. (Recorder, 2016) {Ref#20}

Moreover, the government is introducing new policies regarding trade and economic, child labor and minimum wages etc. (Pakistantoday.com.pk, 2016) {Ref#49} However, implementation of the policies always remains a concern in Pakistan.  Political risk of FSLL is assessed to be high due to the aforementioned reasons.

Economic Factors

Pakistan has made key progress towards economic stability, laying foundation for higher more inclusive growth. Growth is expected to reach 5% in Fiscal year 2016/2017 supported by buoyant construction activity, strengthened private sector credit growth, and an investment upturn related to the China Pakistan Economic Corridor (CPEC) (Imf.org, 2016) {Ref#21}

Standard and Poor (S&P) has raised Pakistan’s sovereign credit rating from B- to B, led by fiscal consolidation to 4.6% of GDP, external account strength and greater monetary flexibility. (Reuters, 2016) {Ref#22}

Moreover, the country foreign exchange reserves is at highest level standing at $24.1 billion translating into import cover of 6 months, discount and inflation rates are at decades low level supported by lower commodities prices. The policy rate is now at 5.75%, more than 700 basis points lower than it was during the year 2012. Similarly, inflation has reduced from double digits to an average of around 4%. (Sbp.org.pk, 2016) [Ref#23}

The improvement in the economy of Pakistan is creating new opportunities for the investment. (Stevens, 2016) {Ref#46} The low inflation and discount rate leads to low raw material prices and finance cost. Although, FSLL is not highly geared; low discount rate is a positive factor in case any new fund borrowings n.

Social Factors

Being the sixth most populated country in the world; the demographics of Pakistan are very much diverse. More than 50% of the population is living in the rural area. 66% of the population are young and are under the age of 30. (arfan, 2016) {Ref#24}

The country is facing other issues like poor sanitation, drinking, smoking, and poor oral hygiene etc. There is high variation in qualification of people living in rural and urban areas. However, In order to achieve a sustainability in health sector, a number of vertical programs are operated in Pakistan including, Lady Health Worker Programs, Malaria, TB and AIDs Control Programs, Foods and Nutrition Programs. (Finance.gov.pk, 2016) {Ref#25}

Due to the various vertical programs being operated by the government and other health awareness campaign runs by different local and international NGO’s, people becoming more informed about the health care activities. (Waheed, 2016) (Ref#44}

The fast changing country demographics, increasing literacy rate and the aforementioned health awareness campaigns are creating more demands for the FSLL’s products. (Center For Global Development, 2016) {Ref#45}

Technological Factors

The development in technology is an unending and increasingly fast growing process. Like any other industry, a pharmaceutical company also needs to keep up with the accelerating pace of technological development. Companies need to be innovative to gain a competitive advantage. Most of the pharmaceuticals companies in Pakistan are using the advanced technology in manufacturing of medicines and drugs. (Industryweek.com, 2016) {Ref#43}

FSLL has agreements with a number of multinational partners for selling, distribution and co-manufacturing of products including the Bagó Group in Argentina, BioGaia of Sweden, Biofreeze of Hygienic Corp., PanTheryx, Boston Scientific and Gilead Sciences, Inc. in the USA., hence mostly the technology used are up to date. (Ferozsons-labs.com, 2016) {Ref#2}

During the financial year ended June 2016, FSLL has invested Rs. 510.8 Million for balancing and modernization of its manufacturing facilities. This investment will further reduce the manufacturing cost of products and improve its competitive position in the industry. (Financial Reports, 2016)

• SWOT Analysis

Strengths

• FSLL has a licensing arrangement with many multinational organizations including the Bagó Group in Argentina, BioGaia of Sweden, Biofreeze of Hygenic Corp., PanTheryx, Boston Scientific and Gilead Sciences, Inc. in the USA. Hence the company has a good reputation and gets benefit from the experience and technology of those companies. (Ferozsons-labs.com, 2016) {Ref#42}
• As a regional partner of Gilead Sciences, Inc., FSLL is the sole distributor of Sovaldi (Sofosbuvir) that is the new miraculous medicine for chronic Hepatitis-C treatment. This is the marvelous strength of the company leading to the tremendous market share in Hepatitis-C treatment and top line’s growth. (Gilead.com, 2016) {Ref#26}
• FSLL is also the marketing and distribution partner of Boston scientific Corporation, USA for the range of cardiac and peripheral products and interventional devices. This allows the company to offer complete medical solutions in cardiology, oncology, urology and gastroenterology and made FSLL the brand name in the mentioned area.
• FSLL has established BF Biosciences limited as a joint venture with the Bago group of Argentina which is the Pakistan’s first biotech pharmaceutical company. The BF Biosciences manufactures biological medicines to treat Cancer and Hepatitis C for the local and export markets.
• FSLL has total debt to total assets ratio of less than 1% meaning that it has the ample strength to get cheaper finance comparatively in case of any future funds borrowings.
• FSLL has a strong and skilled workforce being supervised by experienced team of middle line managers, executive managers and board of directors. FSLL has also developed a culture of continuous training for staff that motivates them and provides a good work environment and job satisfaction to them.
• FSLL has also gets multiple time Karachi Stock Exchange (KSE) Top 25 Companies awards, indicating their strong corporate governance structure, quality financial and non-financial reporting, human resource management and corporate social responsibility. (Recorder, 2016) {Ref# 27}

Weaknesses

• FSLL has only three regional offices for distribution of products in the main cities of Pakistan including Lahore, Karachi and Rawalpindi. But they do not have presence in other areas of Pakistan like Khyber Pakhtunkhwa and Baluchistan provinces, Southern districts of Punjab Province and Interior Sindh province etc. (Ferozsons-labs.com, 2016) {Ref#42}
• Despite having a strong brand name and being a distribution and co-manufacturing partner of many multinational companies, the export of the company is only a 2% of gross sales. (Appendix)
• FSLL is importing around 80% of its raw material from different countries and has a net liability exposure in the foreign currencies. However, FSLL did not hedge against the depreciation of local currency in order to better manage foreign currency risk. (Financial Accounts)

Opportunities

• Currently the government spending on health care is less than 1% of national GDP, however, the recent health care reforms and rise in private health care activities creating new demands for the company’s products. (Data.worldbank.org, 2016) {Ref#41}
• Currently the exports of pharmaceutical products of Pakistan are only $150.9 million during the period from Jan 2016 to Sep 2016. However, there is an immense export potential to Afghanistan and other central Asian countries. (Sbp.org.pk, 2016) {Ref# 28}
• Due to the recent spike in infrastructure activities in the country under the frame work of China Pakistan Economic Corridor (CPEC) and inauguration of Gawadar seaport, export of the country may also become competitive in the Middle East and Europe and hence providing a chance to FSLL to materialize on the opportunity. (Zaidi, 2016) {Ref#39},
• FSLL and other Pharmaceuticals companies in Pakistan all are importing raw materials from different countries. Hence there is great potential in backward integration in the sector.

Threats

• The Drug Regulatory Authority of Pakistan (DRAP) has registered several generic brands of Sofosbuvir, and enforced an arbitrary selling price for these generics, over 80% below Sofosbuvir. In a highly price sensitive market like Pakistan, this shift will have a detrimental impact on sales of FSLL. (Paper, 2016) {Ref# 29}
• Raw material which is one of the main constituent of variable cost of production are importing from different countries primarily from China and India. There is a threat that supply chain may not properly managed due to the long routes and also due to change in trade and commerce policies. (DAWN.COM, 2016) {Ref# 30}
• As mentioned earlier that FSLL are importing all of the raw material, hence exchange rate fluctuation is the major threat to deterioration in the profit margins.
• While there is an immense potential in the sector both in domestic and export market, however, this can also attract new entrants and dilute the market share.
• As discussed earlier in the Political factor of PEST Analysis, the political system is not much mature in Pakistan, the government policies are continuously changing due to political and other motivation that may cause overall industry profitability and hence that of FSLL’s.
• Pharmaceutical plant of FSLL is located in the province of Khyber Pakhtunkhwa which is the main victim of terrorism in Pakistan. There is a threat of terrorists attack on plant etc. (Durrani, 2016) {Ref#40}

• Ratio Analysis

Profitability Ratios

• Gross Profit (GP) Margin

The gross margin of the FSLL for the financial year ended June 2016 stood at 40.5%, 500 basis points lower over the corresponding period of last year. While in comparison to the financial year ended June 2014, the gross margin has tumbled by 7.2% in percentage terms. The decline in gross margin is primarily due to lower margin in imported products. (Recorder, 2016) However, in absolute terms gross profit is showing upward trend. Gross profit for the financial year ended June 2016 clocked in at Rs. 4,594 million, up 177% Year on Year (YoY) as compared to the same period of last year. This hefty improvement in gross profit is primarily due to 98.5% higher revenue over the corresponding period of last year. The exceptional growth in top line of the company was witnessed due to portfolio of imported products, particularly Hepatitis C franchise under license from Gliead Sciences, Inc. (DAWN.COM, 2016) The gross profit in absolute terms has grown at a Cumulative annual general growth rate (CAGR) of 59% over the three years period from July 2013 to June 2016.

However, in comparison to the competitor SCL, the gross margin of the company is lower by 11.5% in percentage terms during the financial year ended June 2016. SCL has improved its gross margin from 44.6% in Year ended June 2014 to 50% in the Year ended June 2016. While on the other hand, FSLL gross margin has decline from 47.7% to 40.5%. As explained earlier this was primarily due lower margins on imported products. In absolute terms, however, SCL gross profit has grown only by 33.5% year on year during the financial year ended June 2016 as compared to that of FSLL 177%.

Gross Margins (%)

(Figure 1 Source: Appendix)

• Operating Profit (OP) Margin

Despite 500 basis points decline in gross margin during the financial year ended June 2016, the operating profit margin of FSLL has improved by 120 basis points. While in comparison to the financial year ended June 2014, operating margin has surged by 500 basis points. The improvement in operating margin is owing to continuous decline in administrative expenses as a percent of sales (Admin expense was 5.1% of sales in year 2014 and 2.7% in year 2016) due to economy of scales. Selling and distribution expenses as a percent of sales are also showing declining trend due the fact that most of the personnel are on fixed payroll.

In comparisons to that of SCL, the operating margin is very much in line. SCL’s operating margin stood at 25.4% during the financial year ended June 2016, while that of FSLL’s operating margin was 25.3%. (Ref Appendix)

Operating Profit Margin (%)

(Figure 2 Source: Appendix)

• Return On Equity (ROE)

The ROE of FSLL clocked in at 48.7% during the financial year ended June 2016, surge by 1,840 basis points year on year compared to the same period of last year. While during the financial year ended June 2014 ROE was 21.3%. This hefty improvement in ROE can be attributed to 143.6% year on year growth in net earnings during financial year ended June 2016.  Net earnings have grown from Rs. 552 million in the year ended June 2014 to Rs. 2,233 millions in the year ended June 2016. Moreover, FSLL has continuously paying a dividend during the periods under review.  During the year ended June 2016, the company paid out 30.1% of net earnings as a dividend leading to the improvement of the ratio.

SCL’s ROE stood at 30.2% during the financial year ended June 2016. The lower ROE as compared to FSLL is due to slower growth in net earnings. During the year ended June 2016, net earnings of SCL have grown by mere 3.8% while that of FSLL has grown by143.6%.  Similarly, during the year ended June 2015, net earnings of FSLL have grown by hefty 116.7% while SCL’s net earnings have surged by 22.3% only. (Ref Appendix)

ROE (%)

(Figure 2 Source: Appendix)

Liquidity Ratios

• Current Ratio (CR)

The current ratio of FSLL stood at 4.67 times as at June 2016. Historically, the ratio was standing in the current range. The ratio was 4.03 and 2.39 times as at June 2014 and June 2015 respectively.  As indicated by the ratio, liquidity position of FSLL is standing at a comfortable position.

While on the other hand, the SCL’s current ratio was standing at 1.65, 2.02 and 2.39 times as at June 2014, June 2015 and June 2016 respectively.

Comparing the ratio to competitors, FSLL is highly liquid to that of SCL. However, this can be a bad working capital management as well. Stock in trade and trade debts of FSLL have grown by 49% and 59% year on year as at June 2016 compared to the same period of last year. While stock in trade and trade debts of SCL have grown by 25.6% and 22.8% year on year as at June 2016 against the same period of last year.

This pileup in current assets may not be ideal; however, the reason may be due to the 98.5% year on year increase in net revenue during the period ended June 2016 against same period of last year. (Ref Appendix)

• Quick Ratio (QR)

Like current ratio, the quick ratio or the cash ratio of FSLL is also quite comfortable. The quick ratio was standing at 2.4, 1.4 and 2.2 times as at June 2014, June 2015 and June 2016.The ratio indicates that FSLL has ample of liquid assets to settle off its current obligations. Similarly, the quick ratio of SCL was standing at 1.2, 1.5 and 1.8 times as at June 2014, June 2015 and June 2016.

However, as discussed in current ratio, the company creating too much current assets which may be not ideal. This may indicate lake of reinvestment opportunities or poor working capital managements. (Ref Appendix)

Gearing Ratios

• Debt Ratio

The only debt that the company has is the short term borrowings of Rs. 43 million as at June 2016. The debt ratio that is defined as total debt/total assets was only 0.63% as at June 2016. Historically, the ratio was 0.10% and 0.04% as at June 2014 and June 2015 respectively. Similarly, the debt ratio of SCL was standing at 24.3%, 17.1% and 10.24% as at June 2014, June 2015 and June 2016.

This ratio indicates that the gearing position of the company is very strong. The company is almost 100% equity financed. So there is less risk of liquidity and going concern issues. Furthermore, the strong gearing position of the company supports an idea of any future investments. If the company wants to expand geographically or increase the products brands, the lenders will easily finance the project. However, equity being expansive source of finance, company needs to reinvest the equity or accelerate the distribution of cash to owners. (Ref Appendix)

• Interest Coverage Ratio (ICR)

FSLL has astonishing interest coverage ratio during the three years period under review. The ratio was standing at 221 times during the financial year ended June 2016. Historically the ratio was also excellent standing at 41 and 86 times during the financial year ended June 2014 and June 2015 respectively. The ample improvement in the ratio is primarily due the astonishing top line and operating profit growth. During the financial year ended June 2016, top line and operating profit of the company have grown by 98.5% and 108.6% respectively. Moreover, as discussed in debt ratio, the company has only interest bearing obligation of Rs. 43 million short term borrowings, it also leads to the improvement of the ratio.

The interest coverage ratio of SCL was standing at 6.4, 7.2 and 25.4 times during the financial years ended June 2014, June 2015 and June 2016. (Ref Appendix)

Looking at the ratio of FSLL and comparing it with the competitor SCL, the company is at very strong financial grounds.

Investor’s Ratios

• Earnings Per Share (EPS)

The top line’s growth of FSLL has trickled down during the periods under review. The bottom line of the company stood at Rs. 73 per share during the financial year ended June 2016, an increase of 143.6% year on year against the same period of last year. The hefty growth in the bottom line is primarily due to the 98.5% year on year growth in net revenues. Moreover, lower finance cost, lower selling and admin expenses as a percent of sales against last year leads to improvement in the bottom line of the company. During the three years period under review, the bottom line has grown at a CAGR of 74%.

Furthermore, the number of ordinary shares outstanding during the three years period fairly remains constant. Hence the increase in earnings per share is primarily due to the bottom line’s growth.

EPS of SCL has grown by a mere 3.8% during the financial year ended June 2016 against the same period of last year. Similarly, the three years CAGR is just 8.3% while that of FSLL’s three year CAGR is 74%. However, the EPS of SCL is diluted due to issuance of 40% stock dividend in financial year 2014, 20% stock dividend and 10% right issue in 2015 and again 14% stock dividend in 2016. (Ref Appendix)

EPS (Rs)

(Figure 7 Source: Appendix)

• Dividend Payout Ratio (DPR)

The FSLL has not only earned plenty of cash for the shareholders but also returning them in the three years period under review. The dividend payout ratio stood at 86.8%, 63.4% and 30.1% respectively during the financial year ended June 2014, June 2015 and June 2016. The ratio has sharply declined in the financial year 2016 due to capital investment of Rs. 510.8 million for balancing and modernization of manufacturing facilities. (Financial Accounts, 2016)

However, the ratio is still in line with the competitors. The cash payout ratio of SCL clocked in at 36.1% during the financial year ended June 2016. Historically FSLL payout ratio was very high compared to SCL. During financial year 2015, SCL has paid out only 12.5% of its earnings as cash dividend. SCL has also paid out 40% stock dividend in the financial year 2014, 20% stock dividend and 10% right issues in the financial year 2015 and 14% stock dividend in the financial year 2016. (Ref Appendix)

While the higher dividend distribution is a positive signal for the shareholders, sometimes it sends a bad signal as well. Higher pay-out ratio sometimes signals that the company did not foresee any profitable opportunities which may restrict future growth prospectus.

Conclusions

FSLL is operating in Pakistan where political system is not much mature. Demographics of the country are diverse; more than 66% of population are young and are under the age of 30. (arfan, 2016) {Ref#24} The country is also facing poor hygiene, sanitation and other health care issues. (Finance.gov.pk, 2016) {Ref#25} However, despite the political unrest and other social issues facing by the country, economy of the country is growing. It is expected that the economy will grow at a rate of 5% in the fiscal year 2017 (Imf.org, 2016) {Ref#21}. Pharmaceutical company in the country is using updated technology due to the presence of different multinational organizations and having collaboration with multinational companies. FSLL’s technology is mostly updated and during the year 2016 further invested Rs. 510.8 million for balancing and modernization of manufacturing facilities. (Financial Accounts, 2016)

Being the selling, distribution and co-manufacturing partner of different multinational organization, FSLL has a unique strength. FSLL is the sole distributor of Sovaldi (Sofosbuvir) that is the new miraculous medicine for chronic Hepatitis-C treatment (Gilead.com, 2016) {Ref#26} However, recently, The Drug Regulatory Authority of Pakistan (DRAP) has registered some generic brands of Sovaldi at a price less than 80% of Sovaldi. In a highly price sensitive market like Pakistan, it is a major threat to the FSLL’s top line growth.

There is immense potential in the sector in the domestic market and also in export market due to the recent infrastructure related activities under the frame work of China Pakistan Economic Corridor (CPEC). (Katoch, 2016) {Ref#33} However, having that attractive profit margin, threat of new entrant is high.

FSLL’s financial performance during the last three year under study is exceptionally well owing to the astonishing top line’s growth on the back of higher sale of imported products mainly Sovaldi.

During the three year under study, sales revenue has grown at a CAGR of 72% compared to the SCL’s three year CAGR of 22% only. Despite the deterioration in the gross margin of FSLL, net margin has improved and per share earnings has grown at a CAGR of 74.1% compared to SCL’s three year CAGR of 8.3%. (Appendix)

FSLL is almost 100% equity financed and having only interest bearing debt of Rs. 43 million short term borrowings as at June 2016. Hence the interest coverage ratio is standing at 220.85 times, compared to SCL’s ratio of 25.43 times.

Liquidity position of FSLL is also comfortable and the current and quick ratio was standing at 4.67 and 2.2 times as at June 2016, compared to SCL’s ratios of 2.39 and 1.8 times.

Furthermore, FSLL is not only earning plenty of cash for the shareholders but also returning them. The cash payout ratio was standing at 86.8%, 63.4% and 30.1% during the period ended June 2014, June 2015 and June 2016 respectively. While the higher payout ratio is a positive signal to the shareholders, sometime it sends a bad signal as well. It signals that the company might not have profitable projects that may restrict future growth prospects. (Thefinancebase.com, 2016) {Ref#34}

Recommendations

Although political risk of the country is assessed to be high, (Bmiresearch.com, 2016) {Ref#35} still the economy is growing at a rapid pace. Government has made economic reforms after getting in power in the year 2013.  A new drug policy was introduced by the government during the year 2015. There is great export potential in the pharmaceutical sector. As FSLL is almost 100% equity financed, it has a potential to raise loan for any project and expansion. Having a licensing arrangement with many multinational organizations, FSLL has an added advantage to capitalize on the opportunity due to experience and technology of those organizations. There is also opportunity of the backward integration in the sector as currently all the pharmaceutical companies importing raw material from abroad. (DAWN.COM, 2016) {Ref# 30} FSLL needs to diversify its product portfolio because other pharmaceutical companies like SCL also have presence in nutrition and beverages sectors. (Searlecompany.com, 2016){Ref#36}  FSLL also needs to expand the distribution network in the country. FSLL should hedge its foreign currency exposure against exchange rate fluctuations.

The low discount (Pakistantoday.com.pk, 2016) {Ref# 37} and inflation rate (Newsdog.today, 2016) {Ref#38}, growing economy (Zaidi, 2016) {Ref#39}, up gradation of sovereign credit rating of the country and the healthy profit margins supports an investment idea in Pakistan and in pharmaceutical sector. However, before making investment decision risks like political instability and terrorism should be consider.