Should We Buy This Healthcare Stock After Its Recent Spike?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Recently, Prestige Brands Holdings (NYSE: PBH) experienced a significant gain of nearly 11% in one day, from $30.34 per share to $33.65 per share, after it announced that it acquired the privately-held healthcare distributor Care Pharmaceuticals. Shareholders of Prestige Brands must be quite happy as the company’s share price has advanced four times since November 2011.

Prestige Brands is in the portfolio of several famous investors including Joel Greenblatt and Wallace Weitz. Should we buy Prestige Brands at its current trading price? Let’s find out.

A cash cow OTC healthcare business

Prestige Brands is considered the provider of branded, over the counter (OTC) healthcare and household cleaning products in North America, operating many brands including Chloraspetic, Clear Eyes, Compound W, Dramamine, and Chore Boy. Most of its revenue, $536.9 million, or 86% of the total revenue, was generated from the OTC Healthcare segment, while the Household Cleaning segment contributed only $86.7 million in sales in 2012.

OTC Healthcare was also the main profit contributor with $240.74 million in operating income, whereas the operating profit of the Household Cleaning segment was much lower at $15.85 million.

I am quite impressed with the historical growth of the company. Its revenue has increased from $313 million in 2009 to $624 million in 2013. However, during the same period, net income has fluctuated in the range of ($187) million to $66 million. Its net income came in at $66 million, or $1.27 per share, in 2013. Prestige Brands is also a cash cow. In 2013, it generated as much as $138 million in operating cash flow and $127 million in free cash flow.

With the acquisition of Care Pharmaceuticals, Prestige Brands will become the owner of the Fess line of cold/allergy and saline nasal health products and Rectogesic for rectal discomfort, distributed in Australia, New Zealand, and other countries in Asia Pacific. Matthew Mannelly, Prestige Brands’ CEO, is bullish about the acquisition. He mentioned that the acquisition would give the company a platform for growth in the Asia Pacific region with a product portfolio that complements Prestige Brands’ OTC product lines.

Highly leveraged operation with high valuation

Investors might be worried about the company’s high leverage level. As of March 2013, it had $478 million in total shareholders’ equity, $16 million in cash, and as much as $971 million in long-term debt. Prestige Brands booked a high amount of goodwill and intangible assets on its balance sheet, of $1.54 billion, which could be quite vulnerable to a potential future write-down.

At $33.65 per share, the company is worth more than $1.7 billion. The market values Prestige Brands at more than 12 times its trailing EBITDA (earnings before interest, taxes, depreciation, and amortization).

Compared to its peers Clorox (NYSE: CLX) and Johnson & Johnson (NYSE: JNJ), Prestige Brands seems to be the most expensively valued. The market values Clorox at 11.55 times its trailing EBITDA. Clorox is a global consumer giant, owning a number of leading brands. Around 90% of its brands have number one or number two global market shares.

Looking forward, the company estimates that it could grow its revenue by 3%-4% and increase its earnings to $4.25-$4.35 per share. The free cash flow growth could reach 9%-10% in 2013 and increase to 10%-12% from 2014 onward. In the past seven years, Clorox has repurchased as much as 40% of its total outstanding shares. Moreover, it has also doubled its dividend in the past five years. At the current trading price, Clorox offers its investors a 3.4% dividend yield. Investors could expect Clorox to keep returning cash to its shareholders.

Johnson & Johnson is the biggest company among the three. The market values the company at 11.1 times its trailing EBITDA. The company recently expanded its business footprint in the oncology drug segment by spending around $1 billion to acquire Aragon Pharmaceuticals.

It has to pay $650 million in upfront cash payment, having the right to ARN-509, a prostate cancer drug in Phase II development. Having ARN-509 would be a good complement to Johnson & Johnson's prostate cancer product pipeline. Johnson & Johnson also pays investors a good dividend yield at 3%.

My Foolish take

According to Barron’s, Linda Bolton Weiser of B. Riley believes that the company could be bought at $48 per share at a price/FCF multiple of 17.4. Indeed, Prestige Brands, with a lot of good brands in its product portfolio, could be a good long-term investment for patient shareholders.

However, with the high valuation, significant amount of goodwill and intangible assets, I would rather wait for a price correction before buying the company’s shares.

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Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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