Buying Discount Baby Formula? Another Win for Perrigo!

Swapping out branded products for store brands is a trend that's picked up steam since the Great Recession. However, eager-to-please parents have been less willing to make the shift to generic baby formula -- until now.

In yet another win for private-label giant Perrigo Company  (NYSE: PRGO  ) , high-profile recalls for well-known brands including Abbott Laboratories'  (NYSE: ABT  ) Similac and Mead Johnson Nutrition Company's (NYSE: MJN  ) Enfamil have shifted more and more parents to store brands.

Recalling the past
Abbott and Johnson haven't done their marketing teams any favors in the past few years. Following the death of an infant in 2011, the media circled around Mead Johnson as retailers including Wal-Mart voluntarily pulled Enfamil from shelves. The media frenzy surrounding that story was one reason Mead saw its North American sales fall 12% year over year in the first quarter of 2012.

Abbott took a similar hit when it voluntarily recalled Similac in 2010. That caused Abbott's U.S. pediatric nutritionals business to sag 7% in 2010.

Couple those two high-profile fumbles with tightening post-recession purse strings, and the share of private-label formula is climbing steadily, improving from 11.2% to 12% over the past year.

Source: IRI MULO; quarterly splits based on 12 weeks ending 9/25/11, 1/15/12, 4/8/12, 7/1/12, 9/23/12, 1/13/13, 4/7/13, 6/30/13, 9/22/13. From Perrigo's FYQ! EPS presentation.

Profiting from private labels
Of course, Perrigo is no stranger to taking market share from branded counterparts. The company has a long history of winning retail shelf space by offering cheaper versions of over-the-counter, or OTC, drugs such as cough syrup and painkillers.

Industrywide sales of private-label OTCs have grown to represent 35% of all OTC sales being collected across retail, and that share growth has increased Perrigo's revenue from those store-branded alternatives to $933 million in the first fiscal quarter of 2014. That was 21% higher than the same period a year ago.

And Perrigo believes there's plenty of running room left for growth, given that it launched 60 products in fiscal 2013 worth $130 million in annual sales and plans to launch 75 products in fiscal 2014 worth $190 million in annual sales.

Perrigo also thinks there's $10 billion in branded sales that could move to OTC over the next five years, and potentially a larger opportunity if drugs currently sold behind the counter, such as statins for lowering cholesterol, move out front.

Bulking up on formula
Sales of private-label baby formula fall under Perrigo's nutritional segment sales, and that business has been growing nicely.

Perrigo generated sales of just $171 million from the segment back in 2008. But the company racked up sales of more than $500 million in 2013.

The broader infant-formula category grew 2.7% in the year ending in September. Meanwhile, sales of private-label formula grew 7.7%. That helped lift Perrigo's nutritional segment sales 25% year over year to $129 million in the fiscal first quarter. The segment's operating margin also improved, increasing by nearly 1% to 11.7% in the quarter from the year prior.

Perrigo thinks it can grow that business even more thanks to larger, bulk containers and packaging that more closely resembles the branded version. Perrigo is also looking to increase sales by boosting its presence in overseas markets, such as China.

Going global
The push into overseas markets isn't limited to baby formula. The company just completed its merger with Ireland-based Elan in December.

As part of that deal, Perrigo lands a nice recurring royalty stream from the blockbuster multiple sclerosis drug Tysabri, which Elan co-marketed with Biogen (NASDAQ: BIIB  ) . Sales of Tysabri have grown by a compounded 19% over the past four years.

Biogen bought out the remaining rights it didn't own from Elan back in February 2013 for $3.2 billion. But Biogen remains on the hook for royalties that will hit 18% of Tysabri sales up to $2 billion and 25% of sales above $2 billion. Tysabri had sales of $1.6 billion in 2012 and $401 million in the third quarter, and a phase 3 trial for expanding the drug to include secondary progressive MS remains under way.

That deal not only gives Perrigo the Tysabri royalty stream,but also provides shareholder-friendly tax relief.

Perrigo forecasts the shift of its corporate tax structure out of the U.S. to Ireland will drop its tax rate from the mid 30% range to the high teens. Combined with operational overlap, the merger is expected to save the company $150 million a year.

Fool-worthy final thoughts
Across Perrigo's many businesses, the company expects fiscal 2014 sales to climb 12% to16% in fiscal 2014. It's also forecasting 23% to 25% operating margin and 13% to 18% EPS growth. Sales of nutritionals, including infant formula, will grow 8% to 12% this year. If that plays out as hoped, the company will generate $6.35 to $6.60 per share in earnings. That projection has analysts modeling for $8.01 in earnings per share in fiscal 2015, suggesting Perrigo will have plenty of profits to reward shareholders going forward.

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