CHC fears unfounded
I have written bullish articles on Perrigo Company (NASDAQ:PRGO) in the past and Perrigo's Q4 earnings today did not let me down (Perrigo's fiscal year ends in June). Perrigo was the largest gainer in the S&P 500 (it went up by 7.3%). Perrigo had missed expectations in Q3 due to a weak flu season and a delayed flea/tick season. The market went crazy and had sold Perrigo all the way from $143 to $126 in the wake of Perrigo's Q3 earnings report.
The CHC (Consumer Healthcare) business segment that houses the flu and animal products had reported flat YoY revenue growth in Q3. But in Q4 Perrigo reported YoY revenue growth of 8% in CHC. Most doctors use store brand according to Perrigo - so Perrigo has science on its side. It was wrong for the market to doubt the strength of Perrigo's CHC segment.
The extra cold winter delayed the flea/tick season. I think the flu season was milder because more people stayed indoors this winter leading to less contagion. But some investors behaved as if the sky had fallen. Perrigo clearly said that last year's flu season was extra strong and this winter the flu was extra weak leading to unfavorable year over year comparisons. But investors paid no heed. The flu will be back in a few months and this time the year over year comparison will favor Perrigo.
Tysabri royalty revenue increases
In my previous articles on Perrigo, I had mentioned the step-up in Tysabri royalty starting May 1 from 12% to 18% of global sales. That works out to an average of 16% for Q4 ([12 + 18 + 18]/3). Perrigo reported Tysabri royalty revenue of $86 million ($534 million * 16%).
Biogen Idec (NASDAQ:BIIB) owns Tysabri. So Biogen Idec's financial statements have the Tysabri data. Looking at Biogen Idec's Q2 10-Q, we see that $54 million of the $534 million in global Tysabri sales was due to the recognition of deferred revenue related to Italy's reimbursement situation. If we back this out, we get $480 million. But next quarter onwards, Perrigo gets 18% of Tysabri sales as royalty revenue. So even if sales stay flat at $480 million, that works out to $86 million per quarter.
But Tysabri grew in the US at 14.7% in Q2 according to Biogen's 10-Q (4% volume growth, rest from price increases). So we can expect increasing revenue for Perrigo from Tysabri over the rest of the year. Perrigo gets 25% of Tysabri sales above $2 billion as royalty, so that is something that might kick in some time next year. Tysabri was approved in Japan in March 2014 - so that would increase Tysabri sales too.
Perrigo's strongest and fastest growing segment is its Rx pharmaceutical segment. Since Perrigo makes harder to manufacture medications in this segment, it has very high operating margins. In Q4, it reported adjusted operating margin of 48% for this segment with revenue growth of 30%.
Perrigo neatly breaks down its revenue increases. Rx Pharmaceuticals revenue was $253 million (an increase of 30% YoY). The increased revenue came from $35 million in new products and $20 million from the Fera acquisition. That is $35 million came from businesses that were part of Perrigo for more than a year and Fera was the only acquisition in this segment in the last year. The $35 million implies 17.6% organic growth (35 / [253-55]).
Fera was acquired for $129 million minus $20 million of tax benefit which is $109 million. Fera had just $30 million in revenue in 2012. If we annualize Fera's Q4 revenue of $20 million by multiplying by 4, we get $80 million in annual revenue. This is an example of how Perrigo successfully integrates acquisitions into its powerful distribution network.
Perrigo looking for acquisitions
Perrigo has delevered after acquiring Elan Pharmaceuticals of Ireland last year. The Elan acquisition gave Perrigo a tax inversion and Perrigo became an Irish company (Perrigo forecasts a tax rate of 16% for FY 2015). Perrigo's leverage ratio has decreased significantly. In the Q4 earnings conference call, Perrigo's CEO said:
What I would simply say to that is there is a lot of things on the table from other companies who have placed themselves up for sale. We continue to be very active. We think there are some great opportunities to build on the platform that we already have. As I said it's either adjacent categories, geographic expansion, or the technology competencies that we're seeking to add to the business. So we're going to continue to be very active there.
Any acquisition would be upside over the EPS forecast. It is only a matter of time before Perrigo acquires someone. Perrigo had been waiting to delever after the Elan acquisition because they are very careful about their credit rating.
By my rough calculation, net debt divided by forward EBITDA has fallen to around 1.7. Remember, this is a non-cyclical company and can therefore sustain much higher leverage. Perrigo has lot of firepower for all-cash acquisitions.
Disclosure: The author is long PRGO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.