Monday, September 20, 2010

Female Health (FHCO - Nasdaq)

Female Health (FHCO $5.00) is the only manufacturer of female condoms in the world.  Male condoms account for 98% of the entire market.  Demand for the female variety has accelerated over the past decade in response to a rising HIV/AIDS infection rate among women, especially in developing nations.  International relief organizations represent Female Health's primary customer base.  They distribute the condoms, usually free of charge, to at-risk populations in Asia, Africa, and South America.  In recent years agencies in the United States and Europe have entered the market, as well, serving homeless and other at-risk women.  Over the past two years Female Health re-engineered its product line to bring down unit costs by 25%-30%, while increasing the absolute amount of profit on each unit sold.  Reported sales have levelled off despite continued expansion in unit volume and overall net income.  Compliance has climbed as women have become more familiar with how the condoms work.  In the early going a lot of them went unused.  Acceptance among women has reinforced the aid groups' willingness to distribute the products.  Lower costs resulting from the redesigned line ("FC-2") are bolstering demand, too.  And U.S. Government programs have picked up with the change in administrations, now that there is less political opposition to promoting birth control in general.

Two order delays caused Q3 (June) results to fall below target.  Neither contract was renegotiated and will be fulfilled in upcoming quarters.  But the uncertainty caused the stock to decline fairly sharply, and it remains below past levels.  Deliveries on those orders are believed to have resumed in Q4 (September).  But it's unlikely they jumped above the regular trendline.  As a result, full year earnings probably finished even with those of a year earlier at $.15 a share (fully taxed).  For the fourth quarter alone income likely advanced 60%-100% to $.08-$.10 a share.

In fiscal 2011 (September) financial results are likely to get back onto the long term trendline.  Absent the recent order delays income probably would have finished at $.20-$.25 a share in the current year.  Unit volume gains of 20%-30% combined with expanding margins could propel earnings up by 40%-50% from there into the $.30-$.35 a share range in fiscal 2011.  Above average growth in the foreign aid market could be sustained well into the decade, since there are no viable alternatives to protect women from HIV/AIDS infection.  Female Health is well capitalized and is on the lookout for related products it could sell through its distribution network.  It also is negotiating with several consumer product companies to develop a commercial product.  (In Washington D.C. female condoms are distributed by a local aid group.  Extensive advertising appears on buses that drive around the city, encouraging poor women to get the products for free.  That promotional activity recently encouraged drugstore operator CVS to introduce the line for commercial sale.)

In 2-3 years earnings could reach $.50 a share.  Applying a P/E multiple of 20x to those earnings suggests a target price of $10 a share, potential appreciation of 100% from the current quote.  If the consumer market shows potential Female Health could become a takeover candidate, targeted by the large male condom manufacturers.  A higher valuation could emerge as a result.

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