WMT - Edgewell Personal Care: Good Prospects But Expensive Valuation

Summary

• In 2023, the company’s revenue growth should benefit from price increases, good demand in the majority of the categories, increasing e-commerce sales, and improved retail distribution.
• Margins should benefit from price realizations, improved supply chain conditions, and cost-saving initiatives.
• Valuation is expensive.

Investment Thesis

Edgewell Personal Care Company ( EPC ) is experiencing good demand for the majority of its product portfolio due to easing COVID-related restrictions globally. Looking forward, in fiscal 2023, the company’s net sales should benefit from favorable pricing, increased shelf space, improved retail distribution, e-commerce and digital expansion, and good demand. In terms of margins, the company should benefit from cost-saving initiatives, easing supply chain constraints and effective price realizations, partially offset by near-term inflationary pressure. So I am optimistic about the company’s growth prospects. However, the company’s valuation is expensive and seems to be already pricing in these growth prospects. Hence I have a neutral rating on the stock.

Revenue: The Story So Far And The Outlook

During the pandemic, Edgewell Personal Care's net sales were negatively impacted due to lower consumer demand as a result of lockdowns around the globe. People spent more time indoors as offices adopted work-from-home culture and outdoor activities were limited due to social and travel restrictions. This led to lower personal care needs, especially in Wet Shave and Sun & Skin Care categories. Moreover, the company was late in responding to the shift to digital and e-commerce channels, resulting in market share loss. For fiscal 2020, only 7% of the total sales were derived from e-commerce channels. However, the company saw an inflection point for sales growth during the second half of fiscal 2021, as a result of easing COVID-related restrictions and easy comparisons from the prior year.

The organic sales growth trend continued in the fourth quarter of fiscal 2022 due to healthy demand and improved shelf space presence, partially offset by the pull forward of orders to the third quarter in the Wet Shave segment. For the full fiscal 2022, EPC's recent acquisition of the Billie brand under the Wet Shave segment contributed 360 basis points to reported sales growth, while FX was a 350 bps headwind.

Looking forward, the company’s sales growth should continue to benefit from improved retail distribution, shelf space gains, healthy demand for the majority of its products, price increases, and increased digital and e-commerce presence.

The company’s Sun and Skin Care segment is expected to continue benefitting from offices reopening as well as increased travel and leisure activities. The company has been executing really well in this segment and has posted double-digit growth in this segment in the last two years. The company’s growth strategy in this segment is to develop and acquire insurgent brands across mass, masstige, and prestige price tiers and focus on their growth through increased marketing and distribution across the channels. A good example of this strategy is the company’s acquisition of Cremo, a couple of years back. Despite tough comparisons, Cremo delivered 8% Y/Y growth last quarter. Looking forward, I expect the solid growth to continue in this segment, helped by economic reopening as well as continued strong execution.

The remaining two segments, Wet Shave and Feminine Care have much more modest growth prospects and, in the past, share losses in these segments were a major concern. Management aims to stabilize revenue in these two segments and maintain their profitability. Both of these segments posted between 1% and 2% organic growth in FY22, indicating management's success towards its goal. Management is focusing on acquisitions, consumer-centric innovations, and increasing retail distribution to drive organic growth in this segment. The company acquired the Billie brand under the Wet Shave segment in November 2022, strengthening EPC’s position in the women’s shaving category. Billie brand’s rollout at Walmart ( WMT ) continues to support the overall portfolio’s growth and is the no.1 Wet Shave refill brand at Walmart. The company is planning to further expand Billie’s retail distribution and improve product availability on shelves for other products in the Feminine and Wet shave categories to drive organic growth.

The company is also focused on consumer-centric innovations to drive growth in this segment. In the women’s shaving range, the company launched Hydro Silk touchup, which continues to be well received by consumers as the product is the No. 1 selling women’s hair removal SKU on Amazon ( AMZN ).

While FX headwinds and a weakening macroeconomic environment are a concern, good demand for the company’s insurgent brands, improved shelf space, and increasing retail distribution should more than offset these headwinds and the company can achieve low single-digit organic growth in the near to medium term.

Margin Outlook

Last year, EPC’s adjusted gross margin and operating margin were negatively impacted by inflationary headwinds including rising commodity prices, wage, and transportation costs. In addition, tight labor and supply chain disruptions also contributed to margin decline.

In the fourth quarter of fiscal 2022, in addition to inflationary headwinds and supply chain challenges, the company’s adjusted gross and operating margins were negatively impacted by an unfavorable product mix and unfavorable currency movements. This resulted in an adjusted gross margin decline of ~450 bps Y/Y. The adjusted operating margin declined by ~230 bps Y/Y. The unfavorable impact from higher cost and currency movements was partially offset by ~$40 million cost of goods savings and further overhead cost savings of ~$15 million.

Looking forward, I believe the company should be able to deliver margin expansion in 2023. The adjusted gross and operating margins should benefit from productivity initiatives and increased price realizations. Management is targeting $65 million in gross cost reduction across both costs of goods and overheads in order to drive efficiency. The company is also focused on stabilizing the supply chain and taking the necessary steps to secure additional raw materials through broader global sourcing. In addition to cost-saving and productivity initiatives, adjusted operating margins should benefit from operating leverage and improving SG&A as a percentage of sales. So, I am optimistic about the company’s margin improvement prospects.

Valuation and Conclusion

EPC is trading at a forward P/E of 17.10x FY 23 consensus EPS estimate of $2.41 and 15.37x FY24 consensus EPS estimate of $2.69. This is a premium to its historical 5-year average forward P/E of 12.67x . I believe the company should be able to sustain its revenue growth and recover margins in fiscal '23 and beyond, benefitting from its improved portfolio execution, new product launches, demand recovery post-COVID, cost reductions, and moderating inflation respectively. However, the company’s high valuation seems to be already pricing in this revenue growth and margin improvement prospects. Hence, I prefer to be on the sidelines and have a neutral rating on the stock.

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