This Cheap Health Care Play Has the Right Formula for Success
Building off our recent wins in this space, this name's attactive valuation and yield make it a compelling value play. Here's our trading strategy.
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We have done well over the past few months executing covered call trades on cheap large pharmaceutical names offering solid dividend yields. Pfizer PFE and Gilead Sciences GILD were two of these trades, and both of which have risen nicely since being highlighted and look destined to expire in the money.
Today, we're lining up another defensive "single" in the form of consumer self-care concern Perrigo Company plc PRGO. The company’s stock recently touched a 15-year low as management remediates issues at its three infant formula facilities. However, its infant formula sales are expected to return to normal by the end of 2024.
Perrigo has been around for more than 130 years and offers scores of private label and branded OTC health and wellness self-care offerings to consumers predominantly in North America and Europe. That no one product accounts for more than 3% of its overall sales is a testament to how diversified the company’s offerings are. These offerings include names like Nasonex and Prevacid.
Right now, Perrigo management is very focused on achieving operational efficiencies. This includes, among other initiatives, laying off a bit over 5% of staff with an overall goal of delivering annualized pretax savings of $140 million to $170 million by 2026. Revenues should be boosted by the launch of launch of Opill (the first-ever domestic OTC oral contraceptive).
This is not a terribly exciting story, but it is a cheap one. Perrigo recently reiterated guidance calling for just over $2.55 a share in earnings in 2024 on organic sales growth of around 2%. Again, hardly scintillating. However, the stock currently trades at around $28. In addition, the consensus analyst firm estimate has profits moving significantly higher to around $3.20 a share in 2025. The shares also currently yield about 4%.
The balance sheet has net leverage of 4.8 times as of the end of the first quarter. However, the company plans to use the divestiture of one non-core business for around $200 million upfront and operational cash flow to bring down leverage in the coming quarters.
Perrigo's low P/E, solid dividend yield and prospect of lower leverage ahead makes the name a compelling, if stodgy value play whose return can be enhanced with the simple covered call strategy outlined below.
Option Strategy
Here is how one can initiate a position in PRGO utilizing a covered call strategy. Remember, covered call orders involve buying an equity and simultaneously selling just-out-of-the-money call strikes against the new position.
Selecting the February $27.50 call strikes, fashion a covered call order with a net debit in the $24.10 to $24.20 a share range (net stock price - option premium). Liquidity is solid with the options against this equity.
This strategy provides downside protection of nearly 17% over the trade’s duration, which includes two quarterly dividend payouts of 28 cents a share. The strategy also provides return potential of 15%, including dividends, even if the stock trades slightly down over its seven-month option duration.
At the time of publication, Jensen was long GILD, PFE and PRGO.
