Increasing shareholder value and bettering the world simultaneously is not a frequent occurrence. Many companies that have done a phenomenal job churning out dividends and other forms of value for shareholders have not been able to do so without some type of cost to the global society. Several people accuse McDonald's (MCD) and Coca-Cola (KO) of contributing to a childhood and adult obesity epidemic. Companies such as Wal-Mart (WMT) and Procter & Gamble (PG) are berated for questionable employment and manufacturing processes every so often. One of my personal favorite stocks, Philip Morris International (PM) has created immense shareholder value, but is not the first company that comes to mind when people think of making the world a better place.
The Female Health Company (FHCO) is a little known company that has helped reduce the occurrence of serious diseases and unwanted pregnancies in many countries around the world. FHCO is the primary manufacturer of the female condom (under the FC2 brand) that is distributed across the world. This product is one of very few that empowers women around the world to make the choice to protect themselves from both unwanted pregnancy and sexually transmitted diseases.
FHCO has rewarded shareholders handsomely with an over 300% increase in share price over the past 5 years. More importantly it has increased its quarterly dividend from 5 cents a share to 7 cents a share over the course of the past 3 years. While 2 pennies does not sound much, this is effectively a 12% increase per annum over the course of the past 3 years. Determining whether or not FHCO can maintain this trajectory is critical in determining whether or not this is an investment worth making. Several factors will go into making that determination.
Revenue growth is the first factor to look at. If a company cannot grow its topline effectively, then it means its products are not selling. If products are not selling, then it is only a matter of time before dividend growth stagnates, or worse the dividend is cut. Revenue potential can be split into two components:
- What happened in the past? (historical growth)
- What opportunity is available in the future? (future opportunities)
FHCO has experienced choppiness in both its revenue growth and unit sales over the past few years. This lumpiness is the nature of its business given the fact that its primary customers are governmental agencies and non-profit organizations with extensive bureaucratic processes. This level of volatility is something that investors will need to get comfortable with before considering an investment in FHCO.
Revenue Growth and Units Sales (2009-2012)
Source: 2012 Annual Report
The next step is to look at, is the future opportunities available to FHCO. Sales of condoms are expected to grow at a compounded annual growth rate of between 6%-8% per annum between 2012 and 2015. 25 billion, yes billion, condoms are expected to be sold in 2015.
Units of Condoms Sold (2012-15E)
In 2012, FHCO owned less than 0.5% of the global condom market. Given the entire market is growing, growth can be obtained by just maintaining share. This mitigates some of the risks that will be discussed later. However, FHCO can likely increase its share of the global condom market for the following reasons:
- Innovation - The female condom does not come without issues today. The FC2 was a better iteration of the FC1 and has allowed FHCO to gain better distribution in commercial channels. Further refinements can be made to the product to increase the product's value proposition to consumers.
- Increased awareness - Campaigns centered on empowering women and reducing the spread of HIV stand to benefit FHCO. Having affiliations with well-known organizations such as the Bill and Melinda Gates foundation can only serve as a catalyst to increase public awareness for FHCO's core product.
- Product value proposition - The female condom comes with several advantages such as being able to be put into place several hours in advance of use. These types of advantages could serve to further sway consumer taste.
- Economies of scale - FHCO has increased capacity several years, and can now produce 100M condoms per year. As production increases, FHCO can potentially increase the competitiveness of its pricing. Prices for the female condom continue to be a signification issue.
If a company has issues with covering its dividend today, then making an investment becomes significantly less compelling. Two ratios that can be used to assess a company's ability to cover dividend payments are the Dividend to Free Cash Flow to Equity (FCFE) and Dividend to Net Income ratios.
Given the choppiness of FHCO's earnings, there is significant fluctuation in the payout ratio as shown below:
Dividend Payout Ratio (2009-12)
Source: 2012 Annual Report
2011 was a challenging year in that major orders from several of FHCO's largest clients were pushed back. The strong performance in 2012 was an anomaly given several orders clients would have placed in 2011 were pushed into 2012. The actual ratio over an extended period of time is probably closer to what was seen in 2010.
Dividends to FCFE
FHCO's dividend to FCFE is relatively high. The chart below shows how this has evolved over time:
Dividend to FCFE Ratio (2010-2012)
If FHCO was not in an industry that was steadily growing, and if it did not have the patents it does, this would be very concerning. However, given how much headroom FHCO has to increase its presence in the condom industry if it plays its cards right, the dividend likely still has room to grow and grow significantly. Investors would be wise to monitor unit sales over time to ensure they are trending the right way.
The FHCO is not a company that does not come without risks, and as such investors need to determine whether or not a stock like this is a fit with their risk tolerance level. Factors that increase one's ability to take risk include:
- A large asset base relative to income needs
- Availability of discretionary cash to fund investment
- A long-term horizon to recoup potential resulting losses
What makes FHCO a riskier play?
Lack of Product Diversification - FHCO primarily relies on sales from its FC2 condom. Condoms have been around for ages, but there is always the potential for someone to come up with a better product that minimizes the value proposition of the FC2 condom. This would be detrimental to the health of FHCO.
Concentrated Customer Base - FHCO currently derives a large portion of its sales from a handful of customers. The chart below shows that this has been how the company has operated for several years:
Concentration of Customer Base (2010-2012)
Source: 2012 Annual Report
In the short term this is okay. However, longer term it would be wise for FHCO to diversify its customer base, which it has already started to do. The FC2 can now be purchased in mainstream outlets such as Walgreen's.
Lack of Competitive Price - According to figures from the WSJ.com, the average price per unit of a female condom is ~$0.60 per unit, roughly triple that of normal condoms. In order to increase competitiveness of its product, FHCO will need to continue to realize economies of scale and further reduce prices as it did in 2010.
Stiff Competition - FC2 faces stiff competition from traditional manufacturers like Durex and Church and Dwight's (CHD) Trojan line of condoms. These companies are dominant in the western world, with CHD's Trojan brand and Durex owning roughly 69% and 15% of the U.S. condom market respectively. As such, FC2's primary opportunity will initially reside in emerging and developing markets until further refinements are made to the product.
FHCO is one of those companies that you can make money with and know that you are invested in a company making a positive impact in the world. This proves that adding shareholder value and bettering the world are not mutually exclusive. While the company remains a great opportunity, it does not come without risks as outlined earlier in the article. For investors that have the ability and willingness to take on this risk, FHCO is a quiet hero that can reward both investors' pockets and hearts.