EPC - Edgewell Personal Care: Good Growth Prospects At A Reasonable Valuation (Rating Upgrade)

2023-07-13 17:10:55 ET

Summary

• Edgewell Personal Care Company is expected to see revenue growth due to good product demand, price increases, and retail expansion.
• The company's valuation has become more attractive due to underperformance, making it a good buy considering its growth prospects.
• Edgewell's sales growth is expected to continue, supported by price and volume increases, good demand for sun and skin care products, and retail expansion.

Investment Thesis

Edgewell Personal Care Company’s ( EPC ) revenue is poised to benefit from price increases and volume growth as a result of good demand for its product categories. The company is experiencing good demand in the sun and skin care category due to the resumption of travel and leisure activities across the globe. The demand is also expected to stay resilient due to increasing brand investments through advertising and promotions. Further, increasing shelf space gains and continuous retail expansion should also help in revenue growth.

On the margin front, the company should also see benefits from pricing, cost and productivity savings, moderating inflation, and easing FX headwinds. I previously covered the stock in February and while I liked its growth prospects, I preferred to remain on the sidelines due to expensive valuations. The stock has underperformed since then, and the company’s valuations have become reasonably attractive now, especially considering its growth prospects. Hence, I am moving to a buy rating.

Revenue Analysis And Outlook

In my previous article, I talked about good revenue growth prospects for Edgewell Personal Care Company as it enjoys benefits from brand reinvestments, shelf space gain, retail expansion, and good demand for sun care products. The company has reported its second quarter of fiscal 2023 earnings since then, and it saw good growth in the quarter.

In the second quarter of fiscal 2023, the growth continued to benefit from good demand for sun and skin care products due to the resumption of travel and leisure activities. The company also benefited from the growth of the Feminine care category due to easy comparisons as it lapped supply chain constraints in the previous year’s quarter. This led to good volume growth. In addition, the sales growth also benefited from price increases. This resulted in a net sales increase of 9.3% YoY to $598 million. Excluding a 2.1 percentage point headwind from foreign currency, organic sales increased by 11.4%. The organic sales reflect an equal contribution from price and volume increase.

Looking forward, I believe the company should continue to deliver sales growth in the coming quarters as well. Revenue growth should see benefits from price increases, good demand for Sun and Skin care products, and retail expansion and shelf space gains across the globe.

The company has been increasing prices, just like the rest of the industry, in order to offset inflationary input costs. This has been benefiting sales growth. The company plans to take additional price increases across all the categories. These additional price increases along with the carryover impact from price increases taken over the last couple of quarters should continue to support revenue growth in the coming quarters as well.

While there are macroeconomic concerns around consumer health in an inflationary environment that could impact sales growth, the company isn’t seeing its impact on its sales and the consumer demand for the company’s product has so far been resilient.

During the global consumer conference with Deutsche Bank last month, CEO Rod Little commented:

We also operate largely in the mid-tier pricing. We're not at the high end of the ladder. So I think there's also room for belief there that there's structural support if the consumer weakens. Look, we've been talking about expecting and anticipating the consumer weakening for the better part of this fiscal year. We haven't seen it. The consumer is incredibly resilient, especially in the U.S. And we haven't actually seen sort of any structural weakening there. We've seen no signs of any rollback of meaningful pricing that's gone in, which is also encouraging. And I think look no further than our second quarter results and even our full -- half year results, we're seeing pretty equal price and volume growth underpinning that organic number. So again, this could shift. If it does, we'll certainly respond. But right now, the consumer is resilient, and we're certainly comfortable with the profile of growth we've put out there with both volume and price”

So, I expect both volume and price should continue to support sales moving forward as well. Moreover, the company’s volume growth should also benefit from good demand for sun and skin care products post-pandemic. As travel and leisure activities continue to resume across the globe, people are finding an increasing need to take care of their skin health through sunscreens and other skin care products. Moreover, management believes that more occasion-based outdoor activities like sun, beach, pool, and park-type, have just started with the summer season. This should further increase the demand for the company’s sun and skin care products and help sales growth in the coming quarters. Moreover, the company is also seeing recovery signs in Japan and China, where growth has been struggling from three-year-long economic closures. As the economy is continuing to recover from COVID impacts, management expects good growth in those markets as the company has leadership brand positions there. In a conference call with Goldman Sachs, CEO Rod Little commented that Japan removed the mandated Mask rule in March, which should help in the recovery of EPC’s sun and skin care categories in the market. I expect sales recovery in China and Japan along with the good demand momentum across the globe should support the international sales and also boost the overall sales for the company.

In addition to good demand momentum, the company is also focused on retail expansion. The company saw good success with the initial rollout at Walmart ( WMT ) of the Billie brand (acquired in November 2021). The company then launched it nationally in the first quarter and is experiencing similar success, which is helping it grow market share in the women’s shave category. The Billie brand continues to be the #1 brand at Walmart under the women’s shaving category and the company also saw similar traction for the brand at Target ( TGT ) gaining the #4 position in the first four weeks of its rollout there. The Billie brand’s national rollout is just in the initial phases, and the company expects the rollout to take a couple of years to be fully launched. I expect this should result in further market share gains for the company in the women shaving category with further national launches and should continue to help sales growth.

Further, the company is also expanding its other shaving brands. It rolled out new product innovations under the CREMO brand at Costco ( COST ) at the end of the second quarter of fiscal 2023. EPC expects these rollouts to contribute to sales growth in the third and fourth quarters of the current fiscal year. These retail expansions are also helping the company in gaining shelf space and further improving sales growth. Additionally, in order to drive demand, the company is continuously investing in advertising and promotional activities. EPC is expecting advertising and promotional intensity to increase at the back of the year. This should further drive demand for the company’s product and help it in gaining and retaining shelf space across the globe. So, I expect continued growth momentum from shelf space gains moving forward.

Thanks to good execution and market share gains, management now expects the company to deliver reported sales growth at the high end of its guided range of 2% to 4%. Organic sales growth is also expected to be at the high end of its guided range of 3-5%. Overall, I am optimistic about the company’s revenue growth prospects, given the resilient demand in its product categories and market share gains.

Margin Analysis And Outlook

In the second quarter of fiscal 2023, EPC’s adjusted gross margin was negatively impacted by an FX headwind, unfavorable mix (a headwind of 30 bps), and higher commodity, labor, and transportation-related costs (a combined 550 bps headwind of inflationary costs) more than offsetting benefits from pricing and productivity gains (a benefit of ~500 bps). This led to an adjusted gross margin decline of 170 bps YoY or 75 bps on a constant currency basis to 40.4%. However, the adjusted operating margin increased by 190 bps YoY to 10.4% due to lower SG&A as a percentage of sales.

Looking forward, I believe the company should be able to recover its margin moving into the second half of the fiscal year, as many of the headwinds it was seeing earlier have started to moderate. The company incurred a total gross inflation of ~500 bps in the first half of the fiscal year and is anticipating gross inflation in 2HFY23 to be half of that. So, inflation should continue to moderate sequentially in the coming quarters. This moderation of inflation should be a lesser pain point for the company in delivering margin recovery moving forward. Moreover, the company also expects FX to be less of a drag as the FX headwind is now expected to be $24 million, compared to the previous estimate of $26 million.

In addition, the company should be able to fully offset these moderating headwinds through price increases and productivity savings. Management is anticipating pricing to be a benefit of 300 bps in the second half of the fiscal year and cost savings to benefit by 200 bps in the second of the fiscal year. So, I expect margins to see sequential as well as year-over-year improvement in margins moving forward.

Valuation and Conclusion

Edgewell Personal Care company is currently trading at 15.79x FY23 (end Sep.) consensus EPS estimate of $2.46 and 13.68x FY24 (end Sep.) consensus EPS estimate of $2.84. EPC has demonstrated success with its turnaround plans and future growth prospects look encouraging given price increases, good demand for its categories, shelf space gains, retail expansions, and a favorable cost environment. The company is executing well and over the next couple of years, it is expected to grow its EPS by double-digit percentage. So, I find the company’s valuation attractive given its growth prospects. Hence, I believe EPC stock is a good buy at the current levels.

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