Perrigo Company plc (PRGO) Earnings Call Transcript & Summary

All right. Thanks, everyone, for being here. I'm Dara Mohsenian, Morgan Stanley's household products and beverage analyst. Just before we get started, for important disclosures, you can see Morgan Stanley's website at morganstanley.com. And with that, we're very pleased to have Perrigo with us here today, including Patrick Lockwood-Taylor, President and CEO; and Eduardo Bezerra, Executive VP and CFO. Thank you very much for being here.

Thank you.

Thank you.

So first, Patrick, you've been at the company for about 5 months. Maybe just talk a little bit about your experiences before Perrigo and how that might apply here? And what made you excited about opportunity at Perrigo?

Yes, very good. Well, thank you for having us. So almost 25 years at P&G, worked four regions around the world, multiple positions across their famous matrix and spent about 10 years in their personal health care business in Asia, globally and in the U.S. And then most recently, about 5 years in Bear, 2 roles. I was running their consumer health business here in North America and also was the President of their U.S. business, all divisions. And then Perrigo. I've known Perrigo a long time, particularly it's -- for the manufacturing, they are suppliers to both Bayer and to P&G. Stand-up, decent high-valued company that I thought really was a blended brand company, store brands and conventional brands, and as such, could create a unique model in self-care, comprising store brand and national brand.

Okay. Great. Usually, I'll start with the long term, but maybe let's start with a couple of short- to medium-term questions here. Just with the cold and flu season upon us. Your perspective on maybe some of the -- with the volatility we've seen in the external environment, right? We're coming off of COVID a few years ago, cold and flu seasons, volatile season to season. So just any thoughts around how you see that ramping up in the U.S. and Europe. And also just your position from a sort of macro standpoint, given all the volatility we're seeing in terms of the consumer? It would be helpful to start there maybe with some external issues and how that impacts your business.

Yes. I mean firstly, on cough/cold. Having been running cough/cold businesses for 20 years, the big insight is they are seasonal. And that varies from year to year. And sometimes it's strong, sometimes it's not, and you manage accordingly in terms of your spend, your inventories and you -- just agility for cash. This year, we're coming off several extraordinary years, which were not representative. I think it's been a normalization. Last year, it was a big season, and it started very early. This year, we see actual incidents in line with projection, consumption probably somewhat tailing that. We're still very early in the season. The CDC had predicted that there would be a normal season, and it would start later, okay? And we'll see. We'll see. For us, unlike others, it's not a particularly large part of our portfolio, certainly from a profit standpoint. Therefore, we are not particularly troubled. In terms of consumer volatility, there has been a little bit of trading down from national brand to store brand, some, and we have seen some recent uptick in store brand share, but not massively. In terms of disruption of -- are they moving across different channels? Yes. I think some retailers have seen increase in foot traffic. Others have seen declines, but it's a sort of a reverse of what happened for 2 or 3 years during COVID. So again, no particularly big disruption, just normalization. Continued growth of e-commerce as it has been for 15, 20 years, so no particular disruption. So I'm not really seeing [ traction ] as such, it is really just sort of many -- a lot of normalization. Self-care continues to grow. It has very favorable tailwinds globally, 3% to 5% sort of growth across category. I think some categories again, though, normalization, vitamins, minerals, they didn't -- they declined slightly, but they're still significantly larger categories than they were pre-COVID. So I think we're -- it's not so much dislocation as normalization.

Okay. And given your mixture and brand portfolio, how does trade down impact your business short term? And how do you see that playing out as you look out over the next year or 2? And any sort of tactical adjustments and strategy as you reconfigure to that environment?

I mean, we, again, blended brand, 90% or so of our business in the international business is branded. A model market for us is the U.K., which is 55% branded, 45% store brand, grows very well, very attractive margins. And that's almost where we're sort of thinking is how we want to grow. So a disproportionate amount of our growth will come from branded. We're launching Opill soon, which I'm sure we're going to touch upon. And we want to get to more global categories and more global brands going forward. For us, because we play across so many molecules, we're much less seasonally impacted. Nothing in our business represents more than 3%, so we're more insulated on that. And because we play in every price tier, we tend to be more insulated during these sort of economic downturns or indeed as disposable income then increases and consumers start to trade up. So we're really loyalty agnostic to that because, again, we're a blended brand company.

Okay. Why don't we talk about the Opill launch and excitement there, and dimensionalize the opportunity for us and how you see that playing out over time?

Yes. So -- we're getting ready to launch, production well underway, marketing qualified. It looks like a very good launch model. Excellent retail support. This does create access to daily oral contraception for about 75 million American women, which is important and a huge audience in a highly convenient value-attractive way. We see very good growth potential from it, of course. It's a net new category. We're the only brand that really is how quickly we can build awareness and trial and just compress conversion. And that's the model that we've been developing. But it is only start of the architecture because we do want to be a mega brand offering solutions across the women's sexual health journey, okay, from the moment she enters into that category, all the way through to post menopause, including fertility. So we will develop out of a mega brand.

Okay. And maybe we can segue into just broadly R&D at the organization. How you develop R&D, your process, the marketing side of things. We obviously talked about it in relation to Opill, but it'd be helpful to have some background there and how you guys sort of approach that.

Yes. I mean one of my surprises coming into the organization was how enormous our R&D organization is. We have probably globally somewhere in the region of about 300 product development people, 300. A lot of that resource, particularly in the U.S., have been on fast following other innovation. And so as we move to be increasingly focused on building brands with consumer-preferred innovation, the big change to our process is consumer qualification, which is relatively straightforward, just to confirm that we are bringing a superior innovation that builds the category and the brand. But we have the resourcing and those technologies already in place. This is just an additional step to our development process. So I mean, Perrigo has phenomenal assets that we need to repurpose in the most growth-orientated, more differentiated way. But the asset base is largely there.

And are you bringing changes to that sort of R&D innovation process or the commercialization of it? How are you thinking about that with...

Yes. Yes. As we focus particularly on the U.S. and building brands, we will bring in brand-building capability. We will bring in digital consumer capability along with everybody else. Having done that a couple of times before, we know very good providers of that. We can build it out quite quickly. Obviously, in the U.S., as we increasingly go to branded go-to-market that is slightly different to store brand selling -- and so there are a number of areas, you mentioned innovation, a number of areas where we are bringing in new capability and bringing in leadership that's more consistent with our future direction, yes.

Okay. Let's talk a little bit about pricing, how you plan to manage that going forward. Obviously, there's been a multiyear period here of excess inflation from a CPG perspective in general. But maybe talk about strategically how you think about pricing, where you think you're at in terms of key pieces of the portfolio today? Are you at the right spot? And maybe we can touch on the cost side of it, too, which obviously is a big driver, ultimately, of the pricing you're looking to realize?

Yes. Yes. Let me take a piece of that. If you look into the portfolio, right? So on the branded side, which is 90% of the international business, we have been increasing prices year-over-year consistently, right? So to keep up without increasing costs that we saw across the board, mainly in Europe in utilities, oil, different components of the portfolio there. So we have been margin accretive in our actions there. When you look into the U.S., right, so there are 3 specific business units, right? So we have OTC, infant formula and you have oral care, right? So in OTC, last year, we had around average 5% price increase. It's -- because there are some places that you're very competitive that you had almost zero. There are others that you were able to get 8% to 10%. So 5% around an average that we saw there in the OTC business. And we continue to look at that opportunistically in the different molecules that we participate. On the infant formula side, there's been a lot of catch-up that we did mainly this year. We were behind in some of the advancements on formulation. So this year, we took 40% price increase to deal mainly with the changes in the regulatory environment that took place early this year, right, and keep up with the additional cost to manage the portfolio. And the oral care, similar to OTC, we've been looking -- we have a branded portfolio that we're able to increase prices and the store brand a little bit more competitive sale. We're going to continue to look into that and see, okay, how much more opportunity we have there to price. But the positive side, like in oral care, we're seeing costs receding because many -- a lot of those imported products from China. On the U.S. side, logistics and other stuff have been receiving as well. So that's helping adjust also our average margins to a positive extent.

Okay. And I guess, as you think out long term in terms of pricing, what goes into that decision? Is it more costs that drive it? How important is the retailer dynamics in that decision or consumer elasticity? And what have you learned in recent quarters as you've had some of that higher than typical pricing?

Yes. So a couple of things. I speak to the short term and there is the second component that's more what Patrick was alluding to, how do we consumerize Perrigo, right? So the first thing is how to make sure that as we look into our overall margins, we have a target to get back to 40% by 2025. So this year, we're growing more than 200 basis points versus what we had last year. So we're pretty well on track and the different initiatives to get our margin up. I think long term, the key thing is how do we look into this blended branded portfolio to really look into, okay, where can we bring incremental pricing to the equation, either through our branded side, store brand, but even opportunity in certain categories to position into kind of a mid-tier portfolio there? Because if you look today, the price differential of the national brand versus store brand has grew significantly over the last 3 years. And so there is a real opportunity to have a mid-tier product that will bring more value, not only to us but also to the retailers because -- and it's something that we believe Perrigo can do, and we are doing today. So for instance, the example Patrick mentioned about the U.K. The U.K., you have store brand. We have our equivalent mid-tier brand, and we have the national brand. And that's a very profitable business that year-over-year, we're able to grow the top line and improve our margin. But I don't know if you want to talk more on the long term on pricing there, Patrick.

I don't think I have much to add. I mean, we believe that we bring a lot of differentiation with our store brand business. We need to get better at that story, and we continue to think we should command more value in that particular piece of the business. So that's what we're focused on.

Okay. You talked about some of the pricing in infant nutrition. Obviously, there's been some volatility there. You talked about it on the last earnings call. Can you just give us an update on your thought process on that business and some of the volatility that we're seeing?

Yes, we continue to manage to stabilize it. It's going to be a few more months before their business is in steady state with the right level of sort of safety stocks. Because we supply so many store brands with different SKUs, our SKU count is much higher than some of the branded competitors. Therefore, the complexity of us in managing line changes and all the new cleaning protocols is just exponentially greater. So it's been slower, more complex, and we're not out of the woods yet.

Okay. Great. Well, shifting more to the long term. You're a player in sort of a land of behemoth to some extent. We just spoke to a new friend on the block a couple of meetings ago in ChemU and other larger organizations, and in theory, some maybe splitting off down the road here. So just maybe talk about your sort of special sauce, sweet spot as an organization, how you sort of manage through that? And how do you think about driving outperformance in your business versus some of those larger competitors?

Yes. I mean we produce about 62 billion units a year, that that by far away is the most. We have the most number of SKUs. If you were to add up some of our competitors, I think we have more SKUs than the top 4 combined. The point being is our secret sauce is how broadly we play. We compete in about 300 molecules, okay? Our competitors are competing in a fraction of that. We're also the only ones who compete in every price tier. So the secret sauce that we have really is our scale. The challenge for us is to get that scale into things that are more meaningful for consumers and create a more sustainable growth model for ourselves, and that's the work that we're currently doing. But I -- a lot of our competitors are very strong in a small number of categories, okay, particularly within the OTC space. We have incredible volume share relationships with some of our largest customers. Amazon is something like a 70% volume share. Walmart is -- these are huge relationships that we have. And how do we serve them better than consumer better using all these incredible assets we have in order to create a more attractive investment opportunity for Perrigo.

Okay. And how are you sort of providing value to those retailer partners? How do you use your scale across categories like that broader product offering across categories versus competitors? Maybe talk about how you use that to your advantage and maybe how you think about it a little differently coming in and running the organization than the way it's been historically or maybe…

Yes. So I mean, I've worked for 2 of the so-called behemoths. And actually, our U.S. business as Perrigo, I think it's slightly bigger than those 2 behemoths -- 2 of the behemoths. I've been very surprised at the strategic relationships that Perrigo actually has with some of these big retailers. We're invited into a discussion and long-range planning at the category level that I've not been a party to before. We're exploring consumer opportunities because we serve them to better serve consumers according to what they want to do as opposed to here is my brand development plan that I sell to you, okay? So we enjoy a much more partnership than I've experienced before. My relationship before has always been how do I best sell my brand. This is how do we craft the self-care category together using our asset base to help them with their strategies. It's a different type of role that I've experienced and I think one that we will continue to build out.

Okay. And as you think about long-term growth profile, which areas are you most excited about? It could be geographic, could be brands, product categories, et cetera, However you guys would sort of dimensionalize it. Thinking about long-term top-line growth, what are the biggest growth opportunities for the company? And maybe under your leadership, what's sort of changing in terms of focus versus where we were previously?

Yes. Obviously, the most immediate opportunity for us is Opill, okay? And so entering into women's health care in a meaningful expansive way. We are increasingly focused on a narrow range of brands that we think have global application. So the -- you will see disproportionate focus and spend now on driving our branded portfolio here in the U.S. and in international. And paring that down, we have to get more focused. So again, it's -- it will be a narrower portfolio of brands and a narrower range of categories with world-class brand-building capability that we need to build out. But really, the thing that gives us scale is the store brand business that will always be an important part of us, and that's what allows us to work more strategically with customers. Again, the U.K. is a great example, 55% branded, 45% store brand, outstanding partnerships, sustainable growth, value-accretive growth. That really is the model that you need to probably be thinking of the Perrigo in the future.

Okay. And how do you see that mix evolving over time? Maybe getting down into a little more detail of geographic, right, the answer is different from a geographic standpoint. And how do you think about the margin implications also of that?

Yes. I mean -- so basically, we're a European and U.S. business essentially at the moment. Within that, there are -- obviously, the U.S. is critical. The U.K. is critical. A significant business in Germany and in Southern Europe and a fast-growing business in Central and Eastern Europe. So they really will be the core geographic focus. No plans at this stage to expand south or east, okay? We have abundant opportunity here. And we are very focused on managing for cash and margin expansion. I'm less concerned about rate of revenue growth. It is the quality of our current revenue that I'm focused on.

Okay. That's helpful. Maybe we can turn to capital allocation, priorities there in general. Is that shifting at all as we think about priorities from here?

Yes. So there mainly 3 major areas of focus that we outlined in the Investor Day at the beginning of this year, right? So first of all, how we deleverage our balance sheet, right? So we were at 5.5x, and we have objective to get to 3x by the end of 2025, and we have clear plans on how to do that, and they have been tracking pretty well there. The second piece is reinvesting in the business, right? So we did certain acquisitions recently and there are some investments that come through that, mainly on the infant formula business to increase capacity to be able to meet our volumes and our targets there. And the third piece is returning value to our shareholders, right? So we're looking to these, and we brought some new thinking about that. On a yearly basis, we returned about $140 million, $150 million through dividends, and we're looking to, as Patrick said, how to make sure we focus the capital allocation to get to the best total shareholder return there. And of course, as we think about how to build these capabilities and narrow the portfolio going forward, there may be opportunities to expand in certain categories, but most likely, it's going to be more on bolt-on acquisitions or switches. I know Patrick has a long history of that and great experience there, and Opill is a great example through the acquisition of HRA. And there are a couple of others that we are building up. But those 3 things are the most relevant ones. Investing, getting our deleverage down and return value to our shareholders. So -- and we're doing that on a holistic way to make sure that our pipeline of innovation, one of the things in Europe, we have today a very decentralized business, how do we extract the higher margin, operating margin from that business is a key priority for us as we're looking to that as well.

Okay. And how do you guys think about reshaping the portfolio over time, either through M&A or divestitures? Do you expect that to be something that's significant or more moderate and not a big focus?

It's a core focus. We're looking at deep diving portfolio now. I would expect we will narrow it, both categories and brands. And then at some stage next year, we'll be sharing what are those global assets that we're looking to drive. And then with time, I expect us to be divesting certain businesses as well.

Okay. We talked a little bit about innovation process earlier. Can you talk about expected contribution? Obviously, Opill is one big launch. But just holistically, as you look across the organization over the last -- the next few years versus the last few years, how do you think about innovation contribution?

I think about it a lot. It's -- we're in a CPG category. We were, historically in the U.S., a fast follow innovation. So we now have to get to consumer leading that expands the category, the brand, our share of it. And that does mean a lot more consumer at the moment with a combination of sort of refresh and new-to-world innovation, that is approximately $300 million a year. I would expect that to continue going up with the contribution from new innovation as opposed to refresh innovation, increasing of that. I think, probably, we would expect 40% of our annual growth to be coming now from innovation. I think, historically, it's been probably more in the 20%.

Yes. And I think the key thing is more focused innovation in big [ bets ] rather than -- because one of the biggest complexities of the large portion of the portfolio in the U.S. as well as the multiple brands in international is -- okay, you dilute a lot of the focus. So we have been focusing a lot on how do we reduce details so that you can invest more in the big bets of what we are really going to be, I wouldn't say disruptive, but what's really going to give you the highest return on that investment. So that's a key component of the capital allocation that we're doing internally as well.

And more of our innovation coming from Switch. It continues to be very value accretive for all stakeholders, including shareholders. There's some very good cash return typically. And so we will be looking at more Switch.

Okay. And it sounds like there could be a narrowing of the portfolio over time. Are there certain areas you're looking to move into over time? Or are you comfortable that you have sort of this broad offering, and it's more about narrowing it down to core choices and really driving growth in that piece of the business?

It's the latter. There are some very obvious places. We have a very good business in sort of what I call damaged skin, that's Mederma. These are great brands. We obviously have a very good OTC business in core categories. The NRT business, we actually do think is part of self-care. It's a great alternate to smoking. That is a large business for us internationally as well. And of course, women's health, which will be one of the fastest-growing parts of our portfolio. Those are almost obvious choices for us.

Okay. And coming in from the outside, are there organizational capabilities that you really want to beef up? Is there levels of spend in certain areas, headcount, infrastructure, whatever it may be? Help give us some insight maybe on some of the areas that could use a bit more investment or even just broader changes execution-wise?

So the first thing, we have a large, quite complex organization. So this isn't about finding new money. This is actually about simplifying our company and allocating our resource to -- resource that we think will help consumerize and digitalize the company. So given that, investment in brand building from top to bottom. Obviously, digital in all aspects of that and innovation, consumer insight, design, really anything that just locks on to brand building, which I spent 32 years doing, and we will build out quite quickly. But this is about spending less, streamlining an organization for having more fit-for-purpose capability going forward.

Okay. And is the bigger payoff in terms of ultimately yielding greater top-line growth through execution? Is it more about their savings as you do this? How do you think about that conceptually?

Yes. I mean, I'm much more focused on the internals, right? So gross profit, expansion, free cash flow -- free cash flow as a percent of yield. This is what we're more focused on. Absolute growth, I think we will see much more growth from certain brands. And then as we execute our sort of portfolio, that will then drive overall growth rate as we exit certain businesses. I'm much more focused on quality of earnings.

Okay. And maybe we can tie that into valuation, right? You're coming in as an outsider. You've obviously been at some of these larger consumer organizations over time. In public markets, you can see some of the higher multiples that some of your peers set. So I guess your thoughts on sort of opportunity there, that's partially our job instead of your job. But your perspective on how you see that and maybe how that ties into some of the strategies that you're installing at the organization?

Yes. So what I hear from our investor base, and then I hand over to Eduardo, much more experience on this. Get to operating reliability consistently. I think we've largely sort of checked that. The second one is show a sustainable growth path that believably gets you to about a 20 OI. That seems to be the magic number, okay? That is uniquely you and is done in a sustainable way. It's not about trying to acquire into that, if you will. That is the work that we're currently going on. And later next year, we'll sort of share with investors what our pathway to that is as we finish our portfolio analysis, et cetera, demonstrate some of the capabilities we brought in and, of course, look at Opill, which internally is much more profitable, obviously, than the balance of the business in the U.S., as you would expect. So it seems to be there. What's the sustainable pathway to 20 OI that sort of starts to get you into sort of CPG known performance, okay? Less focus on extraordinary revenue growth, but again, quality of revenue growth, if you will.

I would just add to what Patrick said. It's achieving that objective while you get your balance sheet. You're deleveraging, and that will enable you to translate into higher cash flow generation. So that really is going to allow you to make other capital allocation decisions, right? So how do you fuel continuous growth in the key categories that you believe you can still -- you can consistently deliver top-line growth at 20%, let's say, OI level, right, or range? And then what is the cash flow generation on each of these businesses? Some are more capital intense; the others may have some more working capital requirements. So you need to balance that in a way that you optimize the equation to improve your cash flow generation there. And that will make us translate that into a different valuation for the company. That would put us…

And related to that, how you're translating that into a more TSR-driving capital allocation strategy as well. And so this is what -- quite literally the work we're going through now. Great. So no great surprise, improve your margin, improve your cash flow and translate it into an investor-friendly [ action ]. You ever heard these before?

Sure. And that 20% magic OI or operating margin number, what are the key drivers as you look out to get there? How do you think about that over the next few years here?

Yes. Remember that we laid out our plan to get to about 15% to 16% by 2025, right? So that's based on our supply chain reinvention, mature acquisitions, synergies and some base business growth, right? So Opill was not there. First year is dilutive, but that's going to be incremental over time. Also, we're looking to how we optimize our cost structure and get more operating leverage there. And then from that point on, as we look forward is -- okay, how do you bring a consistent branded business on top of what we have today that will drive incremental value at a much higher margin, the gross profit, without having to add too much structural cost? Of course, you're going to need to invest in A&P and innovation. But you're going to have the right cost structure setup so that you have even higher operating leverage, bringing that to your bottom line. So that's really the -- let's say, the plan to get from 15%, 16% to 20% there also.

Great. Well, that was very helpful. We appreciate you guys being here. We're just about out of time, so we'll end things there. But again, thanks again for coming.

You bet. Thank you very much.

Thank you very much.