Perrigo Company plc (PRGO) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for attending Oppenheimer's 22nd Annual Consumer Conference. My name is Rupesh Parikh, and I'm the senior food, grocery and consumer products analyst at Oppenheimer. I'm pleased to introduce our next presenting company, Perrigo. We're excited to have joining us today, President and CEO, Murray Kessler; and EVP, CFO, Eduardo Bezerra. Thank you both for being here today. So for those of you who are not familiar with the company, Perrigo is a leading provider of self-care products and over-the-counter health and wellness solutions. The company is the largest store brand OTC player in the U.S. in the categories in which it competes. Perrigo is also a top 10 OTC company by revenue in Europe. The format of today's session will be a fireside chat and then I'll move to audience Q&A. So if you have questions, please enter them into the question panel below the video. Before I get into my questions, I'm going to quickly turn it over to Murray, who is going to take us through a quick overview. So Murray, I'll pass it over to you.

Thank you, Rupesh. Thank you for having us. Let me quickly just run through the forward-looking statement. You can read this at your leisure. But as we get into the presentation itself, I thought it was important to ground you a bit, for those who are new to the story, of the journey that Perrigo has been on for the last 3.5, almost 4 years since I joined the company. When I joined, we were a -- I would classify us as a health care company. Even though the history of the company was a consumer self-care company, about 15 years ago, it had broadened the business and moved away from its focus. The last 3.5 years, we've been transforming the company back to its roots. And in the year 2021, we completed that transformation after investments all across the business, after 13 transactions, 5 divestitures and 8 acquisitions, the largest divestiture being in 2021, the closure or the closing of the sale of our Rx generic pharmaceutical business for $1.6 billion. We announced the EUR 1.8 billion acquisition of HRA, which I'll cover in a minute. And the other thing that we needed to do was the company had some real significant tax uncertainty surrounding it, and we're able to make that go away in '21. So as we enter 2022, we are excited to be focused on the next stage of Perrigo, which is now that we put this company back together as a consumer self-care company, after all of these transactions and the pieces that have been put together across the world, we now see our next step as optimizing that system and that business and then accelerating growth and earnings. There are 3 areas we're focused on right now. We just closed on the HRA deal and integrating that flawlessly. Second, optimizing the supply chain for the newly formed company. And also an area of focus for numerous reasons, but mostly the pandemic and the global supply chain shortages and inflation, recapturing some of the gross margins the company lost. The good news is the transformation has successfully gotten the company growing again. And despite interruption in the businesses on meaningful parts of our business like cough/cold, we were able to grow right through that. And excluding currency, the business on a 3-year basis, if you look at the first quarter results, we just permitted on a 3-year compound annual growth rate, it was up 5.6%. And if you strip out the benefits of acquisitions, organically, the business was at 4%. And that's a goal that we set for ourselves at the median of the best-performing consumer packaged goods companies of a 3% target. So we outperformed that despite business interruption. I mentioned HRA already. HRA Pharma deal closed a couple of months early, and it'll accelerate the Perrigo growth. This is a fantastic business. It was EUR 1.8 billion for the purchase price. We benefited from a stronger dollar. And we originally thought it was going to be USD 2.1 billion, ended up being $1.9 billion. It's a $257 million business last year with 72% gross margins and EUR 56 million in operating income. But those operate -- that operating income was depressed by a number of one-timers, which I'll show you in a minute. Next slide. The thing I want to emphasize is HRA is a star asset and very excited to have it into our portfolio. You heard Rupesh talk about our being a store brand leader in the United States. But the total Perrigo platform, we are a global company. We're in 35 countries. We have $4.5 billion in sales, net sales, and it is split evenly between international now with the addition of HRA in U.S., and earnings are getting pretty close to split evenly. So we're split evenly international, U.S., and we're split evenly store brand and branded products. These 3 marquee brands with Compeed; ellaOne, which is Plan B -- is similar to Plan B in the U.S., but everywhere else in the world, it's ellaOne; and the Mederma scar care, all 3 of these brands are growing. All 3 of these brands are market leaders. All 3 of these brands are very high gross margin products. A lot of questions came up when we put out our 8-K surrounding the financing on that chart that I showed you with EUR 56 million and where we're going to get to the EUR 90 million that we talked about when we announced the deal in its first year for 2022. And the answer to that is emphatically, yes, the business is right on track. The EUR 56 million was depressed a bit for some onetime expenses that go away. And with the base business growth behind it, that continues. We are on track and strongly believe in that estimate. We also talked about '23-'24 that we expect strong top line to continue just as it has in years in the past, as those businesses expand geographically and expand our portfolios adjacently. And we originally started with an estimate of EUR 30 million in synergies, which we now believe will be greater than EUR 40 million. And just as evidence of the strength continues on these 3 brands, HRA in the first quarter was up 27% versus a year ago on its portfolio. So rapid growth continues. Next big area I talked about and has always been for these last year or 1.5 years since the global supply chain disruption occurred is gross margins, can you recapture them. And I said at the end of the first quarter, we believed we would recapture 400 to 500 basis points by the end of the year through these areas. So the productivity we lost, regaining that again when the cough/cold season came back and the business became strong again, which it has; elimination of COVID costs; price increases, the sale of the low gross margin Latin America business; and the accretion of the high gross margin HRA business. And we said that we would recapture that, that it would be primarily second half. But I can tell you right now, Rupesh, it's right on track, and we're seeing recovery as we speak. So it's proceeding well. Next slide. And organically, we raised our organic estimate for the year, and that was -- our biggest uncertainty coming to the year is whether or not we would get a full cough/cold recovery, how much would it recover. The cough/cold season has been strong as sort of the latest rounds of COVID had more flu-like symptoms to them than earlier versions, as well as a slate of meaningful innovative new product introductions we have in our portfolio, including the introduction of our first prime OTC -- Rx OTC switch in NASONEX; the rollout of XLS-Medical Pro-7 in Europe; the first-in-kind Omeprazole mini capsules that the national brand doesn't even have, recently receiving FDA approval, is just a few examples. We also are benefiting this year from, frankly, a terrible situation that -- on infant formula, and I'm sure you've seen it on the news and everywhere else. I was on with the President in a roundtable 1.5 weeks ago. And I need you to know that Perrigo is part of the solution, not part of the problem. We have had no interruption. In fact, we shipped 37% more formula versus the same period last year during the first quarter. We are doing everything thing we can, working with the FDA and literally by optimizing our portfolio, have been running at 115% above our full capacity and are prepared to do so for as long as needed. But right now, we continue to plan that it will be needed through the end of the year. And with that, given that backdrop, when we reported our first quarter earnings, we raised our guidance to reflect HRA. We're forecasting 8.5% to 9.5% net sales growth for the year. We raised our organic number, so it wasn't just the HRA accretion. We raised that to 8% to 9% and are targeting adjusted EPS to 12% to 17%, and that is despite the currency effect of the dollar getting so strong. I mean it had a pretty big negative effect, but these are still very, very strong numbers. So we believe Perrigo is a compelling investment. It's been performing well recently in a dismal marketplace. But -- and we believe that as we have completed the transformation, we delivered on everything we said we would, we are now focused on optimization and acceleration. We have closed on the deal on HRA. It's substantially accretive to our revenue, our margins and our earnings. Gross margins, we expect to recover 400 to 500 basis points this year. Strong organic growth is expected to continue behind the rebound in pandemic-impacted businesses and core products innovation. And as I said, we're guiding to strong growth in our metrics in a difficult -- despite a difficult macroeconomic environment. So that's a 6-minute or 7-minute snapshot, Rupesh, and just to sort of seed the discussion and the fireside chat.

Great. Thank you, Murray, for that great overview.

So I'll dive into some of my questions. So given the latest headlines and was likely top of mind for investors, I'd like to start with a question on your infant formula business. I assume Perrigo benefited somewhat in Q1 from the Abbott recall. Should we expect a more sizable benefit from infant formula over the next few quarters given you are running at 115% of capacity? And do you expect to give back any share gains when Abbott relaunches its Similac formula in a few weeks?

Okay. A lot of questions in there. The first one is you won't benefit to the level you did in the first quarter because the first quarter, you got the benefit of us running at a higher -- above capacity, but you also depleted every single can and tub of inventory we had. So we normally carry 4 weeks, 5 weeks worth of safety stock, and that's gone. So now -- and we were running pretty close to capacity. So you're talking about that on margin, 15% for as long as that continues. I'm on record, if you read the press clippings on it globally, people got mad at me for saying it would take until the end of the year to right itself, and I still believe that. Abbott is just starting. They're going to run from what they've said publicly, the hyper-allogeneic products first and that it would be a couple of months after that before they were able to start affecting retail on the broader line. And it's great that the government is bringing in some products from internationally, but it's small in comparison to what the domestic manufacturers are doing to help close the gap. And then after all of that, you need consumers to stop panicking, not hoard, fill the retail shelves again, fill the inventories at retail again and then fill all the manufacturer safety stock inventory. So it will take the better part of the year to work through it. And I think realistically, some of it will be sticky. Some of it -- we were running at near capacity anyway. We have a number of brands that we have supported. And publicly, it's been talked about. A new brand, Bobbie, that we are co-packing for that is going very well, too. So we'll probably get back some share. That's natural, but that's more like in the beginning of next year. And then -- but hopefully, the initiatives that we have, I think, will make up that gap.

Okay. Great. So another topic I want to touch on is just cost pressure. So obviously, very topical at our conference yesterday and today. So like many other staples companies, you have experienced significant cost inflation in your business. I believe your original expectation was $80 million. And on the latest earnings call, you increased that to $125 million. How is the environment, i.e., freight cost, labor cost, gas, supply chain issues, et cetera, trending since your Q1 call?

Well, we forecasted them to trend up. So that's built into sort of the way we view the business. So right now, I think we're covered in our guidance with the pricing that we have. But listen, gasoline prices and energy costs are continuing to spike. And we'll watch that carefully and -- but so far, so good. Importantly, the business is strong. But as I said, either you're -- we're seeing recovery already in the gross margins.

Okay. Great. And then you said to expect pricing to offset inflation. However, as an example, on Walmart's earnings -- recent earnings call, the company said they will push back on price increases. How are the pricing discussions going with retailers? And in the CSCI business, do you have any issues with elasticity demand with pricing in that portfolio?

Yes. Well, let's start with the framework that we don't price the way national brands price in the U.S. So that's where your question started. I think in the first quarter, we had -- when we talked about our volume growth being up 10%, only about 20% of that was pricing and 80% of that was volume. And that was in stark contrast to most consumer companies that had reported, which it was the other way around. They were reporting similar total growth rates, but the lion's share of that was pricing. So our conversations with Walmart and Target sound -- and the others sound a lot different because we're only forecasting 3% pricing for the year, not the 10%, 11%. They have worked with us. They are understanding. They are brutally tough, and that's no different than it has always been for us with them. But contractually, when it's true cost, they work with us, they have to. But I will tell you that when I was talking about the pricing that was in for the balance of the year, it was already sold and agreed to. It's just it doesn't happen, let's say, on a store brand than it does on a national brand. A national brand -- I ran national brands my whole career. I ran tobacco products. You take a price decrease in tobacco on Friday, it goes into effect on Monday. For us, we negotiate it, it's the right time, and those are staged over a few months, and those are all being implemented. So can the conversations be tougher in the future? Sure. Do we expect that? Of course. We don't rely on pricing as much. We rely on productivity and volume growth. As it relates to CSCI, it wasn't able to take pricing across the different businesses to help offset it. And so far, but we watch it carefully, we haven't seen a significant elasticity related around that. And I think it's because the dynamic is different, Rupesh. In Europe, it's -- there aren't a lot of -- in the countries we're in, there aren't a lot of private label alternatives to trade down to. And when you're sick, your own personal price elasticity is not very elastic. If I'm -- if my kid has head lice, I'm going to buy the product; or if I have a cough, a cold, et cetera, and our prices are very competitive relative to competition. So I'm not saying they can't be affected by it, I'm just saying we haven't seen it yet.

Okay. Great. And then just going back to gross margins, I know you covered it in your slide. I know that when you laid out guidance for the year, you expected gross margins to be weighted to the second half. I'm sure pricing is clearly a part of this, but are there other factors that give you confidence in regaining gross margin as you progress through the year?

Yes. Well, I laid those out in the first quarter. And the pricing is a big piece of it. Then you had a big hit we took last year when the cough/cold season went away for under-absorption. The plant's full again, running flat out on cough/cold products, building inventories for a more normal cough/cold season at the end of this year in the fall when the prebuilds occur. So you recap -- you're beginning to recapture already, beginning to recapture that lost absorption. We had a number of one-timers in the first quarter that aren't repeating themselves, and we're seeing that already. And then you had a couple that are just math, right? We sold a 20% margin south -- gross margin south our Mexican business. And that's out of there, and we bought a 70-plus percent margin HRA business. So I expect you're going to see progress on that when we report second quarter earnings both on pretty much everywhere, right? I think you'll see it in consolidated with the benefits of the sale and -- but you'll also see it on the ongoing business. And there are numerous other initiatives we're working on for more gross margin recovery beyond that. But it's heading the right way.

Okay. Great. So a question for Eduardo. Thanks again for being here. I know you have been at the company for only 1 month or so, but can you talk about what excited you about joining Perrigo? And do you have any initial areas of focus?

Yes. Thank you, Rupesh. Thank you, everybody. It's a pleasure for me to be here today. And so it's been quite intense month. I'm talking to you from Michigan. I'm attending the CSCA sales meeting. And it's been very energizing and exciting to see where the company is going, right? So after the last 3 years, a lot of focus on the business transformation. It's great to hear that the strategy is getting up to the sales team, and everybody is 100% aligned on what we need to do to really optimize and accelerate. All the discussions are how do we can improve our margins, how we're focusing on pricing. And I think some interesting things that I believe put Perrigo in a great position is the evolution of the culture. I think Perrigo has a mix of very strong heritage about the brand and everything that we've done with a completely new view on how we expand into the digital world, how do we leverage new tools and really use pricing and new mechanisms to really get a differential to our customers and then consumers, right? So that's something very, very exciting. And at the same time, I think it's the ability to leverage the scale that we have with the branding power that also we have in CSCI. And now with the acquisition of HRA to really broaden that even further to get some very strong global brands, I think this is going to be a very interesting turning point as we optimize and accelerate that. And I'm really excited in how we're going to do that. And it's great to see the experienced people on the sales organization mixing with the new generation of people thinking digital and how we can leverage different tools. So I'm really glad to be joining Perrigo. It's such a great time. And given my experience both at Monsanto as well as at Fresh Del Monte working with the retail business, I really look forward to add the value fast as we move into this next phase.

Great. Thank you. So let's now move on to consumer demand. So a 3-part question here. So first, are you seeing consumers trade down to store brand in the U.S. just given the current environment?

Well, let me say at this point, it's anecdotal. What I will tell you is our -- I feel confident in the raised net sales and organic growth guidance I gave you. Nothing has backed off that. Our demand remains, and our business remains robust. So how much -- but I hear, like you hear, Walmart and Target and everybody get out there and say there is down-trading. The hard part for me is -- or our organization is it takes a couple of months before you get the consumer diagnostic data, the panel data. They'll be able to do the true switching analysis to say how much of it is because of that. All I can say is our top line remains strong. I haven't seen any slowdown for us, but I hear a slowdown out there for others. And I will also tell you on -- when I heard Target's CEO speak, he mentioned inventories that had started to stack up, and we -- that is not the position Perrigo is in. If anything, we're still light on inventories at our customers. But we are not sitting at excess inventory at retail. So those are all indicators of strong consumer demand, right, and leading indicators. And we'll do the switching analysis we can. But I will tell you, in past recessions, we tend to gain a share -- depending on how long it goes on for, a share point to 2 share points. And the really encouraging thing is because of the quality of our products, when that happens, it tends to stay.

Okay. Great. Then that's a good segue into my last question on this topic. If there is a global recession, how should we think about your store brand business's balance against any impacts to your branded products, including HRA?

I think Perrigo is in a very good position. I mean I'm not rooting for a recession. But in the event of a recession, our infant formula sells for half the price of the national brands. Our -- most of our products in the U.S. on average sell for at least 30% less than the national brands. We are a place consumers go to, to help make their dollars stretch further. In Europe, again, as I said to you before, we -- our model is a bit different. So there aren't the same big mass merchandisers with private label competitors. There is in the U.K., but we have a vital store brand business there as well. So we're balanced over there, but it tends to be more individual pharmacies. And we call on thousands of pharmacies individually with our direct sales force in Europe. The products themselves tend to be a little less elastic. If when you need them, you need them, but I guess time will tell. But in general, I think Perrigo is very well positioned and a pretty good defensive play in, in that type of environment.

Okay. Great. So moving on to HRA. So first off, congrats on closing the deal earlier this year. Do you still expect it to add roughly $1 in EPS accretion in 2023? And what would you say are the biggest risks to delivering on the accretion?

Well, I'll answer the second part first because the biggest risk is the strength -- it's currency. But every single metric that we had hoped for, when we did our deal models and all of that, are being achieved or exceeded. I've done a lot of deals. I made a bold statement that this is the best deal I've ever done, and I've done a lot in my career. They have handed us over a company that has strong brands, talented people, growing share in every single category, meeting their estimates with very strong growth plans in place. So I think we are in great shape in terms of delivering on all of the underlying metrics. But 2 issues. One is what I already said, which is currency, and that affects the whole world. And once we know what the currency numbers are next year, we'll project it. And the second, Rupesh, as I'm digging in more and more to the synergies, there's big synergies to be had over the couple of years, even higher than I said 40 plus. But there'll be some onetime costs associated with that. But we'll make that very clear that they're -- once we understand an example being we're going to go from a distributor model to direct selling, which is a massive synergy savings, but there'll be some inventory impact of that, and we'll make that clear so everybody understands that. But business on track, doing fantastic, and I'm very confident that you'll see not only the strong growth this year from Perrigo, but with the full year of HRA and a number of other initiatives, we're setting up for strong growth, real strong growth again for '23.

Great. So another topic I want to cover is just top line cadence. So first quarter 2022 top line growth for Perrigo was a very healthy 10%. How do you see the top line progressing phasing throughout the rest of the year? And are there any categories that you expect to perform better than others?

Well, yes. Listen, I gave you the top line guidance for the year. I don't give it quarter-by-quarter. But if I said it was going to be up roughly 10% for the year and it's up 10% in the quarter, it's -- we're expecting growth to continue, right? There's -- you're going to get a bit of a -- you'll get a nice bump from HRA, right? So on our organic business underneath, you have strong growth in the first half of the year and then you're layering in HRA, which just started, so we have 1 month of it now. And it will -- so that will supplement the second half where the organic should slow down a bit to more normal levels. And the reason it was so strong in the first half of the year is you had the recovery of all the pandemic-affected products. And everybody likes to talk cough/cold, which is a big portion of our global portfolio, it's 20%. So that's rebounded and is a big driver. The infant formula has been a big driver. HRA will be a big driver. But in the end, it sort of comes out to that number, which is pretty similar to the first quarter, at least that's what we have in our guidance so far. So it should be pretty even, but earnings will be more back half loaded. HRA tends to make more, the recovery, the pricing, all of those are backloaded. So it's versus sort of our normal, you'll be more 60%, 65% back half of the year in the earnings, but all on track.

Okay. That's helpful color. Then 2 more topics I was hoping to cover. So first, new product pipeline. Can you talk about your new product pipeline? What products are you most excited about? And then how is CBD progressing?

Okay. I could talk about this for a very long time, but I will try to keep it short. I'm very excited about NASONEX. It was once a $1 billion brand at Rx that still has high brand, unaided recall of the brand awareness. That product, we're launching into the lower seasonality. Spring allergy season is much bigger than that, but it will help us adjust our marketing plans. And -- but it's a great product, works 2x faster. It treats multi-symptoms and has great brand awareness. So I'm looking forward to that one. But I think the exciting one, I'm going to talk about one that we're not launching at the moment because I covered the others, and there's a number of them. The one I'm really excited about is the O pill. And you'll see about our submissions coming soon to the FDA. And leading a switch, and we believe we will successfully lead that switch, to have the first daily oral birth control pill in the United States. It was already approved in the U.K. It will be submitted not just in the United States, it will be submitted in 3 other countries internationally as well. And I think that has the potential to be huge for the company. I mean there are still 6 million abortions in the United States a year. There are -- in all consumer studies, there are -- 30% of consumers still say it is very difficult to get access to birth control pills. And we will be providing access at an affordable price with an everyday birth control pill. And given everything else that's happening in the world, especially the U.S. right now, I think the timing is right for it. So I'm very, very excited about the potential on that switch.

Okay. Great. So we have 2 minutes left. So one quick question, just on supply chain optimization. On your last earnings call, you talked about supply optimization project. Is there any further color you can provide on the project scope? And when do you expect to share more details on this?

Well, I expect to share the full details of it at a September investment conference, right? I don't think we have an exact date yet, but that's our plan, share the progress. I'd like to get second quarter so I can show some progress as part of that. And then we wanted to have HRA and a chance in there to really see their plans because you're limited on what you can see prior to closing. So you'll get that detail. But at a high level, Perrigo is a great supply chain. We have a high CQ as a company, a complexity quotient, I like to call it. And it is -- but it needs to be optimized. You put all these various companies together, so centralizing finance across the company and the systems associated, the shared services, productivity optimization in our portfolio. We have -- we make 14,000 SKUs, more with HRA now, and probably 25%, 30% of those represent 80% to 90% of the gross margin in the company. So there's significant opportunities to reduce complexity. There are significant opportunities for our customers that we will be working with to show that the complexity that exists in the store brand business, a lot of that is not benefiting consumers. 80% of the complexity in the U.S. is not consumer-facing. That's a huge opportunity. And technology upgrades, more measurement tools, KPI reading right on to the plant floor, some of the things that haven't been done at Perrigo. And while we've made tons of investments, there's more to make in those types of areas, all represent a massive opportunity. And we got $100 million out of momentum or more focusing on OpEx expense. And now we're going after the big $3 billion in cost opportunity.

Okay. Great. Thanks, Murray and Eduardo, for joining us today.

Thank you. Thanks for having us.