WMT - Edgewell Personal Care: Not A Buy Despite Good Execution

Summary

• Edgewell Personal Care’s sales growth should benefit from brand reinvestments, shelf space gain, retail expansion, and good demand for sun care products.
• Margins should benefit from price increases, easing supply chain issues and moderating inflation.
• Valuation is expensive.

Investment Thesis

Edgewell Personal Care Company (EPC) is should benefit from increasing shelf space gains, reinvestments in its brands, price increases, and good demand for its sun care products as the economy reopens. Additionally, the company's strong execution and lesser foreign exchange headwinds should contribute to its revenue growth. As the year progresses, Edgewell should also be able to improve its margins through pricing, cost savings, and productivity initiatives, while supply chain issues and inflation and foreign exchange headwinds moderate. However, the company's valuation is much higher than its 5-year historical average and seems to be already accounting for improved execution. Hence, despite these good growth prospects, I have a neutral rating on the stock.

Q1 FY23 Earnings

Earlier this month, Edgewell Personal Care reported better-than-expected Q1 23 results, with revenue increasing by 1.3% year-over-year to $469.1 million, beating the consensus estimate of $467.7 million. Adjusted earnings per share ((EPS)) decreased by 26.1% year-over-year to $0.31, but still surpassed the consensus estimate of $0.21.

However, the company's adjusted gross margin decreased by 150 basis points year-over-year to 40.3%, and the adjusted operating margin decreased by 230 basis points year-over-year to 7.8%. The increase in revenue was driven by strong execution, good consumer demand for the sun care category due to the reopening of the economy, and increased shelf space gains. The decline in EPS and adjusted gross and operating margins was attributed to inflationary costs and foreign exchange headwinds.

Revenue Analysis and Outlook

As I mentioned in my previous article , Edgewell Personal Care has been improving its execution, and it continued to deliver strong performance in the first quarter of fiscal 2023 by gaining shelf space among major retailers. The company also benefited from recovering demand due to the reopening of the economy and easing COVID-related restrictions.

As a result, the company's net sales increased by 1.3% year-over-year to $469.1 million, with a 2.6 percentage point benefit from the acquisition of Billie and a 4.3 percentage point headwind from foreign currency. On a constant currency organic basis, net sales increased by 3% year-over-year, with a 4.5 percentage point benefit from price increases partially offset by a 1.5 percentage point headwind from volume decline.

Looking ahead, Edgewell Personal Care should be able to sustain its sales growth in fiscal year 2023. The company's acquisition of the Billie brand in November 2021, under the wet shave segment, added 3.6 percentage points to revenue growth last year. However, the rollout of Billie is still in its initial stages.

Initially, the company focused on introducing the brand at Walmart (WMT), which helped it to strengthen its position in the women's shaving category as Billie became the number one wet shave refill brand at Walmart. Now, Edgewell is expanding the rollout of the Billie brand nationally in grocery stores, drug stores, and mass retailers, and I expect to see good traction, similar to what we saw at Walmart.

In addition, Edgewell Personal Care is expanding its grooming product categories under its insurgent brands Cremo and Edge in the U.S., which should further bolster the company's sales growth in the future.

In addition to its good growth in the U.S., Edgewell Personal Care is performing well in international markets. Although international sales were down 1.7% Y/Y, if we exclude the impact of adverse FX movements, organic sales in the international market increased by 5.8% Y/Y. In these markets, the company is benefiting from demand for its sun and skin care products, as the economy reopens, and it is also gaining market share.

For example, in December, the easing of COVID-related restrictions resulted in the highest sales of sun care products in Australia (since pre-COVID). Furthermore, the company's sun care products saw over 30% Y/Y growth in Mexico. Edgewell is also successfully gaining market share. In Germany, which is one of EPC's key international markets, the company's market share increased, largely driven by the strength of its women's shaving business.

I anticipate that the company will continue to perform well internationally, as demand for sun and skin care categories remains strong due to the resumption of travel and leisure activities, and it continues to grow its market share.

The company's strong execution is creating a virtuous cycle, where good revenue growth results in increased profits, which the company then reinvests in advertising and promotional activities. This further enhances demand for its brands among consumers, driving even more sales.

Despite a tough macro environment, EPC is executing well and focusing on what it can control. The company is investing in its brands, increasing shelf space, and implementing price increases. With good demand for sun and skin care products due to the economic reopening, EPC's sales growth momentum should continue despite concerns around consumer spending. In addition, supply chain issues are improving, leading to increased in-stock availability for customers. The sales should also benefit from the carryover impact of pricing increases from the second half of last year. Management has maintained its organic sales outlook for the year, and the reported sales growth is now expected to increase in the 2-4% range (up from a previous outlook of flat to 2% growth), due to lesser FX headwinds. I believe management's sales growth outlook is achievable.

Margin Analysis and Outlook

In the first quarter of fiscal 2023, EPC experienced a negative impact on its adjusted gross margin due to higher commodity, labor, and transportation-related costs, resulting in a combined 500 basis points headwind from inflationary costs. Although there were benefits from pricing and productivity gains, they were more than offset by the aforementioned costs, leading to an adjusted gross margin decline of 150 basis points year-over-year to 40.3%. Additionally, the adjusted operating margin was adversely affected by higher compensation expenses, resulting in a decline of 230 basis points year-over-year to 7.8%.

Looking ahead, I believe that the company should be able to improve its margins in the latter part of the year. The adjusted gross and operating margins should benefit from pricing increases and cost-saving productivity initiatives. Management has set a target of $65 million in annual cost reductions for fiscal 2023, and the company plans to achieve cost savings both in the cost of goods sold and general and administrative expenses. Additionally, supply chain constraints are easing, which should help to improve service levels and productivity. Furthermore, inflation is expected to moderate, and management anticipates a total of 350 bps headwind from inflation for the full fiscal year 2023, which is lower than the 700 bps seen in Q4 2022 and 500 bps in Q1 2023. This indicates that we should expect sequentially fewer headwinds from inflationary costs as we move forward in the year. Lastly, FX headwinds are also moderating, with the company now expecting an $8 million lower impact from currency headwinds on operating profit, compared to its prior estimate of $26 million. This should benefit adjusted operating margin improvement. So, as the year progresses, I am optimistic that EPC's margins should improve.

Valuation and Conclusion

While I like EPC's execution, I don't like its valuation. Currently, the company is trading at 18.45x FY23 consensus EPS estimate of $2.41 and 16.30x FY24 consensus EPS estimate of $2.72, which is higher than its historical 5-year average forward P/E of 12.74x. Although the company's improved execution and performance are positive, the stock price seems to be already reflecting these factors and appears to be fairly valued with FY23 P/E multiple 5.7 points higher than the historical average. Therefore, I have a neutral rating on the stock despite its good growth prospects.

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