In February, we covered Ashtead Group and Rentokil Initial. If you missed these articles, here are the links:
Today, we are revisiting Reckitt Benckiser (“Reckitt”, “RKT”, and “Company”), a company we covered back in September 2023 (Reckitt: Brands, Transformation and Future Potential). Following the latest earnings call, the price dropped by ~10% due to reasons, including the continued rebasing of the nutrition segment, an impairment of £810 million to IFNC (nutrition segment), and a trade spend understatement in two Middle East countries impacting revenues by £55 million and adjusted operating income by £35 million.
On a more positive note, management expects to optimize fixed costs, maintain mid-single digit (“MSD”) growth for Health and Hygiene, and anticipates growth for Nutrition later in 2024.
The question arises: Will these factors be sufficient to drive the price higher, or does this consumer product behemoth deserve the drop? Let’s find out!
We will conclude this analysis with our updated valuation.
Contents:
Performance Update (Health, Hygiene, Nutrition)
Peers Comparison
Valuation
Conclusion
Sponsored by: Borsa: Every earnings call in one app
With earnings season in full swing, we're pleased to share our trusted tool to get through every earnings season. Borsa makes listening to earnings calls as effortless as tuning into a podcast. We love that Borsa is simple yet provides presentation slides, earnings releases, and transcripts along with every earnings call. Check it out -> Borsa
1. Performance Update
a. Overall
The Company's financial performance, particularly in the last quarter, has been impacted by OTC-driven issues and a voluntary product recall (Nutramigen) in the nutrition business, along with the ongoing rebasing of the US nutrition segment. Despite these setbacks, the health and hygiene segments, each accounting for 42% of sales, have demonstrated resilience. They achieved mid-single-digit like-for-like (“LFL”) growth rates in 2023 and maintained strong consumer trust.
Source: Koyfin (affiliate link with a 20% discount; if you are a paid subscriber, you can benefit from a 3-month free trial), StockOpine analysis
Consequently, in 2023, the Company achieved a revenue growth rate of 1.1%, driven by LFL growth of 3.5% (7.8% price/mix & -4.3% volume) and negatively impacted by adverse FX. It has also seen its margins recover to the 60% levels, driven by pricing power, product premiumization and innovations.
Kris Licht, CEO also noted “We are known to be able to generate high gross margins, and we are back at a historical level. That's quite a good level. I don't have an ambition to dramatically expand that. In fact, I think we are at a good place.”
While gross margins have likely peaked, and brand equity investments are expected to remain high (13.1% of sales Vs 11.8% in 2022), the target is to improve efficiencies to achieve a mid-20s adjusted operating margin. The fixed cost optimization program, set in motion, is expected to drive a 200 bps improvement, despite short-term restructuring costs. It’s worth noting that the drop in 2023 operating margin, was mainly driven by the nutrition business and a product recall of a competitor for IFNC in 2022. Without this impact, margins would have improved by 10 bps.
In terms of free cash flows (“FCF”), Reckitt has finally shown signs of an upward trajectory, achieving close to 16% in 2023. This was fueled by working capital improvements due to enhanced inventory control, although offset by higher interest costs and taxes. The resulting £2.3 billion FCF was utilized to pay down debt, reducing its net debt to adjusted EBITDA from 2.1x to 1.9x, increase the dividend by 5% (yielding approximately 3.6%), and commence funding for its recently announced £1 billion buyback program.
In the past, Reckitt has disappointed shareholders with costly acquisitions. Before hastily judging current management for the impairment (a consequence of past actions), it's worth considering deeper questions. Would I be willing to recognize an impairment if I wasn't responsible for the acquisition and I was a new CEO? Would I be willing to publicly admit that our processes failed in the Middle East, even if the impact wasn't material? For most people, the answer would be no.
Nevertheless, management has demonstrated qualities with improving gross margins, cleaning any balance sheet overstatements, and terminating employees involved in fraudulent activities. Additionally, six months after our prior write-up, we've observed CEO Kris Licht's approval rating on Glassdoor increase from 80% to 82%, indicating incremental improvement in the right direction.