PBH - Holding Prestige Consumer Healthcare

Summary

• I'd characterise the recent financial history here as "sclerotic". Although I don't expect much growth, I don't expect the business to crater either.
• The valuation is ambiguous in my estimation, the shares are either reasonably or richly priced. I'll neither add to, nor take from my current position.
• Previously I added about 4% to my total return by selling puts. Unfortunately it's not possible to initiate a similar trade today.

It’s been about 50 months since I wrote my bullish article on Prestige Consumer Healthcare ( PBH ) and in that time, the shares have returned about 36.2% against a gain of 48.3% for the S&P 500. The stock has had a rather bad time of it in August, though, so I have an urgent need to review the name. I’ll work out whether I want to buy more, sell, or hold the position by looking at the most recent financial results, and comparing those to the stock valuation. Additionally, four years ago I wrote some puts on the stock, and I’m absolutely champing at the bit to write about how that trade worked out.

I can’t speak for all of you, but late summer is a fairly busy time for me. For instance, it’s the time of year when I frantically search around for my igloo making and ice fishing gear before the first snows of September. For that reason, time is short for me as I imagine it is for you. In an effort to save you time, I present the “gist” of my thinking in a summary paragraph called the “thesis statement.” This gives you access to my point of view while subjecting you to as little of the bragging and other tedium as possible. You’re welcome. Anyway, I don’t expect much growth from this business over the next few years, but I also don’t expect the shares to crater. The shares are cheap by some measures, but relatively expensive by other measures. For that I’ll neither add nor reduce my position. Also, I added about 4% to my total returns by selling puts previously. While I like the strategy of selling deep out of the money puts, I can’t do so here because the premia on offer is quite thin in my estimation.

Financial Snapshot

On their most recent earnings call , the CEO opined that Prestige had achieved:

The highest level of quarterly sales in our company’s history

While that’s technically true, I’m a bit more muted in my appraisal of the performance. Specifically, I note that revenue for the most recent quarter was only about 2.9% greater, while net income was about 4% lower than the same period a year ago. This is consistent with longer term financial performance here, as revenue in FY 2022 was only about 4% greater than it was in 2018.

It’s not all bad news at Prestige, though, as the balance sheet has improved nicely over the past four quarters, with long term debt down about 4.7% from the same period last year, while cash was about $8.7 million higher over the past three months.

While I don’t expect a huge uptick in the number of sore throats or warts that will drive revenue higher here anytime soon, I think this is a reasonable business to buy at the right price.

The Stock

In the same way that a fast growing company can be a terrible investment at the wrong price, a slow grower like this one can be an excellent investment at the right price. Put another way, if you pay a near infinite price for very healthy growth, you'll eventually lose money. Put yet a slightly different way, growth isn’t worth an infinite price and low growth isn’t worth a zero price. The idea behind this is that the "business" and the "stock" are very different things, and that's why I write about them separately. Simply put, stocks are affected by forces that are in addition to, and in many ways distinct from, the ups and downs of the firm. For instance, a stock may move up or down in price because of what an influential analyst said about a related, or only peripherally related, business. Also, the stock is also very definitely affected by our collective views about the overall market, and stocks as an asset class. So, for instance, investors in Prestige may be worried about what Jerome Powell says, in spite of the fact that his utterances have nothing whatsoever to do with the number of wart treatments this company will sell over the next five years. For these reasons, we need to consider the stock as a thing distinct from the business. It may be tiresome that your stock gets buffeted around by forces having very little to do with the company, but in my experience this creates tremendous opportunity also. The only way to consistently make money trading stocks is to spot discrepancies between the crowd's view about a given company, and subsequent results. Further, we want to go long a stock when the crowd becomes overly pessimistic, and we want to avoid stocks when the crowd becomes overly sanguine.

I want to buy when the crowd is particularly pessimistic and I measure pessimism in a few ways, ranging from the simple to the more complex, and I publish some of those measures on this forum. On the simple side, I look at the ratio of price to some measure of economic value like earnings, free cash flow, the dividend yield and the like. I want to see a stock trading at a discount to both the overall market and its own history. You probably recall that over four years ago I became bullish on this name when it was trading at a price to free cash flow ratio of about 10.11. Fast forward to the present and things are only slightly more expensive per the following:

Source: YCharts

In addition to looking at simple ratios, I actually use a large number of other, more complex valuation measures, one of which involves trying to understand the assumptions currently embedded in price. If you read me regularly, you know that I rely on the work of Professor Stephen Penman, and increasingly Mauboussin and Rappaport to do this. This approach uses a company's stock price itself as a source of information. It involves "reverse engineering" the assumptions that create the current price. When I apply this to Prestige, I forecast a growth rate of ~5.5% for this company. I considered that to be fairly optimistic, and thus relatively risky. Given the low growth I’m expecting here, and what is a pretty optimistic price, I can’t recommend buying more at this price.

Options Update

As promised earlier in the article, I’m about to offer a not so subtle brag about how my short puts performed here. At the time that I published my article on Prestige, I wrote October 2018 puts with a strike of $35 for $1.55. These were about $3 out of the money at the time, they expired worthless, and thus added about 4% to my overall return here. This is yet another example of the risk reducing, yield enhancing power of these instruments. If you haven’t considered generating income by selling out of the money puts on your favourite investments I would urge you to consider the strategy.

That said, it’s not always possible, and that’s the case here at the moment. For instance, the January 2023 puts with a strike of $45 are currently bid at $0.35, which I consider to be a paltry return, and so thus not worth it. If the shares fall precipitously in price, I’ll likely re-enter the trade, but for the moment there’s nothing to be done here in my view.

Conclusion

I’m neither willing to buy nor sell Prestige at the moment. The company is not in danger of a crisis anytime soon in my view, but I also don’t expect much growth here. If the valuation were compelling, or if there were greater premia on offer from the options market, there might be something to do. There’s nothing to do here, though, so I’m just going to wait, and will react accordingly if the shares move dramatically in price from here. If anyone asked for my one sentence appraisal of this investment as of late August 2022, I’d say “don’t expect much growth, but don’t expect much further pain from the stock.”

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