Perrigo Company plc (PRGO) Earnings Call Transcript & Summary

Good morning or afternoon, everyone. Thanks for attending our conference. I'm Susan Anderson, one of Canaccord's consumer analysts. And I'm very excited to have Perrigo here and particularly to host the company's new CEO, Patrick Lockwood Taylor; and then CFO, Eduardo Bezerra. Thanks so much for joining us today. So maybe we'll kick it off, Patrick. So you're fairly new. I think it's your 40th day at Perrigo. Maybe if you could just give a quick overview of your background and then also just give a high-level view of how you see Perrigo and how you potentially see the future.

Firstly, thank you so much for hosting us, and hello, everybody. Can you hear me okay? I have this very soft English accent. Background, I started in Procter & Gamble, worked for them for almost 25 years, 4 different continents. I worked in every category, multiple functions, and we're all familiar with the unique matrix in almost every part of it. So that was great, but finished my tenure with them as a Senior Vice President of the Consumer Health business, self-care. Then went and did a stint in a mid-cap, distressed mid-cap, which was Oneida, which was excellent assignment. Then moved into Bayer. Firstly, to run their North American Consumer Health business, which was underperforming, got that back on track and then took over as the President of Bayer U.S., about an $18 billion business across crop, pharma and consumer. And then joined Perrigo, as you rightly say 40 days ago. I started that work with Perrigo, the search, et cetera, in January of this year and then worked through the normal sort of process and agreed to join the company early May. In terms of the company, it's -- it's an interesting combination of assets. What struck me, I think the repositioning of the company into self-care sort of pure play was a correct one. It's in the very early stages of that, and there's a lot of work to do. But the asset base is good. I like the leadership that we have in the international business, the culture there, the growth, they've integrated their business extremely well. So international is very, very encouraging to me, and we will continue to drive efficiencies there, a more regional portfolio there. The next is our manufacturing scale, which I talked about on the call yesterday is phenomenal. Okay. I mean it's just phenomenal. The question is, well, how do you better leverage it and monetize it -- are a big surprise. Everybody talks about Perrigo as fast-follow innovation. And yes, that's true, but I don't think gives enough credit to we're actually consumer-leading innovation, new molecules, combination of molecules and really offering consumers benefits they can't get elsewhere. We typically then sell that into store brands or sell it into national brands, and they get disproportionate value from that, okay? So I think that is a value-creating opportunity for us as well. We have incredible consumer reach in the U.S. There are very few companies that you take certain categories that we sell, 80% of the units sold come from us. Fifty, 60 volume shares, almost 1 in 2 of the units we produce end in consumers' homes in a given category, that's a phenomenal reach. But how do you leverage that, monetize that? So the opportunity for the company is to continue to focus on sustainable growth, but greater value creation and capture. To really think about how we consumerize the company, and that's a much bigger opportunity and importance in the U.S. We think for -- as per our history, customers, volume, contracts when actually the opportunity for us is to leverage our assets to grow consumer preference. So that I could talk for quite some time, but that's my big thoughts.

That's a great overview. Maybe since we're kind of on the topic of the U.S. and Perrigo's large share, 50% in the U.S. and private label. A big question I get from investors a lot is how do you kind of maintain that share? How do you keep from other players coming in and taking it? What drives the retailers such as Walmart or Target, who's always looking to cut costs from just moving to someone else? I guess maybe if you could talk about your differentiation in the category in the U.S.

Yes. So thank you, Susan, for the opportunity to be here. And so one of the key things when we look into the U.S., so we have the 3 different businesses, right? So OTC nutrition and oral care. So specifically in Nutrition, we are working now with the acquisition of Claire water or the Gateway facility from Nestle, that's bringing another component in our portfolio to have a brand, but also at the same time, how do we bring up new formulas into the marketplace and be able to differentiate ourselves and even get closer to the premium brands there. On the OTC side, I think there is a big opportunity. The more we're seeing as national brands have stepped up pricing significantly over the last couple of years, and while store brand, which saw a pickup in volume and not so pricing to the same level, we believe that there is a big space there for us to differentiate ourselves from other store brand suppliers. And so that's really a great opportunity. And what's very interesting and nice is that Patrick is bringing a different language and approach on how to look into consumer to be very differentiated in our U.S. business. We have a little bit more of that in international, but that's a key opportunity that we have in the U.S. business.

Great. That's exciting. And then Eduardo, maybe you could talk about just maybe some big longer-term sales forecast and your margin outlook that you gave during your Investor Day and kind of the building blocks of getting to that margin outlook?

Yes. So that's quite interesting. So in early March when we launched our Investor Day and we came out with our plans up to 2025. So you mentioned specifically 3 key components, right? So on the topline, we were expecting high single to double-digit topline growth, right? We talked about a significant recovery in our margins. So last year, we closed about 36% of our gross profit margin and our objective is to recover to 40%. And that's going to be a combination of strategic pricing. Also, we talked a lot about our supply chain reinvention and how we can recover some of the margin that were lost in the last years there, but also the benefit of the different acquisitions that we did, mainly HRA as well as the Gateway facility that we acquired from Nestle. So that's a key component on how we drive that gross profit margin improvement. And then we expect that to translate into also a significant operating margin improvement. So last year, we were at 11%, we're guiding towards between 14% and 16%, and we expect that to happen through the synergies on the HRA integration, the analyzation of the different acquisitions and the supply chain reinvention. So that's really going to drive us to achieve that 15% operating margin range. And the third component that's very critical is our ability to how we convert all this cash that we're going to generate plus also cash from some strategic non-core assets, divestitures to be able to deleverage our balance sheet. That's one, another key element of focus that we have that also will bring an EPS benefit by lowering our interest expenses. So those are 3 key important components that we're working on to deliver on our 2025 commitments.

Great. And then so you mentioned the non-core assets and some potential divestitures. Maybe can you talk about just the brand portfolio? What areas do you see as core? What areas do you see as non-core or that potentially you could divest at one point?

Do you want to talk a little bit?

We create more value in certain parts of our portfolio, obviously. We have a greater right to win in certain points of our portfolio that better leverages our core strengths and assets. We're going through an exercise now of how do we double down in the near-term on those to sustain performance and create more value. And we're moving from sort of category, if you will, to category going through that. As we come out of that and look across these categories, we'll get a much better sense of which are the most financially attractive, which plays to our strengths, where do we need to be focusing going forward, which responds well to our manufacturing, which responds best to our innovation and what's the most scalable, okay? We are, as you know, the sort of a conglomerate of different things, and we need to bring more efficiency to that. So that work is initiating now and is underway, and I think we'll have a much better sense of what is a more strategic, attractive portfolio over the next few months.

And just to complement, the way we're talk internally is we have defined our sandbox, right? So we're now 100% dedicated to consumer self-care, right? So this was the work that took over the last 4, 5 years. Now it's, okay, now that we know the sandbox, where we're going to really play successfully to win in the long run.

Yes. Okay. Great. That sounds good. And then you mentioned, so the HRA and Gateway acquisitions. Maybe if you could just talk a little bit about kind of where you're at with those integrations. When will the integration be fully complete?

Yes. So starting with HRA, right? So it's going very well. So Beginning of this year, we got the teams working together because of works council, et cetera, in Europe. So the organization that mainly in international is set up, teams are working together. We had the integration of sales force, of our marketing teams. And so our original expectations in terms of synergies, we have been able to over-perform. So we're projecting that we're going to be slight ahead this year on our synergies' target, and also, at the same time, when you look into our distribution transition component, that's a one-time impact that we see for this year, we're also tracking very well there. So we expect that the full benefit or 95% of that benefit to take place by 2024. So we are very on track on that side. On the gateway side, so we're working now to integrate our operations, order to cash is one of the key things that we expect to roll out now in the beginning of the fourth quarter that we're going to be integrating 100%. But we see already the significant value accretion to our results that took place in the second quarter in Nutrition business because of the Gateway facility integration.

Great. And I guess just a follow-up on the infant formula business with the changes with the FDA, what they're making, how does that impact your business and managing that business?

It's been a volatile category for quite some time. I think it's getting to normalization. The major brand players back building out their SKUs spend share, okay. The new regulations essentially introduced more stringent cleaning protocols. How scientific that is, debated, but okay, they are the protocols and that's meant more disrupted operation. It's essentially meant more costs, less capacity. So we are still in a situation of we are undersupplying versus demand. We will see -- we are seeing recovery, and we see a particularly strong recovery early in quarter 4. But this is still stabilizing. And the regulations on top of what was already a complex capacity-challenged industry have complicated things further.

Okay. That sounds difficult. I guess maybe Eduardo, can you talk about capital allocation, I guess, just remind us where you're at with your leverage ratio and the goal that you want to get to? And then I guess, longer term, and Patrick, maybe you too, how are you thinking about the brand portfolio? Is there opportunities to fill in any categories you would want to be in? Or do you see potential acquisitions again down the road?

Yes. So on the first piece is, in Investor Day, we came clearly with the -- our direction that we want to reduce leverage below 3x by end of 2025, right? So we ended 2022 at 5.5x and Q2 we're 5.1x. So we are progressing well on both metrics, right? So on the cash generation and the EBITDA generation as well. And it's -- when you look to the overall cash generation over the next 3 years, we expect to generate between $1.6 billion to $1.8 billion of cash, majority coming from the operating cash flow, but also the divestiture of some non-core assets. And then we're going to deploy that on our CapEx investments, our capital expenditures to deliver on our supply chain reinvention that is so critical as number one. We're going to continue to grow our dividends. That's our commitment. And also, we consider to reduce our debt. We have bonds that are due at the end of 2024, and we're expecting to reduce debt. And that's why 2025 is going to be the key element we're going to see that significant reduction in our leverage.

In terms of portfolio, as I mentioned earlier, we've got work to do. I do expect a more focused portfolio. And I do expect we'll do select but scalable bolt-on acquisition and unbolt divestiture as well as we really refined our sustainable value-accretive growth model.

Great. And then we haven't really talked about the international business much, which is more branded, right? It's the opposite of the U.S., and I think it's interesting because there's less private label in the international business versus the U.S. So there's not as much opportunity for that trade down. Maybe if you could just talk about how the international business is doing and how the consumer is doing internationally, too.

Yes. I mean, quick observations from me and then we'll get the real answer. The quick observation, actually, the market there is surprisingly buoyant, actually -- good growth rates, lifting all boats. Our brand performance is good. We are out looking value share growth, which is encouraging. We have very good distribution, very good direct coverage of about 100,000 pharmacists, a very strong relationship in the U.K. where we do actually have own label business as well. It's much more developed in the U.K. So overall, that business is performing well and credit to the team. The integration work has been good, the operationalization and refocus of the business is good. And now we're just going to move it to a more efficient structure. It's multiple country organizations, multiple country brands. And so really, it's now about driving convergence of that.

Yes. And that's quite interesting. When you look into the international business, there are 4 different let's say, business units, let's say. So you have what we call the branded business. We have oral care, we have industrial, which is mainly leveraging our excess capacity to contract to other players. And we have our U.K. consumer health care. The interesting piece is when you look into the margins of our branded core business, we are very similar to the top players in the industry. What happens is because of oral care industrial, that dilute that margin. So when you look into margins on the international business at around 50%, when you look to the branded business, we're talking about 60% to 65%. So that's a very profitable business, et cetera. Why don't see that translating exactly on the operating margin, that's exactly what Patrick mentioned. The way the business still operates is very decentralized. And so that's one of the areas that we saw as a major opportunity, and we're tackling and addressing that to make sure we can convert that into a better operating leverage and improve our operating margin for that business.

Great. It looks like we have a few minutes left here. Maybe I have a couple more questions. I guess, on the inventory in the U.S. at retail, I'm curious just your thoughts there. It had some pretty big swings over the past couple of years because of COVID and supply chain constraints. I guess where do you see the inventory right now at retail? And how do you guys sit within that?

Yes. So having experienced similar challenges on the previous job, stabilizing, normalizing but not complete yet, and it varies to some degree by category. I think most of the big manufacturers are now in the sort of 80% to 90% case fill rate, service level. And so inventory at shelf still slightly behind probably pre-COVID, but recovering.

Yes. Okay. That's kind of what we're seeing, too.

And the key thing there is -- as you said, the last 3 years have been very erratic, right? So we are considering that for our second half, we're going to have more of a regular and normal cough and cold season. So we would expect retailers to start filling up their inventories in Q3 right? So that's a big assumption and we need to see how that's going to evolve in the next couple of months.

And they'll probably stock more normal too versus in the past.

That's what we expect.

Okay. Great. And then I guess we have a minute left here, just one question that we're asking all of our consumer companies. We're curious just your thoughts on the consumer. And I guess, both internationally and in the U.S. as we look into the back half of next year with some inflationary pressures, concerns about a recession that has yet to happen, but it's out there. And so how are you thinking the health of the consumer is going to shape up as we look into the back half of next year?

Yes. I mean, I think all of these concerns about recessions, et cetera, for whatever reason, were exaggerated. I think the economy was fundamentally much more robust. Yes, there have been shifts in cost of borrowing, and that will correct, inflation is -- was always seen as being just a relatively short-term impact. It was driven by disruption not fundamental imbalances. So I think the consumer was stronger than was being said 12, 18 months ago. And I think that's playing out now. We haven't seen big trade downs, trade-outs. Every time I go to a restaurant, it's packed. So I think it was exaggerated and the fundamentals were stronger than they were talked about and the consumer optimism and outlook was stronger. If I looked at what was being privately spent, it was high and has stayed high.

Great. Great. Yes. That's kind of what we're seeing as well. Well, thank you so much, Patrick and Eduardo for joining us and your insights today. It's been really helpful.

Okay. Thank you Susan, thank you very much.

Thank You.