PRGO - Perrigo Outlook Healed By Repositioning

2023-06-12 17:30:05 ET

Summary

• Perrigo is repositioning itself as an exclusively consumer-facing over-the-counter brand, streamlining its sales process, and expanding its market through acquisitions.
• PRGO's Opill contraceptive is expected to receive FDA approval for OTC usage, potentially boosting the company's net sales in the women's health and contraceptive category.
• Despite concerns about debt levels, PRGO's 3.31% dividend yield and position as one of the largest consumer staples manufacturers make it an attractive recession-resistant dividend investment in my view.

Investment Thesis

Perrigo ( PRGO ) is a manufacturer of private-label and contract-produced over-the-counter medications. In FY20, PRGO embarked on a program to reposition itself to be an exclusively consumer-facing OTC brand. This includes simplifying the sales process for 1000 products, extensive divestitures, and expanding the addressable market through acquisitions.

PRGO has seen an acceleration in its top line growth thanks to its efforts in streamlining and repositioning. While we have concerns about the debt level, the 3.31% dividend yield, coupled with being one of the largest consumer staples manufacturers, helps make PRGO attractive for a recession-resistant dividend investment.

Estimated Fair Value

EFV (Estimated Fair Value) = E24 EPS (Earnings Per Share) times PE (Price/EPS)

EFV = E24 EPS X P/E = $3.05 X 16.2 = $49.41.

Operations

Unlike traditional pharmaceutical companies, PRGO is repositioning to be an exclusively OTC consumer-care brand. In the United States and Europe, PRGO owns brands that treat common ailments such as allergies, colds, and flu. Additionally, PRGO operates several women's health, baby food, and skin care brands. Often overlooked, the OTC drug market size is expected to increase by 50% to $233 billion globally in the next decade. As part of the "Optimizing and Accelerating" program, PRGO is changing how it distributes drugs to consumers and stores utilizing a direct sales model. This initiative attempts to reduce supply chain hangs which have caused infant formula and children's medicine shortages. This will optimize the delivery of nearly 1,000 products by FY24. This changeover will slightly decrease net results for FY23, but in the long term should increase accessibility and marketability.

Acquisitions and Approvals

PRGO typically utilizes M&A very aggressively to expand the product portfolio or streamline existing operations. PRGO conducted 14 M&A operations from 1Q22-1Q23. M&A will remain an important part of the realignment toward being a dedicated consumer care company.

A critical approval is likely on the way for PRGO. The most effective classification of Birth Control in the United States has previously been prescription only. PRGO's Opill has been submitted to the FDA's advisory committee and, as of May 10 ^th was recommended for approval for OTC usage. Opill was previously prescription only, and the formulation has been approved since 1960. The US contraceptive market was valued at $8.3 billion in FY22 and is expected to grow at a 6% 5 year CAGR. Pills have had only 40% market penetration, given the barriers to entry. PRGO has increased net sales in the women's health and contraceptive category by 95.4% in 1Q23, which could easily grow once Opill sees widespread OTC distribution.

In FY22, PRGO acquired Nestle's (NSRGY) infant formula plant for $170 million and an additional $60 million for modernizations and expansions. This will allow PRGO to produce 100 million more units annually by the end of FY23. PRGO manufactures baby formula for 17 off-label brands and is a contract manufacturer for several private-label brands, including Nestle. PRGO will also acquire the Canadian Good Start baby formula brand as part of the transaction.

Risk

In March of FY23, the FDA released new guidance for baby formula. The guidelines pertain to new quality control standards for infant nutrition. While PRGO does not release exact figures, management stated that the new guidelines would "significantly increase" manufacturing costs. PRGO still expects to be able to undercut name brands by 40% and increase the margin of the segment through the added scale of the Nestle plant and increase in contract production demand.

PRGO maintains a debt-to-EBITDA level of 5.3x, a decrease quarter over quarter. The expected bump in operating cash flow conversion will likely assist in delevering, we still have concerns about the debt load, given the high-interest rates. The large interest expense of $180 million on the total $4.31 billion in debt caused PRGO to refinance during FY22.

Outlook

PRGO has embarked on a divestiture campaign to eliminate margin-dilutive businesses. Previously, it manufactured and marketed various generic topicals for dermatological purposes. This unit was sold off in late FY21 for $1.5 billion. In FY22, South American segments were entirely divested for an unreleased sum.

FY23 outlook is positive, with EPS expecting to land between $2.5 and $2.7 per share with net sales growth at 7-11%. Operating cash conversion is expected to increase from 32% to 100% conversion by the end of the year. Results will be weighed toward the year's second half, when most impacts of the previous year's M&A and divestitures will be realized. The largest positive from 1Q23 was the dismissal of the Notice of Proposed Adjustment from the IRS. This eliminated $974 million in potential tax-related losses .

Seeing a significant recovery in net margin, increasing 400bps year over year, is promising. If efficiency improvements continue to be realized, coupled with the Opill going OTC, PRGO is likely in much better shape than in previous years.

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