The Female Health Company (FHCO) makes female condoms. These are similar to male condoms, and the product fills an important niche. Female condoms are the only female-controlled method of sexually transmitted infection prevention and birth control. This is especially valuable in the developing world where infection rates (especially of HIV and AIDS) are higher and women have less access to high-tech birth control than in the developed world.
What initially attracted me to FHCO was its 3.5% dividend yield and 40% payout ratio, 43% profit margin, and P/E of 12. These all that suggest it is a good business, so let's get to the specific numbers.
Profit Margins: The most recent quarter FHCO managed a 60.2% GPM. 2012 was 58.9% and 2011 was 53.1%. This is decent and seems to be trending in the right direction. it did not report any R&D expenses in the last three years (the company spent over $100 million prior to that developing, patenting, and getting FDA approval for its product). After deducting selling, general and administrative expenses, we see a 31.2% net margin in 2012. It averaged 18.7% the two years prior years, so it seems to be heading in the right direction.
Accounts Receivable: One of the worrying signs about FHCO's performance is the growing balance of accounts receivable as a percentage of revenue. It's hardly at crisis levels yet and most of FHCO's customers are government agencies (who tend to pay their bills). It is something to watch, though.
Cash/Debt: FHCO had $4,331,000 of cash and equivalents on hand in the MRQ balance sheet. This is a nice cushion against setbacks and should be plenty to fund further expansion. Increasing the existing production capacity by 20% to 100 million units annually cost $700k. Further expansion may well be more expensive, but FHCO should be able to self-fund whatever is required. FHCO also carries no long-term debt, which is a very good sign.
Tax Carry-Forwards: FHCO is sitting on a total of about $100 million of tax loss carry-forwards ($65 million of which are in the United Kingdom and do not expire). This will provide a continued boost to net income and may be attractive to potential suitors (it's worth about a dollar a share to a qualifying purchaser).
So, FHCO looks pretty attractive by the numbers, let's look at some more macro factors:
Market Prospects: At the moment, the world condom market is made up almost entirely of male condoms. In 2005, 10.4 billion male condoms were sold worldwide. Estimates for 2015 worldwide sales are between 18 billion and 27 billion. FHCO is the only significant producer of female condoms, and its current maximum production of 100 million units is under 1% of the annual global condom market. This leaves significant room for growth.
The obvious risk here is that if female condom usage becomes significant, then a big producer of male condoms -- like Church & Dwight (CHD) -- could decide it wants to get involved. Increased competition may well see FHCO get swamped, although its existing relationships with key customers and patented product do provide some defense. The FC2 female condom was patented in June 2010, so it has awhile to run. It's entirely possible that any existing condom maker wishing to enter the market will simply acquire FHCO rather than attempt to fight it. This would be good news for FHCO investors.
HIV/AIDS is one of the most significant health challenges facing the developing world. As such, it's the focus of large amounts of government and charitable spending. The female condom potentially has a major role to play in this fight. Having both female and male condoms available reduces unprotected sexual activity by 10%-35% compared to having only male condoms available.
Lumpy Earnings: FHCO depend on a relatively small number of customers buying its product in large quantities and then distributing them. This means that earnings can be somewhat unpredictable. However, for investors with a longer time frame, some quarter-to-quarter volatility can provide buying opportunities, or can just be ignored while you pocket the dividend and wait for the market to catch up.
Management: 31% of the company is held by insiders, so the executives definitely have skin in the game. The CEO has been in place since 1987 (chairman, then CEO), so there is good stability at the top. He also seems to have a firm belief in making the world a better place by reducing rates of STIs and increasing women's ability to control family size. I like this goal on a personal level. More importantly, I like it as a potential investor -- good things happen when companies focus on goals that are larger than just making next quarter's earnings target.
Obviously, FHCO is a risky investment. It's a small company with one product. It could be very vulnerable to competition or political changes, or even more unlikely events like someone discovering a cheap cure for HIV. However, it looks to have significant upside potential and has the kind of balance sheet that can save a company during challenging times. That it is paying a reasonable yield is the icing on the cake.