Tuesday, August 17, 2010

Pfizer Vs. Merck, Part III: "Quick Ratio", Or Current Coverage Multiple

As a general rule, most businesses of size like to have, at any given moment -- in current assets -- about twice what they owe, in current liabilities. Now, as is true with all general statements, there are exceptions to the general rule. However, they wouldn't apply here. A pharma business, with potentially vast short-term cash requirements, ought to try to keep at least double its current liabilities on hand, in current assets (highly marketable securities, cash and high-quality, short dated receivables). That way, it can afford twice as many rainy days as it expects -- without a liquidity event. Thus, the 2x rule.

As the barrel-chart at right shows, Pfizer is about 15 percentage points ahead of Merck, on this "quick coverage" test, as of Q2 2010. Pfizer is at 2.07x (per pages 4 and 149, of the Pfizer's most recent SEC Form 10-Q), Note that Merck actually failed to meet this above-described general rule -- at only 1.70x (page 3 of the Form 10-Q), as of the end of Q2 2010. [This is not even remotely life-threatening, it is just sub-optimal, in my estimation. A slew of rainy days in a row could present problems.] Significantly, Pfizer's "quick" coverage is now above 2x -- when it was at only 1.66x at year end 2009. Merck's has slipped(albeit marginally) since then, from 1.81x at year end 2009, to today's 1.70x.

And all of this is, of course, one more reason to suggest that Merck is fully-valued at around $37, and Pfizer is undervalued, as of tonight's NYSE close -- at around $16. That has been the theme of these two prior posts -- here (i) and here (ii) -- as well.

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