You might have bought some of the over-the-counter (OTC) healthcare products that Prestige Brands Holdings, Inc. (NYSE:PBH) distributes without realizing it, when you were down with a headache or maybe an eye irritation. In addition to being adept at discovering and solving the common problems that consumers face when it comes to OTC drugs, Prestige Brands Holdings, Inc. (NYSE:PBH)’ efficient operating model allows it to deliver best-of-class operating and free cash flow margins. Despite this, Prestige Brands is expensive at 1.9 times PEG and does not offer a dividend despite boosting of strong free cash flows. An initiation of dividends or a share price pullback could offer reason to have another look at the stock in future.
The best thing about investing in consumer related stocks is that an investor is able to put himself in the shoes of customers and ask why he will buy or not buy the company’s products. An example will be helpful in illustrating how Prestige Brands Holdings, Inc. (NYSE:PBH) has been spot-on in identifying and meeting the needs of consumers.
One example is its Clear Eyes line of products. Most eye drops products either fall into the one-size-fits-all category or are unclear in their communication to consumers about the specific symptoms they relieve. In Prestige Brands’ case, the full line of Clear Eyes products is specifically tailored to relieve various eye irritations such as eye redness and itchiness with certain products targeted at specific users like contact lens users and travelers. Prestige Brands Holdings, Inc. (NYSE:PBH) also paid special attention to the product packaging by listing the specific attributes of the different eye drops products and differentiating different eye irritations relievers by color, so that consumer can easily pick out the right products they need.
Efficiency makes a difference for OTC drugs
Consumers are typically more price-sensitive when it comes to purchasing OTC drugs, which are sold without the need for a doctor’s prescription. This is because they have to pay for these OTC drugs from their own pockets, unlike prescription drugs that could be potentially reimbursed under insurance plans. Also, while the success of prescription drugs depends on research and development, brand management and marketing play a more important role in driving the sales of OTC drugs. With this background in mind, it is easy to understand why Prestige Brands’ efficient operating model is a competitive advantage.
Prestige Brands Holdings, Inc. (NYSE:PBH) chooses to keep critical functions like marketing, brand building and product quality control in-house, and outsources non-value added functions such as manufacturing, logistics and distribution. This results in improved efficiency, which is reflected in headcount numbers. According to a management presentation at its recent Investor Day, Prestige Brands only grew its headcount by a mere 35% for the past three fiscal years, compared with a doubling of revenue from $302 million to $624 million over the same period. Prestige Brands also delivered positive free cash flow for every year in the past decade, as a result of using a flexible third party contract manufacturing model.
Peer comparison
Prestige Brands Holdings, Inc. (NYSE:PBH)’ peers include Johnson & Johnson (NYSE:JNJ) and The Clorox Co (NYSE:CLX). Based on Morningstar statistics, Prestige Brands’ operating margin of 31% and free cash flow margin of 20% put it head and shoulders above its peers. Comparatively, Johnson & Johnson (NYSE:JNJ) delivered an operating margin and free cash flow margin of 24% and 18%, respectively, for the trailing twelve months. The Clorox Co (NYSE:CLX)’s operating margin and free cash flow margin are also inferior to that of Prestige Brands, at 17% and 8%, respectively. Johnson & Johnson (NYSE:JNJ) and The Clorox Co (NYSE:CLX) both sport forward dividend yields of 3%, while Prestige Brands does not pay a dividend.
Johnson & Johnson is the manufacturer of the Visine brand of eye drops, which competes with Prestige Brands’ Clear Eyes line of products. According to Prestige Brands’ most recent fiscal 2013 10-K and its 2012 10-K, Visine is currently the number one brand in the allergy/redness relief segment with 24.1% market share; Clear Eyes is a close second with a 19.9% market share. However, it is worth highlighting that Clear Eyes has closed the gap with Visine, improving its market share from 17.2% a year ago, while Visine’s market share is down significantly from 29.7% previously. This improvement in market share for the Clear Eyes brands is consistent with I have written about how Prestige Brands has managed the products.
Prestige Brands Holdings, Inc. (NYSE:PBH) also derives about 14% of its revenues from household cleaning products, and competes with Clorox in this area. Despite facing threats from private label products, Clorox has managed to hold its ground. According to its most recent investor presentation, its brands in bleach, water filtration and charcoal have more than 60% market share, successfully fending off the challenge from private labels. Moreover, it enjoys pricing power, with more than 95% of price increases implemented since 2005 still intact.
Conclusion
I will love to buy any stock with best-in-class operating and free cash flow margins among its peers, but not at any price. At 1.9 times PEG, Prestige Brands is overvalued. In addition, it is highly geared with a gross debt-to-equity ratio of 200% and does not pay a dividend. At this moment, I will have to say no to this stock.
The article An Above Average Company At Above Average Prices originally appeared on Fool.com and is written by Mark Lin.
Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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