2023-12-15 17:19:42 ET
Summary
- Declining retail volume, particularly in the Tableware segment, remains a concern.
- The significant price increase in the Tableware segment has led to continuous volume decline over the past quarters.
- While management aims to reset prices and adopt promotional strategies, the recovery will take time.
Summary
I'm following up on my coverage of Reynolds Consumer Products ( REYN ), where I previously recommended a hold rating as the valuation seemed to have already priced in the improved business profile. This post is to provide an update on my thoughts on the business and stock. I remain hold-rated for REYN as the retail volume outlook remains weak, and it is uncertain whether the management strategy to reset the price point would work as it did in the past. Management was also clear in communicating that recovery in volume will take some time. As such, I expect the stock to stay rangebound until the market sees positive signs of recovery.
Investment thesis
Starting with the 3Q23 results , REYN reported total revenue of $932.2 million, representing an organic sales decline of 3%. The decline was felt across all the underlying segments, with Reynolds Cooking & Baking down 5%, Presto Products down 2%, and Hefty Tableware down 7%. The only product line that showed positive organic growth was Hefty Waste & Storage at 3%. That said, gross margin improved to 26.6%, leading to an increase in EBIT margin to 14.3%. The increase in profitability is primarily due to better pricing and lower operational expenses. For guidance, management revised their FY23 guidance. They now expect net revenue growth to decline by 2%, a downgrade from the previous guided range of -1% to 1% growth.
While margin improved, I think the results and guidance indicate that the upcoming performance is going to be weak. With the stock still trading at its historical average of 17x, I believe there is room for valuation to de-rate further down to the low end of its trading range (15x) if the turnaround strategy fails. As such, I am reiterating my hold rating on the stock. Below, I discuss why I believe performance will be weak.
First of all, I would like to mention that REYN's organic growth could’ve been worse in the quarter if not for the Clorox cyberattack. The Clorox ( CLX ) mishap was a fortunate event for RENY as consumers shifted their purchases to REYN’s Hefty brand. While the exact magnitude is unclear given the lack of disclosure, the CLX Household segment saw a 12% decline in volume, which I think gives a sense of things.
Secondly, I believe the Tableware segment, which is 25% of the business revenue, is going to report weak sales ahead. I expect REYN to face the consequences of its huge price increase in the segment, which has pushed the price point out of its usual customer segment. For context, since 3Q21 (the start of the price hike), the price point has increased by 33% (6% in 3Q21, 21% in 3Q22, and 4% in 3Q23). This is a huge delta from the typical price increase pace that REYN has done in the past (usually 10+% over 3 years). Share loss in the segment is clearly evident in the results, where volume has declined continuously for the past 3 quarters at an accelerating pace . The only way to work around this is to reduce the price point. The good news is that management has successfully pulled off such strategies in the Wrap product line through increased promotions. This time around, the plan involves a number of changes, such as adjusting pack sizes, promoting sales to reset retail prices, stepping up advertising, etc. I believe these are great strategies and seem like they could work. However, it will take time for REYN to regain lost customers and rebuild its image with customers. As such, I believe this is going to heavily impact topline growth, as REYN needs to reset ~15 percentage points of the price delta in the near term. Moreover, the investment in promotion will impact the cost line as well, bringing down margins.
Nonetheless, it's going to take some time to see the full benefit of those actions as it did with Reynolds Wrap and we've gone through that previously. That's the primary change in the revenue gap. 3Q23 earnings results call
Lastly, I expect management 4Q23 guidance to keep the stock price rangebound. While the 3Q23 revenue decline was in line with guidance, the 4Q23 revenue outlook is horrible. Management is guiding 4Q23 revenue to decline by 7–9%, driven by the tableware business (in line with my expectations above), while overall retail volume is expected to continue declining by 2–4%. While REYN is showing stable to growing retail volume trends in aluminum foil, waste bags, and food bags, I believe the market is not going to give credit for this positive traction until overall retail volume turns positive. I give management credit for its past success in resetting the price point; however, this does not mean it is a guaranteed success this time around. Suppose management mis-executes, tableware volume could see further decline, thereby dragging down the entire group performance. As such, I think it is more conservative to wait for signs of stabilizing or recovering (at the group level) before investing.
Valuation
Own calculation
Previously, I used a long-term DCF model to derive a target price. The flaw in using a long-term DCF model is that it does not accurately reflect the near-term price performance. This time round, I am using a near-term model that focuses on FY24 performance as REYN is effectively in a turnaround mode (specifically, the Tableware segment). Given that management has a pretty good track record of revenue guidance (in the +/- 3% range), I am using its FY23 guidance for my FY23 estimate. The main assumption I made for FY24 is that management successfully pulls off the price-point-reset strategy; as such, the business does not see further decline. Because of the cost involved in promotions, I do not expect margins to improve. Lastly, I assumed REYN would continue trading at the current multiple of 17x forward PE, as it is in line with its historical trading range. There are no visible reasons that I see will drive this valuation upwards in the near term. When compared to other home product peers, it also makes sense for REYN to trade at a discount today because of the weak volume outlook and turnaround situation.
Risk
If management were to successfully pull off the turnaround situation earlier than expected, we could see a recovery in retail volume within the next 1 or 2 quarters. This would flip the negative sentiment to a positive one, which I think could be a catalyst to drive valuations upward.
Conclusion
In conclusion, I remain hold-rated due to the expected weak retail volume outlook, primarily in its Tableware segment. The Tableware segment's substantial price increase has led to a major decline in volume, which now requires management to reset prices. Management's guidance for 4Q23 revenue is a decline of 7–9%, which I believe will set the stock in rangebound territory for the near term. Hence, until clear signs of volume stabilization or recovery surface, I recommend staying at the sidelines.
For further details see:
Reynolds: Weak Volume Outlook Could Keep The Stock Rangebound