RBGPF - Reckitt Benckiser: Uncertain H2 2023 To Pressure Valuation In The Near Term (Rating Downgrade)

2023-08-02 06:08:49 ET

Summary

• Reckitt Benckiser's 1H23 results were slightly better than expected, with growth in both the Health and Hygiene divisions.
• The stock currently trades at a discount to peers, but the valuation gap may take time to close.
• Uncertainties surrounding the 2H23 outlook and no clear signs of volume recovery have led to a revision of the rating to a hold.

Summary

Readers may find my previous coverage via this link. My previous rating was a buy, as I believed Reckitt Benckiser (RBGLY) valuation would re-rate once it demonstrated sustained gains in market share, given that its valuation was at a discount to peers. I am revising my rating to a hold in the near term as I await the 3Q23 results to confirm the volume growth trend, which will help determine the range of outcomes in 4Q23 and FY23. I expect valuation to stay under pressure (discount to peers) for the time being.

Financials/valuation

Results for RBGLY's 1H23 were slightly better than expected. The Health and Hygiene divisions each contributed to the 2Q23 LFL revenue growth of 4.1%, with the former contributing 4.9% and the latter contributing 5.5%. The Health division was the shining example of resilience, showing robust LFL growth and 40bps margin expansion. On the other hand, Hygiene saw the highest LFL growth, driven by Lysol. Management is now anticipating LFL revenue growth of 3-5%, which includes the lapping of the US nutrition market. The expected range for EBIT margins is flat to up, minus the 80bps impact from US Nutrition.

The crux of my previous thesis was that the valuation gap between peers should close. I have now taken a more conservative approach to how long this closure will take. Specifically, for the near term (next 3 to 6 months), I think it will be hard for this to happen as 2H23 is going to face tough comps, and there are no signs yet to show volume is recovering with strength. It is likely that valuation will continue to stay pressured; hence, the upside is not attractive in the near term.

At 17x forward PE, the stock trades at a ~30% discount to peers like L'Oreal, Clorox, Procter & Gamble, Beiersdorf, Church & Dwight, and Colgate. Given the strong execution and guidance, I still believe it is only a matter of time before this gap closes. If RBGLY shows volume growth in 2H23, showing a path to normalization, I anticipate the re-rating to close the gap between its current valuation and its true value.

Comments

With strong performance across OTC and Intimate Wellness and an improving China, RBGLY saw 4.9% LFL growth in the Health segment. Although the current quarters look promising, I would be wary of extrapolating this growth into 2H23 because of the tough comparison with 2H22. This is especially true if the upcoming cold season is weaker than anticipated. Also, it seems that growth was also juiced by retailers stocking up on inventory ahead of the cold season, pulling forward demand (making 1H23 a tough comp for 2H23). However, I am optimistic that the new management team and product lineup will find a way to drive performance improvement in in Dettol.

For the Nutrition segment, RBGLY saw LFL growth of 0.9%, with growth in Canada offsetting US comps in part. Weakness in ASEAN counteracted the region's strength in Latin America. WIC's positive contribution and pricing benefit also contributed to the increase in margin. I believe that, like the Health segment, the Nutrition industry will have a challenging 2H23 due to factors such as the elimination of WIC benefits and an increase in trade marketing expenditures brought on by a more competitive market.

For the Hygiene segment. Overall Hygiene volume improved sequentially, while Lysol's growth rate returned to the high single digits in 2Q (now growing >50% above the pre-pandemic levels), contributing to RBGLY's 5.5% LFL expansion. I anticipate that 2H23 volumes will continue to improve in H2 as I anticipate a sequential improvement in performance thanks to new innovations and increased BEI investments. However, prices will begin to lap the increases seen in 2H22, making year-over-year comparisons challenging on a headline basis. That said, at the bottomline, margins should grow in 2H23 as cost inflation moderates.

As a whole, RKT's performance in the 2Q23 was satisfactory. Things aren't completely stable yet, but I believe the periods of volatility experienced over the past few years are winding down. On the other hand, there are still future volume concerns, especially when compared to its peer, Unilever, which has seen volume resilience. Unilever's volume in 2Q23 was relatively stable (down 0.3%), with sequential gains in both North America and emerging markets.

The new management strategy has only been in place for two years, so I wouldn't rush to judgment just yet. But if the company can't show volume recovery after 2H23, I believe the market will lose patience. Because of this, I believe the pressure on short price will continue until 3Q results are released, at which point investors will know the volume trend and have a perspective on 4Q performance.

Risk & conclusion

I have revised my rating for RBGLY from a buy to a hold due to uncertainties surrounding the 2H23 outlook. While the 1H23 results were slightly better than expected, the tough comps in the second half and no clear signs of volume recovery make the near-term valuation under pressure. The stock currently trades at a discount to peers, but it may take time for the valuation gap to close.

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