PRGO - Perrigo Company: Still Not Getting There

2023-05-18 15:12:00 ET

Summary

• In 2021, I hoped and anticipated that Perrigo Company plc was leaving its turbulent past behind.
• The company resolved its issues around its tax situation, but then announced a rather expensive deal as well.
• Poor execution and higher debt assumed has caused uncertainty on Perrigo Company shares ever since, resulting in continued pressure on shares.
• Given this lack of execution, I am simply very cautious, despite the low adjusted earnings multiples at which Perrigo Company plc shares trade today.

In September 2021, I discussed that Perrigo Company plc ( PRGO ) had announced a big deal after the company cleaned up part of its past issues, selling the RX business, resolving some of the Irish tax issues, and obtaining a refund from the Omega deal. In fact, the company was making a substantial acquisition, as I hoped and believed that the company might be learning from its past poor capital allocation strategies, although this relatively expensive deal came a bit early in the recovery story.

A Recap

Perrigo has a troubled past, as the company participated in the M&A frenzy which took place during in pharma space in the 2010s, with industry momentum driven by higher prices for drugs and anticipated tax inversion benefits.

The company announced an $8.6 billion deal to acquire Elan, and furthermore acquired Omega Pharma as shares rose from the $20s in 2009 to a peak of $200 in 2015 as Mylan was looking to acquire Perrigo itself.

With drug prices coming down, regulatory and legislative scrutiny on such practices increasing, high leverage incurred, and tax claims arising, shares of Perrigo and many of its peers which participated in these practices imploded in the years which followed. Shares subsequently fell to the $50 mark pre-pandemic, a 75% pullback from the highs in 2015.

In 2020, the company grew sales 5% to $5.0 billion, with the business comprised out of a $4 billion consumer business segment and a billion RX unit, which the company sold early in 2021 in a more than $1.5 billion deal. The deal tag came in at 1.6 times sales and just over 6 times operating earnings, low valuation multiples, but needed as the business was simplifying and telling a more concentrated story to investors.

Net debt would essentially be cut in half to $1.5 billion upon this deal, as the 136 million shares valued shares at $5.6 billion at $41 per share, granting the business a $7.1 billion enterprise valuation post the RX deal. The remaining consumer business posted sales of $4.1 billion and adjusted operating earnings of $540 million, as leverage seemed under control and the business would become a lot more stable. Hence, the business had the potential to become a stable consumer play, but of course, the company still dealt with a potential $1.6 billion tax liability at the time.

Over the summer in 2021, it was evident that the core business could post earnings close to $2.50 per share, as the maximum tax liability of the business was reduced to a billion. Amidst this improved momentum, the company announced the purchase of HRA Pharma, a self-care company in a $2.1 billion deal. With a $400 million sales contribution and $116 million EBITDA contribution, valuations were demanding, even as Perrigo guided for strong accretion to adjusted earnings per share, driven by strong growth of the business.

Pro forma net debt should rise to $3.2 billion upon this deal, post the RX divestment, but should fall to $2.8 billion as a judge granted a repayment in relation to the Omega deal, although the tax issue might increase debt again. With the business arguably becoming a bit more stable and earnings per share set to surpass the $3 per share mark, while the business should become much more stable and hopefully boring, I was cautiously optimistic in anticipation of a recovery.

Stagnation

The cautiously upbeat stance in September 2021 has been too early with the benefit of hindsight. Over the past one and half years, shares have traded in a $30-$40 range, with shares now trading towards the lower end of the range.

In March 2022, the company posted its result for 2021 with sales up a percent to $4.14 billion. Adjusted earnings fell from $2.33 per share to $2.06 per share, even as another GAAP loss was reported. Without factoring in a contribution from the HRA deal, the company guided for 2022 sales to rise by around 4%, with adjusted earnings seen between $2.10 and $2.30 per share, hardly an inspiring outlook. That deal for HRA closed in May 2022, with the purchase price being reported at $1.9 billion deal, a bit lower than the value communicated at the time of the announcement.

Forwarding to February 2023, reported sales rose to more than $4.45 billion, including some contribution for HRA for the majority of the year, offset in part by the divestment of some operations in Latin America. The company saw adjusted earnings improve to $2.31 per share (in constant currency terms) and reported at $2.04 per share on a reported basis, and while this was a bit higher than guided for at the start of the year, it is generally disappointing given the significant contribution of HRA.

Moreover, net debt of $3.4 billion was steeper than I anticipated in dollar terms, and earnings power has been lagging severely compared to expectations, although uncertainty on the Irish tax liabilities have been largely settled by now, although it should take until 2025 before leverage is reduced to 3 times EBITDA, or less.

Quite frankly the company sees a reasonably solid outlook for 2023 with reported sales seen up by a midpoint of 9%, as adjusted earnings per share might improve to $2.50-$2.70 per share. Growth looks solid, but is again in part aided by the fact that HRA will contribute to sales and earnings for the entire year now.

What Now?

The reality is that Perrigo Company plc shares are down by about a quarter in the past fifteen months as the performance has been softer than expected. Earnings have been lagging in a meaningful way, as the HRA deal actually leverages up the business significantly, all in a high interest rate environment here today.

Amidst all this, there are valid reasons (despite the solid strategic route of the business) why investors are cautious as operating performance feels a bit soft, earnings remain complicated, and leverage is high (which is disappointing after leverage caused havoc on the business in the past).

For me, Perrigo Company plc remains a case in which management has something to prove. Quite frankly, I see no reason to add more Perrigo Company plc shares here today. In fact, I would be susceptible to sell out of my Perrigo Company plc position in case shares show a meaningful uptick.

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