FHCO - Female Health Company

[LC]

FHCO is a company I've been invested in for about 9 months now, I originally discovered them with finviz's screener as displaying excellent margins and low/no debt. 

 

Business Operations Summary

Female Health Company manufactures and sells the Female Condom (FC2). FC2 is a cost-effective update to FC1, the first female condom. FC2 is the only product under a woman's control approved by the F.D.A. to prevent HIV/AIDS and pregnancy. Internationally, until recently FC2 was the only product approved for the same reasons by the W.H.O. (World Health Organization) and approved for purchase by U.N. agencies. Recently a competitor's product, the Cupid was also approved by the W.H.O.

 

Three customers account for 85% of sales:

1. UNFPA (United Nations Population Fund)

2. USAID (United States Agency for International Development - via John Snow Inc.)

3. Sekunjalo Investments Corp. (a South African firm)

 

FHCO manufactures the FC2 at its facility in both Malaysia and in India. They have recently expanded production to meet demand through funding from operating cash flows.

 

FC2's main competitor, the Cupid, is also manufactured in India for export in 12 countries. By contrast, the FC2 is available in 138 countries worldwide.

 

I believe customers are relatively sticky as relationships with government agencies take years to develop and FHCO is the leader in their field.

 

Financial Summary

-Originally debt-financed, FHCO has been debt-free since 2003.

-They have substantial deferred tax-assets. This quarter management has reduced their deferred tax valuation allowance, increasing these deferred tax assets, as they believe there is a >50% likelihood of future income to offset past tax losses.

-Management owns approx. 25% of shares, Bares Capital is the only large insitutional holder with an aprox. ~15% stake.

-Margins have been as follows:

Gross Margin 5 yr average of 52%

Operating Margin 5 yr average of 20%

Net Margin 5 yr average of 29% (increase over Op Margin due to tax assets)

-Pays a dividend which was recently increased to $0.06/share

 

Trades at aprox 13x earnings, just had a record quarter/year with record earnings & income, I think the deferred tax allowance adjustment signals management thinks earnings will continue to be strong, however the market doesn't seem to be pricing any of this in. In fact the stock has fallen after releasing their most recent earnings.

 

Edgar link here: http://www.sec.gov/cgi-bin/browse-edgar?company=&match=&CIK=fhco&filenum=&State=&Country=&SIC=&owner=exclude&Find=Find+Companies&action=getcompany

 

[Palantir]

Solid idea....nice dividend yield....obviously not that knowledgeable about the business model...but can be learned.

[Sportgamma]

Didn't Soros have a stake in this one?

 

 

[LC]

Didn't Soros have a stake in this one?

 

Yes, I believe he sold as his latest 13F does not list it.

[jay21]

Why are margins so high?  What's stopping a competitor from entering?  What are competitors margins?

[LC]

Margins are high because they control manufacturing and IP. And because they are selling to non-profits and government health organizations. They moved operations from London to Malay/India and switched to a different material which also improved margins. Their gross margins are high because (and this may sound weird) their net margins are low. Why? Because they also spend $$ on education for their product. I believe this is part of "the deal" they have with these NGOs/non-profits and adds to the stickiness of their customers. FHCO pays for education of the product, which reduces their margins but adds to the mission of these NGOs: namely, to prevent unwanted pregnancies/HIV&AIDS and empower women's sexuality in second/third-world countries. In this respect FHCO operates as the capitalist extension of these non-profits/NGOs.

 

This situation does lend itself to competition: I mention in my original post, their main competitor is the Cupid, which only months ago received W.H.O. approval. They do not have the long-term relationships formed with customers (NGOs etc) that FHCO has. And I have a hunch, as they are also produced in India, that the same manufacturer produces their product. I have no evidence of that, however. At any rate, the name of the game is selling to world health organizations, and Cupid doesn't have the relationships nor capacity that FHCO does.

 

Cupid's margins are lower: http://www.bseindia.com/stock-share-price/cupid-ltd/cupid/530843/

 

As seen in the above link, Cupid's Op Margin is 13.5% and Net margins are 8.25%.

[jay21]

Margins are high because they control manufacturing and IP. And because they are selling to non-profits and government health organizations. They moved operations from London to Malay/India and switched to a different material which also improved margins. Their gross margins are high because (and this may sound weird) their net margins are low. Why? Because they also spend $$ on education for their product. I believe this is part of "the deal" they have with these NGOs/non-profits and adds to the stickiness of their customers. FHCO pays for education of the product, which reduces their margins but adds to the mission of these NGOs: namely, to prevent unwanted pregnancies/HIV&AIDS and empower women's sexuality in second/third-world countries. In this respect FHCO operates as the capitalist extension of these non-profits/NGOs.

 

This situation does lend itself to competition: I mention in my original post, their main competitor is the Cupid, which only months ago received W.H.O. approval. They do not have the long-term relationships formed with customers (NGOs etc) that FHCO has. And I have a hunch, as they are also produced in India, that the same manufacturer produces their product. I have no evidence of that, however. At any rate, the name of the game is selling to world health organizations, and Cupid doesn't have the relationships nor capacity that FHCO does.

 

Cupid's margins are lower: http://www.bseindia.com/stock-share-price/cupid-ltd/cupid/530843/

 

As seen in the above link, Cupid's Op Margin is 13.5% and Net margins are 8.25%.

 

Thanks. 

 

It seems like a commodity product so I think at some point more competitors will enter this space and margins will come down.  It's just a matter of time.  Obviously you disagree, but the barriers you listed don't seem that strong to me.

[Morgan]

Margins are high because they control manufacturing and IP. And because they are selling to non-profits and government health organizations. They moved operations from London to Malay/India and switched to a different material which also improved margins. Their gross margins are high because (and this may sound weird) their net margins are low. Why? Because they also spend $$ on education for their product. I believe this is part of "the deal" they have with these NGOs/non-profits and adds to the stickiness of their customers. FHCO pays for education of the product, which reduces their margins but adds to the mission of these NGOs: namely, to prevent unwanted pregnancies/HIV&AIDS and empower women's sexuality in second/third-world countries. In this respect FHCO operates as the capitalist extension of these non-profits/NGOs.

 

This situation does lend itself to competition: I mention in my original post, their main competitor is the Cupid, which only months ago received W.H.O. approval. They do not have the long-term relationships formed with customers (NGOs etc) that FHCO has. And I have a hunch, as they are also produced in India, that the same manufacturer produces their product. I have no evidence of that, however. At any rate, the name of the game is selling to world health organizations, and Cupid doesn't have the relationships nor capacity that FHCO does.

 

Cupid's margins are lower: http://www.bseindia.com/stock-share-price/cupid-ltd/cupid/530843/

 

As seen in the above link, Cupid's Op Margin is 13.5% and Net margins are 8.25%.

 

Thanks. 

 

It seems like a commodity product so I think at some point more competitors will enter this space and margins will come down.  It's just a matter of time.  Obviously you disagree, but the barriers you listed don't seem that strong to me.

 

I tend to agree with jay21 that it is a commodity product. Although as you say LC, FHCO does have the relationships with the NGO's which is a barrier to entry to some extent. But how long will that last is part of the question.

 

As a comparison of the two companies situations, let's assume that they are manufacturing their products in the same factory and thus have identical products. One issue is that if the products are the same, the key to gaining market share is relationships. LC you mention that Cupid has recently gotten WHO approval for their product, which means they are at least beginning to growing their relationships with the various NGOs. Do you know if Cupid is better at building relationships than FHCO?

 

Another aspect of this is the quality of education each company can bring to the table. LC you say FHCO sells 85% of its product to three clients, one being a South African (SA) company. About 1 in 5 people in SA are HIV positive so if Cupid can prove to the NGOs that they provide better education and can prove it with data, that could be a huge selling point. (This also assumes the decision makers aren't corrupt and will objectively choose the best option for the people.) Do you know which company has better education? Or how Cupid may develop a better method of education? Or why is FHCO's education so good that Cupid would be unable to displace it?

 

One more thing. I assume that FHCO has a solid balance sheet (debt-free, high margins, probably strong FCF, etc) and will become stronger more quickly than Cupid is able to because of its poorer margins. Do you think FHCO will use its superior business postion to undercut Cupid, kill it's margins and hope to run the company out of business? If FHCO did this, how would it affect the company's profits? How long would you estimate it may take? What would happen to the share price if FHCO's margins fall from ~50% to 30%? I assume the multiple assigned to the company would fall as well.

 

Overall a very interesting company and good write up. Cheers!

 

[MYDemaray]

Any data on usage/compliance in third world countries?  Obviously, a problem is that men don't want to use condoms in these countries.  Any idea if the men are opposed to women using condoms (does it affect the man's sensation/experience?).  This is great from a public health perspective.  I would be interested in knowing if the women in these countries actually use them, or if NGOs are simply handing them out.

[LC]

Any data on usage/compliance in third world countries?  Obviously, a problem is that men don't want to use condoms in these countries.  Any idea if the men are opposed to women using condoms (does it affect the man's sensation/experience?).  This is great from a public health perspective.  I would be interested in knowing if the women in these countries actually use them, or if NGOs are simply handing them out.

 

Just a quick reply: I'm not sure about usage in third world countries but a report was done on how female condoms saved millions when used in Washington DC. I wish I remembered the specifics, if you'd like I can dig up the report.

 

Quote: "The study showed that the Washington, D.C. FC2 prevention program, a public-private partnership to provide and promote FC2 female condoms, prevented enough HIV infections in the first year alone to save over $8 million in avoided future medical care costs (over and above the cost of approximately $445,000 for the program)"

 

NGOs are handing them out, but FHCO also sells to distributors as well. I will say at the London Summit (in summer 2012 I believe) the Bill/Melinda Gates Foundation and other NGOs/Non-profits committed to ~$4.5 bln of support for women's contraceptives during 2012-2020.

 

A seeking alpha write up is here: http://seekingalpha.com/article/1094051-the-female-health-company-play-and-keep-it-safe

 

Additionally,  FHCO had an excellent quarter and year ending 9/30/12. Financials available here: http://www.sec.gov/cgi-bin/viewer?action=view&cik=863894&accession_number=0001171843-12-004364&xbrl_type=v#

 

Personally I re-initiated my position with a cost basis of $7.27/sh

[LC]

10-Q out today as well as the conference call:

 

Record quarterly revenues of ~10M, they did a good job keeping COGS down for a gross margin of 60%.

 

Otherwise business as usual, two interesting notes from the conference call:

 

-Management was asked about the competitive landscape and commented "one other product [Cupid] has received WHO approval, however that company is 'a long ways away' from being able to ramp up production to FHCO's level".

 

-In terms of increasing FHCO's production, increased inventory levels are due to filling orders. Additionally, management said there is still room to grow in their current Malaysia facility but they are seeing the limits. However they are confident relatively easily acquire additional production capacity in the same area, and mentioned that forethought was put into their production facilities in terms of future production. They hope to ramp to 200+million units/year. For reference, 2012 produced 60mm units.

[LC]

http://femalehealth.investorroom.com/2013-03-27-The-Female-Health-Company-Declares-Second-Quarter-Cash-Dividend-at-17-Higher-Payout-Rate

 

Highlights:

Dividend increase from $0.06 to $0.07 per share

"The Company also announced that it plans to increase the activity under its stock repurchase program" (they have one million shares remaining under the plan which expires 12/31/13)

 

 

[eggbriar]

http://news.medill.northwestern.edu/chicago/news.aspx?id=221489

 

article on female condoms that mentions FHCO

[GrizzlyRock]

This is better biz than I thought. Significant first mover advantage here and much lighter capex than I thought.  Does this deserve super high IP-driven margins and ROE? Perhaps...

 

Valuation rich for me here but something to watch.  Any of you GARPy guys should look at this one hard - volume could 2x in the next 5 years especially with Gates Foundation backing. Here are some notes from a management presentation:

 

Female Health Company

- Firm increased manufacturing capacity by 17 million units (to 100 mm units) at a cost of only 0.7 mm).  Wow! Just wow. Means they can essentially maintain FCF in lockstep with unit growth.  This is super significant.

- training and education is competitive advantage. They get into countries by partnering with local NGOs and then teaching them how to educate their respective populations.

- training local agencies creates demand at company level

- sell product to public sector at $0.57 per unit and and to US retail at $2.00 per unit at retail

- growth is combo of disease prevention and family planning

- took 6 years and $12 million to get US FDA approval

- 2 competitors (Cupid) India in Mumbai exchange which received WHO approval in June 2012 but isn't yet ready for manufacturing (allegedly the education is different in terms of how to use the product. This seems shaky to me - how hard can it be to use properly? I have no idea)

- 2nd competitor is a woman's condom developed by the US NGO Path (no not the Facebook knockoff...)

- attempting FDA approval

 

- 90% of sales are distributed outside us

[LC]

Even in the US they are slowly increasing exposure. They sponsored a study in Washington DC which recorded the economic benefits of HIV prevention and are making headway in NYC.

 

I sold my position in the 9.85 range, but I am looking to re-enter in the 9.00 range or if there are significant developments operations-wise.

 

My thesis about a year ago was that they had 2-3 years before competition truly emerged to commoditize the business. I think they are still about 2 years away from that happening.

[MYDemaray]

One thing of note...I went back and read the Ks starting with their first one...they originally tried to do U.S. consumer primarily and it was a bust.  I think the NGO route is much better and would be concerned if they started pushing to U.S. consumer biz too hard.  Potential to blow a lot of cash doing this.  Also the CEO and driving force is old.  That said, I am long.

[LC]

Very good article on FHCO, specifically on the points of increased competition. I've exited my position, but would consider re-entering at a lower valuation.

 

http://seekingalpha.com/article/1514442-the-female-health-company-a-great-story-for-women-but-not-for-investors?source=yahoo

[LC]

Management is forecasting lower business next Q.

http://www.businessweek.com/ap/2013-07-15/female-health-co-shares-slide-on-weaker-outlook

 

Shares down today, I am not sure if the reason business is slowing is due to the timing of shipments (as the company received large orders, so timing of revenue is lumpy) or if it is due to increased competition from Cupid et. al.

 

I don't think I will be purchasing more until I have a clear picture of what the competitive dynamics are and what level demand from customers is going forward.

[kmukul]

For those interested stock is down 10%

[LC]

http://femalehealth.investorroom.com/2013-08-01-The-Female-Health-Company-Reports-Third-Quarter-and-Nine-Month-FY2013-Operating-Results

 

Major issue is COGS increase of 12%.

 

The real fear in my opinion is we could be seeing the first signs of increased competition. Anyone thinking of a position should inspect Cupid's most recent financials and check how the competitive landscape has changed since 2011.

[LC]

FHCO not really on my radar much anymore as I believe increased competition is here. On that note, this memo from June 26, 2013 from Cupid:

 

Cupid Ltd has informed BSE that the Company has entered into 3 year Long Term Agreement (LTA) to supply Male and Female condoms to UN Population Fund (UNFPA).

 

This Agreement to supply Male and Female Condoms on worldwide basis is valid until March, 2016.

 

The Quantity and value of each consignment will vary from time to time as per UNFPA’s global procurement requirements.

 

Overall I am pretty happy with how I handled this particular scenario. Bought the company at depressed earnings on good business news, had an informational advantage over most other market participants (digging up competitors financials on the BSE), and selling at a reasonable price before the market priced in increased competition. If only every situation could play out this way!

[LC]

Was speaking with Brandon from moatology.com and he mentioned he attended a micro-cap conference in LA and met with FHCO management (OB Parish & the CFO), he had this to say:

 

'"I am not so sure Cupid can displace them. Cupid is an Indian company with a male condom business and they have very little capital to scale up and go after FHCO's customers. They also added that to sell their product they would have to engage in all of the training and education FHCO did over the years since it operates slightly different compared to the FC2. OB also shared that their largest public buyer desires to ultimately have female condoms represent 10% of the public sector condom demand. This would put female condom demand around 1B units annually and FHCO captures 100% of the market, shareholders could do very well."

 

If demand continues to increase from the NGOs etc. I am interested again... I'm not sure how much I buy the argument vs. Cupid put forth by management...but Cupid does file on the BSE so we can obtain their financial results to see what is accurate. But interesting point regarding the education component. It is an interesting theory regarding moats: when competing products are "inconvenient" to learn how to use (as there are small differences in actually implementing/using the product) that the consumer simply pays the small premium to save themselves the hassle. This, combined with the factor that this is a very personal product, so women/couples are apt to continue using what they find comfortable and the NGOs supplying these know that. They want them to be used, so they will make it as convenient as possible for women to use them. Interesting incentives and behavioral dynamics going on.

 

(unrelated: we also spoke about Chris Reed of REED and that business if anyone is interested I can PM you his email or you can get his contact info from his website)

[Carvel46]

Reminds me of the sponge episode on Seinfeld.

http://www.yadayadayadaecon.com/clip/69/

[stahleyp]

Below $6. It's down quite a bit over the past month on a fair amount of volume (relatively anyway).  It's now trading at a lower price than it was in parts of 2009.

[LC]

Looks interesting. Buyers today should do their research on the progress of competitors. Last I checked Cupid was capacity constrained.