Perrigo Company PLC

On shoulders of a long list of disappointed value investors!

Perrigo Company plc, commonly known as Perrigo, is an American-Irish manufacturer renowned for its private label over-the-counter pharmaceuticals. The company's roots trace back to 1887 when it was founded by Luther Perrigo in Allegan, Michigan. In 1887, Luther Perrigo, who owned a general store and an apple-drying business, conceived the idea of packaging and distributing patented medicines and household items to country stores. To boost customer loyalty, Luther introduced the "private label" concept, offering to print the store's name on labels of products like Epsom salts, sweet oil, bay rum, and many other wet and dry goods at no extra cost. Perrigo established its first manufacturing facility in Allegan, Michigan, in 1921 and secured its first major private-label customer in the mid-1930s. This milestone marked the company's transition from a re-packager of home remedies to a manufacturer of affordable healthcare products.

By the 1980s, the company had established itself as a key player in the private label over-the-counter (OTC) pharmaceutical market. In 1988, Perrigo went public, listing its shares on the NASDAQ stock exchange. The 1990s saw Perrigo extend its reach internationally, setting up operations in various countries and acquiring several companies to broaden its product portfolio and market presence.

Perrigo's growth was further propelled by the advent of prescription-to-over-the-counter (Rx-to-OTC) switches, which allowed prescription products to become available over the counter. This shift significantly expanded the market for OTC products, providing Perrigo with new opportunities for growth and innovation in the healthcare sector.

Perrigo's long-term strategy was to  become a leading global provider of self-care products. The company sought to leverage its strengths in the consumer health sector rather than the more competitive and lower-margin generic drug market. The company made a significant move in 2013 by purchasing the Elan Corporation, which not only relocated its corporate domicile to Ireland but also positioned it as a global pharmaceutical industry player. The redomiciling of Perrigo to Ireland allowed the company to benefit from Ireland’s lower corporate tax rates compared to the U.S Another notable acquisition was in 2015 when Perrigo bought Omega Pharma, a leading European OTC healthcare company, further solidifying its market position. 

In 2016, Perrigo acquired PBM Products for $800 million, an infant formula business, which manufactured formula for major retailers like Walmart and Kroger, as well as other private label infant formulas.

In April 2015, Mylan,  known for its generics and specialty drugs, made an initial offer to acquire Perrigo at $26 billion or $205 per share. Management at Perrigo rejected this offer and the stock has done nothing but go down since! A bird in hand….

In 2016, Starboard Value became one of Perrigo's largest shareholders, advocating for changes to improve the company’s performance and value. Starboard wanted Perrigo to focus on its core consumer self-care business including on operational improvements and divest non-core assets, such as its generic drug business. It would eventually do that, but it would take much longer than anyone expected.

In 2020, Perrigo reached a settlement with the Irish tax authorities. As part of the resolution, Perrigo agreed to a payment of $1.9 billion to settle the tax dispute which was a substantial hit to the financials. In 2021, Perrigo issued a voluntary recall of certain lots of baby formula due to potential contamination concerns and then in 2023, it faced further issues in its newly acquired infant formula facility from Nestle. 

These challenges have contributed to the creation of numerous value investors who developed promising investment theses, only to see their efforts consistently thwarted by ongoing issues. In many instances, even when the investment setup starts to improve, former investors may be reluctant to re-evaluate the situation due to their prior negative experiences with the stock. The repeated setbacks can lead to a reluctance to reconsider the investment, despite evolving circumstances.

This is where the mental flexibility of renowned investors like Warren Buffett becomes particularly notable. Despite having a notably poor experience with investments in the airline industry, Buffett made another investment in the sector once he observed improvements in the industry’s structure. His ability to reassess and invest based on evolving conditions, rather than being anchored by past disappointments, highlights a crucial aspect of successful investing: the willingness to update one’s views and strategies in response to changing market dynamics.

Finally, in February 2021, Perrigo announced the sale of its generic drug business, which was part of its Rx segment, to a private equity firm, TPG Capital for $1.55 billion.

Perrigo is now a pure OTC business  focused on its core consumer self-care business, which includes over-the-counter (OTC) health and wellness products. By divesting the generic drug business, Perrigo aimed to streamline its operations and concentrate resources on areas with stronger growth potential and higher margins. 

What can be…..unburdened by what has been:

The company now reports two segments: Consumer Self-Care Americas (CSCA) Consumer Self-Care International (CSCI). Both divisions develop, manufacture, and market over-the-counter (OTC) store brand products, primarily in the cough, cold, allergy, analgesics, gastrointestinal, smoking cessation, infant formula, and oral care. However, the CSCI division in Europe and ROW actually markets under its own brand names earning much higher gross margins (50-55%) than the US division (30-32%).

Private brands are a win-win-win as retailers offer private label products at competitive prices, often lower than national brands, which attracts cost-conscious consumers while providing higher profit margins due to reduced marketing and distribution costs. However, as consumers may initially perceive private label products as lower quality,  establishing a strong private label brand demands consistent quality and effective marketing efforts. Due to this, retailers are always careful with their partnerships and focus on quality and scale rather than just price. 

What are Perrigo’s competitive advantages?

“I think Perrigo has advantages, their size and the amount of things they're able to produce. They definitely have a competitive advantage in that space. Anything a specific retailer wanted, they got”

-Former executive at Perrigo (Alphasense transcript)

Scale and scope:

In a pharmacy, the extensive range of products is crucial for gaining national distribution with major retailers like Walmart, CVS, and Walgreens. Retailers prefer to work with companies that offer a broad portfolio of products because it simplifies the procurement process and allows them to stock multiple items from the same supplier. If a company only sells a limited number of products, it becomes challenging to convince these major retailers to carry their items, as the retailers might prefer suppliers who can offer a wider selection and meet various consumer needs.

Regulations:

The business of over-the-counter pharmaceuticals is complex due to the various FDA approvals required. The FDA’s approval process for OTC pharmaceuticals involves multiple stages and types of approvals. Each stage requires thorough documentation, testing, and compliance with specific guidelines. This process can be time-consuming and requires careful planning and execution.

Who is the consumer?

Consumers are increasingly savvy about over-the-counter pharmaceuticals, particularly in terms of cost and quality. Unlike in the 1980s and 1990s, when branded products dominated and store brands were less trusted, today’s market has seen significant growth in store brands and generic options. Consumers today - whether high income or low income - are more informed about the equivalency of products. They recognize that, for instance, both Advil and Costco's Kirkland ibuprofen are FDA-approved and essentially the same, so they opt for the more affordable option to save money.

Revenue Growth

Perrigo revenues should grow with the category which, in aggregate, is growing at low single digits.

Perrigo is the the third largest OTC company in the US and the 8th largest OTC company in Europe.

Historically it has enhanced its growth with M&A and new product launches.

Would I say that Perrigo is one of the most, let's say, innovation-savvy companies? Maybe not. When it comes to innovation and creating new products based on consumer demand or market situation, I think maybe there's companies who are doing it better. On the other hand, if you think about the acquisition and entering new categories through acquisitions or entering new categories through utilizing the footprint in the market because of the presence in multiple categories, I think definitely that's one of the things Perrigo can do much better than many of its competitors.

-Former executive at Perrigo (Alphasense transcript)

Earnings growth

The company aims to increase its adjusted gross margin to at least 40% over the next three years. To achieve this target, Perrigo is employing several strategies:

• Global Supply Chain Reinvention Program: This initiative is expected to deliver annualized run-rate savings of $200 million to $300 million by the end of 2028. These savings will come from optimizing production processes and improving efficiencies across the supply chain.

• Integration of Acquisitions: Perrigo plans to integrate recent acquisitions, such as HRA Pharma and Gateway, which are expected to be margin accretive. For example, the integration of HRA is projected to achieve €50 million in synergies by the end of 2024 by shifting distribution from third parties to Perrigo's in-house infrastructure.

• Pricing Actions: The company anticipates benefits from the annualization of inflation-justified pricing actions taken in 2023/2024. It is important to note that Perrigo was behind branded players when it came to pricing and is just now catching up. 

Again, I think there were a lot of silos and a lot of duplication across the organization. Because of the acquisition of HRA Pharma who had Opill and then Compeed and a number of brands in Europe, I think the European group, branded-wise, fantastic. They're continuing to really make progress, but I think there's duplication across the board, and there's some things that need to be centralized like digital and branded marketing and channel management or commercial strategy and implementation.

-Former executive at Perrigo (Alphasense trancript)

“Project Energize. Similarly, there was an investment cost to this, but you can see the $140 million to $170 million in savings by the end of 2026. Overall investment, $40 million to $60 million. But once again, this is a five-year ROI of over 80%. We are an amalgamation of several transactions, but it is critical that we streamline this company to one operating model, which we refer to as One Perrigo”

-CFO at Oppenheimer conference June 2024

Perrigo achieved this status early in 2024 and the benefits from restructuring are still ongoing due to which, this is probably a minimum expectation!

Turnaround of Infant Formula

Perrigo received a warning letter from the FDA on August 30, 2023, regarding their infant formula manufacturing facility in Eau Claire, Wisconsin. The letter outlined significant violations of FDA regulations pertaining to good manufacturing practices, quality control procedures, and more. These violations were discovered during an inspection conducted from March 6 to April 26, 2023. Specific issues included inadequate process controls to prevent contamination and the presence of Cronobacter spp. in several batches of their infant formula products. Despite these warnings, the FDA has reassured the public that it does not currently advise parents and caregivers to avoid purchasing any specific infant formula products from Perrigo. 

“We have made outstanding progress. The large-scale plant reset at three plants that went through significant remediation that is now behind us, was completed some months ago. We have seen significant improvements in quality control, production, packaging and release attainment. To put some numbers around that, we've seen a 10-fold improvement in our environmental stability, which is outstanding”

-CFO at Oppenheimer conference June 2024

Perrigo took immediate steps to address the issues. This included halting production and conducting thorough cleaning and sanitation of their manufacturing equipment and facilities. More importantly, Perrigo spent capital in upgrading facilities so that this issue is solved once in for all. Until this upgrade was done Perrigo could not manufacture or sell infant formula! This was a bold step as this would take away the revenue and earnings contribution from their infant formula business and Perrigo would have to miss guidance. Investors, who had had a series of setbacks in Perrigo were further disappointed by ‘another’ guide-down. We believe this was the final capitulation where many value investors gave up on the stock. 

“Remember, when we talked about our earnings guidance, we expected a $0.65 impact related to infant formula into our results for 2024. We're well on track to recapturing $140 million of annual adjusted operating income in 2025, capturing all of that plus in 2026.,The key element that we are considering is building some inventory stock that's going to be important to make sure that we can manage any shocks in supply so that demand is not impacted by that. So, we expect a significant portion of that $0.65 to recover.”

-CFO during earnings call

However, in its just reported earnings, Perrigo preponed the timeline where it should see the recovery of some of its infant formula business in 2H 2024.

This means that they should do around $2.58 in EPS in 2024 and the stock is currently trading for 11x this EPS estimate.

Perrigo’s balance sheet has been leveraged but the maturities are spread out and coupon rates are relatively low:

Importantly, Perrigo is a very cash generative business and has plans to aggressively pay down debt over the next few years:

Free option - Opill

Perrigo launched Opill which is a progestin-only oral contraceptive pill, which, unlike combination birth control pills, contains only progestin and is suitable for a broader range of women. In 2023, Opill received FDA approval as the first over-the-counter (OTC) birth control pill in the United States. This makes contraception more accessible without a prescription. Opill enhances access to birth control for many women, including young women, those without health insurance, and individuals in areas with limited healthcare services. 

Launching an OTC birth control pill requires significant educational and marketing efforts to ensure proper use and integration into broader healthcare conversations. Due to this, Opill is currently dilutive to earnings but management expects it to start contributing to earnings in 2025-26. We believe that there is a significant market opportunity for a pill like Opill and this should contribute meaningfully to Perrigo’s results in the near future. 

Going forward, one can expect:

• Organic net sales growth in the low to mid-single digits 

• Earnings will grow faster due to operating leverage and cost cutting programs. In addition, the fill force of infant formula and some contribution from Opill means that EPS can hit $3.25-3.50 in 2025/26.

• After that, a HSD percentage growth in adjusted operating income and a higher low-teens growth in EPS due to debt paydown and lower interest expense

Due to all this, we believe that Perrigo should be trading at a 14-15x multiple of this $3.50 in earnings in 2025/2026 leading to a projected share price of $50 which is close to a double compared to the share price today. 

Management

Murray S. Kessler was appointed the CEO in 2019 and played a big part in leading the company through various strategic initiatives. Kessler was the Chairman and CEO of Lorillard, Inc., a major tobacco company. 

Patrick Lockwood-Taylor took on the roles of President, Chief Executive Officer, and Board Member of Perrigo starting June 30, 2023 and has been instrumental in its turnaround. Prior to joining Perrigo, he was the Regional President of Consumer Health North America at Bayer AG, where he also held the position of President of Bayer U.S. His career includes over two decades at Procter & Gamble, where he held various brand franchise and general management roles. 

Now, the good news is I think Patrick Lockwood, who became CEO right as I was leaving, comes from a branded background and comes from P&G. I've watched the executives that they've hired, and I'm like, "Maybe they're turning the corner because those are executives who understand the branded game and understand where the investment needs to go.

-Former executive at Perrigo (Alphasense transcript)

Perrigo is an execution heavy business (that no ham sandwich can run) and has chewed through CEO’s in the past. We believe Patrick is doing the right thing and comes from the right background for this opportunity. The decision making at Perrigo has been much improved where they are making the right decisions for the company on a long term basis since the appointment of Patrick. We believe he will see this through and increase the quality of the business over the very long term. 

Conclusion

Owning a high-quality business offers several significant benefits that can enhance an investor's portfolio. Perrigo stands out as a high-quality business due to several key attributes that contribute to its strong market position and investor appeal. 

Perrigo has a diversified portfolio focused on consumer self-care products, including over-the-counter medications, nutritional products, and infant formula. This diversification helps mitigate risks associated with dependence on any single product category.

Moreover, Perrigo's scale and scope as well as its experience with various regulatory bodies and extensive manufacturing and distribution network helps build a moat which is difficult for competitors to match. 

Finally, Perrigo has shown resilience  - even with all the disappointments - with consistent revenue and profitability. Its ability to generate strong cash flows supports dividend payments to shareholders and should help de-lever the balance sheet in a rapid manner.

Disclosure: The author and the accounts managed by the author hold shares in Perrigo. This article is for informational purposes only. We may be wrong in our analysis and encourage all readers to come to their own conclusions.