U.S. Baby Formula Crisis is a one-time boon for narrow-moat Reckitt; Shares Fairly Valued

Business Strategy & Outlook

Reckitt’s portfolio is well positioned in categories that benefit from secular growth drivers across consumer health and hygiene, which should translate into growth ahead of its peer group in the midterm. The acquisition of Mead Johnson has added to its portfolio a leadership position in infant nutrition–a segment with pricing power and generally sound margins. However, the timing of the transaction, ahead of a period of declining birth rates and intensified competition in China, posed significant challenges and has dampened revenue growth in the last few years. Management sold the infant nutrition business in China in 2021, and the future of the remaining core infant nutrition business remains uncertain. While the segment’s reduced size presents an opportunity for management to refocus on faster-growing businesses–positioning them for longer-term success past the peaks in demand generated by the coronavirus pandemic–further secular declines in birth rates in the U.S. could continue to be a drag to the company’s mid-single-digit growth ambitions. Nonetheless, the worst is behind the company.

Reckitt’s pricing muscle will also be its strongest test in the current highly inflationary environment. One is cautious about price decisions that are too aggressive and could impact the consumption of some of its products, but believe the company is well positioned to deliver superior price/mix through its portfolio of strong brands and its advantaged category mix. Further supporting top-line growth, the productivity program started in 2020 that now stands at GBP 2 billion over four years has enabled management to reinvest around GBP 1 billion so far in key areas such as research and development, or R&D, and e-commerce. These investments were necessary as Reckitt was at risk of falling behind peers in its customer acquisition investments. One doesn’t see large portfolio restructuring as part of its strategy in the near term. The Reckitt to continue to make marginal portfolio adjustments, acquiring fast-growing brands that complement its existing portfolio, especially in the consumer health sector.

Financial Strengths

Prior to the Mead Johnson acquisition in 2017, Reckitt had a strong balance sheet with debt/EBITDA of around 1 time. It significantly increased its leverage to finance the $18 billion Mead Johnson acquisition, which lead to a peak net debt/EBITDA of 6 times in 2017. Since then, it has been diligent in reducing its leverage and closed 2021 with net debt/EBITDA of 2.6 times, a slight increase compared with the 2020 level of 2.4 times, but closer in line with its peer group. From a cash perspective, this level of debt is manageable for the company given EBITDA covered interest expense about 12 times in 2021. In future, to see continued debt reduction, which should enable Reckitt to start increasing dividends again or pursue slightly larger bolt-on acquisitions in the medium term. Dividends have amounted to GBP 1.2 billion per year for the last three years and one doesn’t expect to see meaningful growth in the near term as Reckitt is targeting a dividend cover closer to 2 times before reinitiating dividend increases.

Bulls Say

Reckitt’s portfolio is well positioned in categories with long-term structural growth potential, and the turnaround initiated by new management in 2020 is progressing well.
The disposal of the infant nutrition business in China will free up management’s focus and enable Reckitt to refocus its efforts on its faster-growing segments.
The additional investment in the business financed by the GBP 2 billion productivity program should translate into accelerated growth through penetration gains and increased e-commerce contributions to net revenue.

Company Description

Reckitt Benckiser was formed in 1999 through the merger of the British firm Reckitt & Colman and Dutch-based Benckiser. Recently rebranded under the corporate name Reckitt, it sells a portfolio that includes a variety of household and consumer health brands, such as Lysol, Finish, Durex, and Mucinex, many of which hold the number-one or -two positions in their categories globally. Reckitt has repositioned its portfolio and has entered the infant formula market through the acquisition of Mead Johnson in 2017, expanded its consumer health presence by acquiring Schiff Nutrition, K-Y, and Biofreeze, and has exited the food industry. The firm operates in 60 countries and sells products in more than 200, generating around 35% of sales from emerging markets.

(Source: Morningstar)

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