At least two investment firms upgraded Prestige Brands' (NYSE:PBH) stock July 9 on news it had acquired a small Australian firm giving it access to the Asia/Pacific region. While there's a lot to like about the branded over-the-counter drug company, its stock's trading at 27 times earnings. Is there enough growth to justify this type of multiple? Should you be buying? I'll have a look.
Over The Counter
This is the company's only focus. With the health and wellness trend becoming mainstream, Prestige Brands is nicely positioned to take advantage of this. Its 14 core brands, which include Chloraseptic, Gaviscon, Efferdent and Clear Eyes, represent 70% of its fiscal 2013 revenue of $624 million. When CEO Matt Mannelly was hired in September 2009, its annual revenue was $293 million. By the end of March, 2013, its revenues had more than doubled as a result of three acquisitions totaling $943 million that Mannelly undertook in fiscal 2011 and 2012. Adding 23 different brands including 17 it picked up from GlaxoSmithKline (NYSE:GSK) for $663 million; it's made itself more attractive both as a possible acquisition for a larger consumer products company but also to any smaller companies looking to partner with a larger, more stable business. Whichever way the wind blows, Mannelly's put Prestige shareholders in a position to benefit.
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Adding products if it doesn't lead to greater profits simply doesn't make any sense. In fiscal 2013, Prestige Brands achieved several records including revenues of $624 million, a gross margin of 56.6%, an EBITDA margin of 34.9%, $138 million in cash flow, $127 million in free cash flow and 52% adjusted earnings per share growth. Of course, none of this was achieved without paying a price. Its long-term debt at the end of March 2010 was $328 million. By the end of March this year it had risen to $978 million, almost three times the amount. As a result of the increased debt, its interest expense increased to $84.4 million with a 7.9% cost of funds, 120 basis points higher than in 2012. However, as long as the company can keep growing margins on a quarterly basis, it'll do just fine. As it stands now, its EBITDA margin of 35% is 380 basis points higher than the industry median of 21.2% and better than both Johnson & Johnson (NYSE:JNJ) and Colgate-Palmolive (NYSE:CL). Furthermore, it paid approximately 7.2 times EBITDA for the three acquisitions and now it's valued at 12 times EBITDA, suggesting the 23 brands have added $500 million in value to the company.
The company has a simple formula: If it can continue to grow its core over-the-counter business by 1-2% above than the industry average, generate more than $125 million in free cash flow per year leading to faster debt reduction, and continue to generate attractive M&A transactions, its stock will continue to deliver tremendous upside. To the end, the last 12 quarters it's outperformed the industry average by more than 1-2%; Its free cash flow over the last four years has grown by 18% annually on a compound basis; and just yesterday it made a small deal to buy Care Pharmaceuticals in Australia, which gives its OTC products immediate access to the Asian market. Given its ability to generate free cash combined with a strong operational focus, Prestige Brands could borrow as much as $2.4 billion in the next couple of years and still have a healthy balance sheet. While it's doubtful it will be able to find such a beast; it's nice to know it could.
B. Riley analyst Linda Bolton Weiser believes that Prestige Brands will find another target within the next 6-12 months. If it does it generates additional cash flow. If not, it pays down its another $125 million in debt. Ultimately she believes it will be acquired for $48 per share or 17 times free cash flow. Either way, shareholders win.
Most of what it sells isn't sexy. They're definitely not Michael Kors (NYSE:KORS). But we all need its products from time to time and because they aren't very expensive, we tend to lose them occasionally and have to buy more. In other words, it's very much a consumables business with little capital spending required to keep the products rolling off the lines. Can you think of a better business model? I can't.
Should you buy its stock at 27 times earnings? I say go for it. But then again, I wouldn't be selling in two or three months. Good things sometimes take time.