PRGO - Perrigo's New Chapter: Its Bold Turnaround Plan Is Worth Buying

2023-11-15 00:28:11 ET

Summary

• Perrigo Company focuses on the consumer self-care market and aligns with the growing trend of investing in well-being products.
• The company has faced regulatory issues with its baby formula production, leading to FDA warning letters and recalls.
• Appointing a new CEO and implementing a strategic plan to increase organic net sales and improve shareholder value may present a buying opportunity, but execution risks should be considered.
• My valuation analysis suggests a 56.9% upside potential if PRGO's turnaround plan works out. However, investors must be aware of the execution risks related to this investment thesis.

Perrigo Company plc ( PRGO ) is headquartered in Ireland with a strong presence in the US, Europe, and other international markets. The company's new strategic approach to Pure-Play Consumer Self-Care aligns with a growing consumer trend to invest in well-being products. It remains to be seen whether the "Optimize and Accelerate'' strategic plan delivers the results announced in the company's growth roadmap to increase organic net sales, expand its adjusted gross margin, and improve shareholder value. The appointment of Patrick Lockwood-Taylor as the new President, CEO, and member of the Board of Directors, effective June 2023, marks a new chapter for PRGO. Yet, while it’s true that PRGO is in flux at this point, I’d argue it’s appropriate to rate it a “buy” if we acknowledge the execution risks of betting on a turnaround.

Business Overview

Perrigo is a company focused on providing consumers with affordable healthcare and well-being solutions, with a strong emphasis on over-the-counter (OTC) personal solutions. The (OTC) products include remedies for colds, flu, allergy, pain relievers, and sleep aids. PRGO also offers digestive health products, stop-smoking aids, and oral care. An important offer in its portfolio is store brand and generic baby formula. PRGO also provides vitamins, minerals, and dietary supplements. PRGO is headquartered in Ireland and operates in the US, Europe, and other international markets. PRGO's business strategy aligns with market trends, particularly the consumer’s increasing focus on self-care and preventive health and well-being measures.

PRGO’s products must comply with the regulations and standards across its global locations. Unfortunately, sometimes there are problems on this front. During March and April 2023, the FDA conducted inspections at a PRGO facility in Wisconsin, where baby formula is produced, and found problems with the control of the fabrication process to avoid adulterations due to microorganisms. The FDA issued warning letters, and PRGO submitted corrective action plans in May. In the FDA's judgment, these actions were insufficient, and the need for additional corrections was noted. Finally, PRGO voluntarily recalled part of its Gerber Good Start formula in March due to possible contamination with Cronobacter sakazakii bacteria.

In PRGO history, a significant development changed its course in 2015. Mylan's $29 billion takeover offer for PRGO was launched directly to the shareholders. PRGO's management and shareholders ultimately rejected the proposal with the argument that it undervalued the company and its prospects. Following the rejection of the purchase offer, PRGO's share price experienced volatility. In May 2016, its investors filed a lawsuit against PRGO, alleging that the company made misleading statements that persuaded them to vote against accepting Mylan's offer.

At the same time, there were significant changes in PRGO leadership. Joseph Papa resigned from PRGO to become the CEO of Valeant Pharmaceuticals, and John Hendrickson took over as CEO and president. Hendrickson retired in 2016, and a new CEO, Uwe Röhrhoff, was appointed. Less than a year later, PRGO installed Murray Kessler as its third CEO in less than three years. Amid all this instability, since Mylan's offer in 2015, PRGO's market value has declined. Currently, the market capitalization is around $3,850 billion , a value much lower than that proposed by Mylan.

A Perrigo Pure-Play Pivot

PRGO has decided to focus more on the (OTC) market and sold the prescription drug portion of its business. This strategic move indicates a reorientation of the company's operations and resources towards the (OTC) health and wellness sector. PRGO has completed the sale of its Generic Rx Pharmaceuticals business to Altaris Capital Partners for $1.55 billion, with potential additional payments of $50 million for research and development milestones. This sale closed in March and marked a significant transformation of the company. Generic Rx specializes in topical medications and offers prescription medications.

Furthermore, PRGO has acquired new personal care product brands for its strategic realignment. In November 2022, it bought three brands of hair loss treatments and skin care products from Sanofi in Eastern Europe. The brands included in the deal, Emolium, Iwostin, and Loxon, made about $23 million in net sales over the 12 months ending June 30. Sanofi is a multinational pharmaceutical company headquartered in Paris, France. It is one of the largest pharmaceutical companies in the world and is involved in the research, development, manufacturing, and marketing of prescription and (OTC) medicines.

During the Investor Day held in February 2023, PRGO announced its strategic plan for the next three years, titled "Optimize and Accelerate." This plan outlines the company's approach to driving long-term profitable growth and enhancing shareholder value. Key aspects of the plan include the transformation to a pure-play consumer self-care company. To this end, twelve transactions were carried out in previous years, culminating in acquiring Héra SAS ("HRA Pharma") in 2022. As a result, the company achieved a constant currency net sales CAGR of 7% from 2018 to 2022, excluding investments, and an organic net sales CAGR of 3%, generating a 55% CAGR in e-commerce net sales.

Within this plan, PRGO aims to continue growing , focusing on market and product category penetration, global brand expansion, new product development (especially in women's health and skin care), and investments in electronic commerce. PRGO plans to increase its adjusted gross margin to at least 40% in three years, leveraging its Global Supply Chain Reinvention Program and integrating acquisitions such as HRA and Gateway.

Yet, notably, one of the key recent developments was that PRGO announced the appointment of industry professional Patrick Lockwood-Taylor as its new President, Chief Executive Officer, and member of the Board of Directors, effective June 30, 2023. This designation was made after Murray Kessler’s retirement. And this is where its new potential valuation begins.

Turnaround Plans: A Valuation Analysis

From a valuation perspective, I’d argue that PRGO’s balance sheet does look relatively healthy. It has roughly $600 million in cash against $4.29 billion in debt. This capital structure is manageable because I estimate that PRGO generates about $387 million in FCFF using the TTM figures, so I don’t foresee any liquidity crunch in the near future. Additionally, it's worth remembering that PRGO is looking to buy back some of its debt before it matures, using borrowed funds to improve its financial situation. Hence, I think it's safe to consider PRGO fine if we solely look at its balance sheet.

But while this is an interesting move, I think the real story lies in the new CEO’s ambitious plan of reaching and sustaining 40% gross margins, which I estimate would expand PRGO’s current EBIT margins of 6.1% to about 10.9%. Moreover, PRGO’s long-term revenue CAGR has been about 1.7% since 2014. However, the new management team also aims to reach a long-term revenue CAGR of 3.0%. Both of these aims are significant improvements over the current declining trajectory of PRGO and would create considerable shareholder value.

So, from a valuation perspective, I think it’s worth considering how much PRGO could be worth if it delivers on these aims. Accordingly, I first used my valuation model's current analyst revenue estimates for 2023 and 2024. Then, I tapered those yearly revenue growth rates to the company’s long-term goal of 3.0%. After that, I also assumed expanding EBIT margins to reflect the gradual improvement of the company’s profitability according to management’s plans. Lastly, I employed the historical average margins for D&A, NOWC, effective tax rates, and CAPEX . With that, I discounted the implied FCFFs at PRGO’s WACC of 7.5% and adjusted the resulting value for its cash and debt as of the latest quarterly information.

As you can see, my valuation results suggest that PRGO would have a significant upside potential of 56.9% if it gradually delivers management’s plan. This would imply a fair value for its market cap of $6.04 billion, implying a $44.56 price target per share. Moreover, I think that such a target is indeed achievable because, looking back, PRGO used EBIT margins of well over 10.0% before 2018. Also, PRGO is expected to grow at 4.7% and 5.6% YoY in its sales into 2023 and 2024, so sustaining a 3.0% long-term revenue CAGR isn’t unrealistic. Hence, as a whole, I think the numbers indicate that PRGO could indeed be a good “buy” at these levels.

Risks to the Investment Thesis

Nevertheless, as optimistic as management’s expectations can be, the reality is that there are execution risks associated with this investment thesis. After all, we simply don’t know if the new CEO can deliver on his promises. If he were to fail in his aims, my valuation model would shift significantly because it reflects a gradually improving profitability picture and not PRGO’s current disappointing trajectory.

For context, my valuation model yields an entirely different result if we don’t assume such a substantial turnaround for the EBIT margins and a long-term revenue CAGR of 3.0%. Instead, by changing those estimates to the current 6.1% EBIT margins and long-term revenue CAGR of 1.7%, my valuation model implies a fair value of $2.83 billion. This would be a 26.6% downside potential from current levels, showcasing the inherent risks of basing our valuation on management’s expectations.

Conclusion

As a whole, PRGO is trying to change its ways after years of disappointing performance. It all started after refusing a potentially lucrative offer from Mylan, which would have been a windfall for shareholders. It’s been downhill since then, and the stock performance accurately reflects this. Nevertheless, the recent management changes and a seemingly ambitious yet realistic turnaround plan to improve gross margins and revenue growth renewed optimism about PRGO. As a result, I believe it’s reasonable to give PRGO the benefit of the doubt, and if we assume they deliver on their stated goals, then I think the stock is a good “buy” at these levels. Still, investors need to be aware of execution risks related to this investment thesis and size their investments accordingly.

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