Haleon: World's Largest Over-The-Counter Business Looks Like A Buy Here
Vince Martin | Aug 22, 2022 03:11PM ET
Recently spun off from global health giant GlaxoSmithKline (NYSE:GSK), Haleon (NYSE:HLN) is a powerhouse. The provider of over-the-counter medicines and treatments has sales in over 170 countries. It is the world’s largest OTC business, with top market share in the U.S. and a number two ranking in China.
Haleon, responsible for a world-leading portfolio of consumer health brands including Sensodyne toothpaste, continues to grow revenue—including a double-digit increase in the first half of 2022—and operating profit margins have expanded. Trailing twelve-month revenue is nearly £10 billion (almost $12 billion). In 2021, nine “power brands” generated 58% of sales.
Indeed, those margins are impressive. In 2021, Haleon posted adjusted gross margins of 63% and adjusted operating margins just shy of 23%. Few consumer-facing businesses show that kind of brand and pricing power.
And yet, since last month’s HLN spinoff, the stock has fallen sharply. Shares are down 16% from where they opened on July 18, the first day of regular trading.
The cause of the sell-off is rising worry about Haleon’s potential legal exposure. But, right now, that worry looks like an overreaction.
h2 The Zantac Problem/h2Common spinoff dynamics may have pressured HLN stock of late. Spinoffs often trade weakly at first since many shareholders who receive shares have a tendency to sell them quickly.
But the core problem has been a wave of concern about Haleon’s exposure to lawsuits regarding the over-the-counter antacid Zantac. Zantac was pulled from shelves in both the U.S. and the European Union amid concerns that the product contained a carcinogen.
It hasn’t just been HLN stock that has sold off. Shares of GSK and Sanofi (NASDAQ:SNY), too, have taken a big hit. But the sell-off is a bit confusing in several respects.
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The first is the timing. Investors have known about these legal issues for some time. In its Form 20-F filed with U.S. regulators, Haleon disclosed potential liabilities from Zantac. GSK mentioned the product in its past filings. It’s not clear why investors suddenly are pricing in massive liability when they largely ignored the issue just a few weeks ago.
The London Sunday Times posted that U.K. analysts were late in coming to awareness of the first U.S. trial, which was due to take place later this month. The Times noted that the issue had merited relatively little commentary from analysts leading up to the Haleon spinoff.
But even that explanation isn’t quite satisfying. That initial lawsuit in the U.S. was dropped last week amid conflicting reports over whether the plaintiff had settled with other companies. That presumably good news did nothing for HLN, GSK, or SNY, which suggests either that a) something else might be at play and/or b) investors are simply selling first and asking questions later.
The second point of confusion is whether Haleon has any real responsibility here. It may not. Haleon hasn’t controlled the product since 1998; its 32% owner, Pfizer (NYSE:PFE), divested Zantac in 2006. As Haleon noted in a press release this month, the company does have a potential indemnification requirement to both Pfizer and GSK, but only if other third parties with their own requirements don’t pay up and only if Haleon is determined to be liable. Notably, Haleon is “not a party to any of the Zantac claims” and never marketed Zantac in the U.S.
And yet Haleon has lost more than $7 billion in market capitalization over the past few weeks.
h2 The Case For HLN Stock/h2That seems like an enormous overreaction. Some liability may trickle down to Haleon via a convoluted legal process, certainly. But such liability would be years away, and there seems a minimal chance that Haleon must bear the burden alone. (To be clear, this is not legal advice.)
Yet HLN seems to be pricing in pretty substantial liability. Again, this is a company growing both revenue and profits at a rapid clip. Yet the stock, even pro forma for higher interest expense as a standalone company, is trading at less than 18x trailing twelve-month earnings (as of the first quarter; Haleon hasn’t disclosed Q2 profit figures yet.)
Even mid-single-digit EPS/FCF growth going forward, a deceleration from the current trend, suggests a price above $7—and a market cap of more than $5 billion higher. In other words, if we knew that Haleon would have to pay $5 billion over time, the stock would still look reasonably attractive here. The expected value of potential outcomes, on a present value, seems to come in well below that $5 billion figure. (To repeat, this is not legal advice.)
As a result, investors can own a hugely attractive franchise—one of the best in the consumer space—at an enormously attractive valuation. Between lawsuits, concerns about the European economy, and inflationary pressures, there no doubt will be volatility going forward. But from a long-term perspective, just above $6 HLN stock looks like an opportunity.
Disclosure: As of this writing, Vince Martin has no positions in any securities mentioned. He may initiate a position in HLN this week.
Read the full article at Overlooked Alpha
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