RBGPF - Reckitt Benckiser: Stable Prospects Fair Valuation

2023-08-22 13:30:28 ET

Summary

• Reckitt Benckiser is implementing a growth strategy focused on innovation-led branding investments to achieve mid-single digit top line growth and higher operating margins medium term.
• Despite challenging macro conditions and tough comps, the company delivered a decent 1H 2023 and momentum is largely expected to continue in 2H 2023 despite anticipated weakness from Nutrition.
• Positive strategic implementation on product innovation so far, and investments on brand building could bear fruit. Medium term targets are not impossible to achieve.
• Valuation appears fair.

Reckitt Benckiser ( OTCPK:RBGPF ) ( OTCPK:RBGLY ) is implementing a medium-term growth strategy based on innovation-led branding investments whereby continued product innovation along with branding investments and premium pricing drive medium-term growth targets of mid-single digit top line growth and operating margins in the mid-twenties from the low-twenties currently. Their medium-term growth strategy appears to be delivering some encouraging early results which bodes well for their medium-term outlook. Valuation appears fair.

Company Overview

Reckitt Benckiser is an English consumer goods company with worldwide operations engaged in the production and distribution of household cleaning, health, and nutrition products.

• Their Health business which accounts for 42% of revenues comprises products such as antiseptics, and personal care products sold under market-leading brands including Dettol, Veet, and Strepsils.

• Their Hygiene business which accounts for 41% of revenues comprises household cleaning products such as surface disinfectants, pest control, and air fresheners sold under market-leading brands such as Lysol, Mortein, and Air Wick.

• Their Nutrition business which accounts for the remaining 17% of revenues comprises nutrition products for infants, children, and adults such as infant formula, children's milk, and adult milk supplements sold under market-leading brands such as Lactum, Enfamil, and Nutramigen.

Background

Despite tough comps and cost pressures, the company delivered a good 1H 2023. Much of it was driven by pricing actions however it may also be suggestive of encouraging early results from their growth strategy considering challenging macro conditions and tough comps.

• Net revenues rose 6% on a like-for-like (LFL) basis, largely driven by price/mix with a 10.4% contribution, offset by a negative 4.4% impact on volumes. On a reported basis net revenues were up 8.1% to GBP 7.5 billion. Growth was weakest in developing markets where revenues rose just 2.2% YoY LFL compared with 6.5% in North America and 9.7% in Europe/NZ.

• Gross margins expanded 130 bps to 59.4% from 58.1% the same period last year.

• Adjusted operating profit declined 180 bps to 23.8% however this was partly due to a significantly high margin the previous year which included some one-off items.

• Free cash flows increased 31% to GBP 758 million from GBP 727 million the same period last year.

By segment:

• Hygiene grew 3.6% YoY LFL, driven by a 12.5% contribution from pricing/mix offset by a 8.9% drop in volumes. On a reported basis, revenues rose 6.2% YoY to GBP 3 billion and adjusted operating profit amounted to GBP 583 million.

• Health grew 8.8% YoY LFL, driven by an 8.3% pricing/mix contribution, and a 0.5% volume contribution. On a reported basis net revenues rose 9% to GBP 3 billion. Adjusted operating profits were GBP 882 million

• Nutrition rose 5.3% YoY LFL, driven by a 10.5% pricing/mix contribution offset by a 5.2% drop in volumes. On a reported basis revenues rose 10.7% to GBP 1.3 billion. Adjusted operating profits amounted to GBP 304 million.

2H 2023

It remains to be seen when Reckitt Benckiser could return to volume growth however certain positives in 1H 2023 could continue heading into 2H 2023; Lysol returned to growth in 1H 2023 (a noteworthy performance as the brand is growing from a 50% higher base created during the pandemic). Meanwhile, continued growth momentum on the back of new product launches (such as their new Lysol air sanitizer) could support their Hygiene business, and moderating inflation may help contain market share erosion thereby stemming overall volume declines.

Meanwhile, on the profitability side, management noted earlier in the year that cost inflation appears to have peaked , and their improving gross margin in 1H 2023 is a reflection of that.

While their OTC and intimate wellness portfolio business delivered a strong first half growing by 20% and high-single digits, 2H 2023 may not be as strong due to tough comps for the OTC business particularly in the final quarter as last year's cold and flu season was one of the worst on record .

Their Nutrition segment is one of the few weak spots with management expecting volume declines in 2H 2023 due to tough comps and growing competitive pressures. The Nutrition segment benefited significantly last year due to the U.S. infant formula shortage which Reckitt Benckiser was the biggest beneficiary (their market share increased to over 40% , and they jumped from the U.S.'s second-biggest infant formula player to the largest player as market leader Abbott struggled with supply issues). It remains to be seen if Reckitt Benckiser could retain their newly clinched market-leading position. Abbott has already captured 75% of the market share lost last year, and competitive pressures could increase in 2H 2023 as Abbott works to recapture the remaining lost market share.

Nevertheless, improving volume trends in Hygiene (driven by Lysol), a business accounting for over 40% of revenues, could offset declines in Nutrition, a relatively small business accounting for 17% of revenues. Overall, Management expects 3%-5% top line growth in 2023 (including the lapping of the US Nutrition impact in 2022), and full year 2023 adjusted operating profits to be slightly better than 2022 (excluding the one-off benefit in 2022 related to US Nutrition).

Medium-term growth strategy

Towards their mid-single digit top line growth target medium-term, Reckitt Benckiser aims to drive mid-single digit growth across all business segments as follows:

• Hygiene's medium-term mid-single digit growth target to be driven by branding and innovation.

• Heath's medium-term mid-single digit growth target to be driven by increased penetration and market share in existing markets and through entry into new markets.

• Nutrition's medium-term mid-single growth target to be driven by focusing on fast-growing and premium segments.

Progress to date includes :

• Hygiene: The launch of product innovations for Air Wick, Vanish, Dettol and Lysol (all part of their Hygiene segment) which have generated positive growth results according to the management. An innovation-led premiumization strategy could support margin expansion for the Hygiene segment which at 20.4%, has the lowest margins among all business segments. For perspective Health's segment margin is 27.5%, and Nutrition's segment margin is 23%.

• Health: Stepped up brand investments, notably in countries like India and Indonesia to boost market penetration of Intimate Wellness, as well as the launch of new innovations . These countries offer tremendous potential for growth given their youthful populations and relatively low usage rate.

• Nutrition: As part of their strategy to focus on fast-growing and premium segments, the company appears to be looking to offload their remaining infant formula business, possibly due to rising compliance costs due to increasing regulatory scrutiny of the sector around the world.

Overall product innovation and market expansion efforts under their innovation-led growth strategy, were supported by increased branding (brand equity investments or BEI rose 14% YoY to GBP 918 million in 1H 2023). BEI spending outpaced revenue growth in 1H 2023 (BEI as a proportion of revenues increased to 12.3% of revenues in 1H 2023 compared with 11.7% the same period last year), however, it is possible that those investments could yield results medium-term as volume growth headwinds from post-pandemic normalization trends and inflation fade supporting margin expansion targets.

Risks

• Execution risks: Financial performance could be hindered due to execution missteps such as product recalls (early this year the company recalled two batches of infant formula) and advertising and marketing missteps (which coil result in costly penalties).

• Competitive risks: Competitors and new entrants could eat into market share and hinder market share gains and financial performance.

Conclusion

Reckitt Benckiser has a Hold analyst consensus rating.

Reckitt Benckiser's near-term results are decent considering tough comps and macro challenges suggesting their growth strategy could be delivering results which bodes well for their medium-term target of mid-single digit revenue growth and operating margins in the mid-twenties.

Assumptions

For further details see: