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Perrigo $PRGO
is one of those stocks that torment investors. The long term outlook
and positioning of the company is excellent and its a sector of the
economy whose growth prospects are actually bolstered by a slowing
economy. Everything looks great and then you look at the evaluation and
conclude that it’s expensive, so better wait for it to fall into your
value range. It never does.
Instead it goes up and then every time you look at it again, it keeps
going up and winking at you saying ‘buy me, buy me, you know you like
the story, buy me’. Of course, there is an inevitable downside to this.
The evaluation gets ahead of itself and the stock is susceptible to the
slightest hiccup and this is exactly what happened recently.
Perrigo Who?
What makes this stock so exciting is that it is a key beneficiary of a
combination of an aging demographic, the need to reduce healthcare
costs and the drive of stores to increase their in-store and private
label sales. Around 80% of Perrigo’s business is in the over-the-counter
(OTC), consumer healthcare, and nutritional private label business. In
other words, they make the store brand products for pharmacies like Walgreens$WAG and CVS Caremark $CVS and also for the big box retailers like CostcoWholesale $COST, Wal-Mart $WMTor Target $TGT
It is a growth area. For example, CVS Caremark recently stated that
it wanted to increase its own brand sales from 17% to 20% in the next
few years. Walgreens is similarly inclined to increasing its private
label sales. The big advantage of doing this is that it is a win-win
situation for the stores and for the consumer. The consumer gets a
cheaper version of the drug and the store makes more money (even though
the retail price is less) because it has far lower costs. The loser in
this is the consumer healthcare company that owns the brand being
copied.
Perrigo has four major growth drivers which should help it expand
sales. The first is the trend towards retailers rolling out in-store
private label brands as outlined above. The second is increasing number
of drugs that are shifting from prescription only to OTC. The third is
the companies continued release of new products and the fourth is the
increasing willingness of consumers to buy private label brands. These
are powerful drivers and they are also correlated with long term
healthcare trends. Perrigo’s growth over the last few years has been
very strong as a consequence.
So What Went Wrong With the Latest Results?
The price chart tells you all you need to know about the optimism
surrounding the company and this was-in no small part- encouraged by
internal guidance which was rising through the year. Here is how the
company raised guidance sequentially throughout the year.
Perrigo’s EPS numbers were fine but the market was not impressed by
the revenue number coming in right at the bottom of the guidance it
gave at the end of last year. Operating cash flow came in near the mid
point of guidance too. Having raised guidance across the board
throughout 2012, the final numbers came in as a bit of a disappointment.
The stock sold off aggressively.
Incidentally, the EPS guidance for 2013 assumes an 8% rise at the
mid-point but the 2012 numbers include a tax benefit of 28c. Stripping
this out gives a much more impressive underlying growth rate of 14.6% at
the mid point.
What’s Wrong With Mid Teens Earnings Growth?
Nothing really, except that the company appears priced for much
higher growth. As attractive as the company is I can’t see paying an
EV/EBITDA multiple of 16x. No pharmaceutical manufacturer is without
risk and Perrigo’s fortunes are also subject to strategic decisions made
at the retailers. The mid-point of next years guidance puts it on a
forward PE of 20 and from a cash flow basis the stock doesn’t look cheap
either. The stock does deserve a premium, but it is very hard to argue
that it is good value.
By way of comparison a generics manufacturer like Mylan Labs $MYL trades on an EV/EBITDA multiple of 9.2x and a forward PE of 9.5x while Teva Pharmaceuticals $TEVA
trades on multiples of 7.7x and 7.5x respectively. These two have their
issues. For example, Teva reduced earnings guidance. With Mylan, I have
a certain amount of scepticism over some parts of its growth program.
However, valuation still counts in investing as far as I am concerned.
Both these stocks are positively exposed to the general idea of a polity
and populace trying to reduce health care costs and are probably worth a
closer look while waiting for some of the excess optimism to be taken
out of Perrigo’s stock price.
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