Description

Perrigo is a special situation investment opportunity with an attractive asymmetric return profile (80-100% upside and 20% downside).  Perrigo, perceived for the last decade as a generic pharmaceuticals manufacturer, is in the late stages of transitioning to a pure play Over the Counter (“OTC”) Consumer Healthcare company, as well as resolving overhanging legacy tax matters.  Proforma for a large, branded OTC Consumer Healthcare acquisition (HRA Pharma, $2.1B, expected to close June 30, 2022), Perrigo’s business will be split roughly 50/50 between private label OTC consumer healthcare products (in the U.S.), and branded consumer healthcare OTC products (primarily in Europe).

Perrigo is the leading OTC private label manufacturer in the U.S. due to partnerships with all the leading retailers including Walmart, Amazon, Target, CVS, Walgreens, and Costco.  Perrigo manufactures more acetaminophen than Johnson & Johnson (the maker of Tylenol) and more ibuprofen than GlaxoSmithKline (Advil).  Perrigo is also the leading provider of private label smoking cessation products (nicotine gum) and is the only private label infant formula manufacturer in the United States.

In October 2018, Perrigo hired Murry Kessler to lead the transformation of Perrigo to a pure play consumer healthcare company.  In 2021, after numerous smaller divestitures and acquisitions, Perrigo announced three major transactions that transformed the company and its prospects.  1) Perrigo exited its generic prescription pharmaceutical business which dominated the story for the past decade. 2) Perrigo settled a potentially large ($3 billion) tax dispute with Ireland for $3__m.  3) Perrigo announced the acquisition of HRA Pharma, which closed at the end of April 2022.

While Perrigo has executed well on many aspects of its restructuring, Perrigo has faced COVID driven fundamental headwinds over the past two years such as wild swings in consumer demand for cough and cold products and heavy supply chain and material cost pressures which have muddled the fundamental story.  Furthermore, with the divestiture of its generics business, Perrigo ceased to have operations in Israel, causing the stock to be dropped from the Tel Aviv stock exchange index and leading Management to delist Perrigo from that exchange causing significant disruption in the shareholder base due to forced selling from Israeli Index funds and Israeli investors not wanting to hold a security traded on a foreign exchange.

Consumer Product stocks typically trade at a premium to the market multiple given the stable growth and strong cash generation profiles of the businesses.  Currently, Perrigo continues to be covered by generic pharmaceutical analysts and trade at a steep discount to consumer product sector.  We see that eventually changing and Perrigo being rerated to a market multiple (i.e. between where it is now and the leading branded consumer healthcare names)

The strength of Perrigo’s business has been masked during COVID due to the aforementioned wild swings in consumer demand for OTC healthcare products.  Q1 and Q2 2020 saw huge spikes in demand for cough and cold products, pain relievers and frankly most things found at drug stores.  A sharp drop in demand in Q1 2021 was as deep as the peak was high in 2020.  Perrigo experienced another sharp spike in Q1 2022 due to a reemergence of a cold/flu season in North America (as COVID is now manifesting with milder cold/flu type symptoms) and the reopening of society in general.

Now that the deal for fast growing HRA Pharma has closed and COVID continues to fade we expect Perrigo to impress investors with steady top line growth and significant cash generation.  Eventually, we expect Kessler to sell the business at a significant premium to its trading price, as he has done twice in the past with Lorillard and US Tobacco.

Proforma for the HRA deal, we expect Perrigo EPS to range between $2.25 and $2.45 which includes only 8 months of HRA contribution.  In 2023, Perrigo should benefit from legacy Perrigo organic growth (low single digits rev), a full year of the price increases commenced in 2022, a full year of supply chain normalization, a full year contribution from HRA Pharma, HRA pharma growth (low teens), and operating cost synergies from the HRA Pharma deal ($40m).  We expect 2023 earnings could be $3.47-$3.66.  Organic growth at legacy Perrigo and HRA Pharma plus the benefits of a supply chain reengineering project could bring 2024 earnings up to $4.09 to $4.41.  EPS and Free cash flow per share are about the same.  The Dividend is $1.04/per share.  A focus on debt paydown will also be a tailwind to earnings growth.  Share repurchases will not be a focus until Debt to EBITDA gets closer to 3x (currently 5x).

Asymmetric upside is available in the story from 1) potential FDA approval of an OTC oral contraceptive in the U.S. (for which HRA would have 3-year exclusivity, on a progesterone only formulation), 3) Launch of a branded alternative to Plan B in the US, 3) a sale of the company.

Oral contraceptive.  HRA has been developing a progesterone only “pill” for OTC sale.  HRA began selling this product in the UK under the brand name Hanna last fall, is expected to make regulatory application in 2022 with possible approval in 2023.  Perrigo is already selling a private label version of the Plan B contraceptive but the use case for that product does not lend itself well to discounted product.  Perrigo is exploring combining its product and HRA’s women’s health marketing expertise to launch a branded alternative to Plan B in the U.S.

Sale of the Company.  CEO Kessler has sold the his last two rodeos, Lorillard, and US Tobacco.  We would think given his age that around 2024, once HRA is integrated after oral contraceptives have been launched and earnings are seen tom be north of $4, that he pursues a sale of the company closer to $80 than to $60.

The primary risk is that Perrigo’s ability to raise price in their US portfolio is limited to contract negotiations with their retail partners.  Given branded players are aggressively raising price, Perrigo is seeing success passing through recent rising costs to consumers through higher prices, albeit at a lag.

Catalyst

Price increases

normalization of volumes

oral contraceptive approval in the U.S.

EllaOne Approval in the U.S.

HRA synergies

Cost renegineering project

recognition as a consumer products company rather than generics manufacturer

Sale

Further Rx to OTC switches