Reckitt Benckiser: Undervalued Stock Meets Improving Business

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A few days ago, Reckitt Benckiser (OTCPK:RBGPF) reported full year results and the market reacted quite positive after the earnings release with the stock gaining not only 5% during the trading day, but also continued to increase the following days – despite a very challenging market environment. In my last article about Reckitt Benckiser, which was published in August 2021, I claimed that the stock is looking like a bargain and since then, the stock could not only gain in value but also outperform the S&P 500 (SPY), which declined 3.9% compared to Reckitt Benckiser increasing 12.75% at the time of writing.

Chart
Data by YCharts

While I was also bullish from a fundamental point of view, the stock was especially interesting due to the technical picture as it was trading close to a strong support level. And it could make sense to start by looking at the chart again.

Technical Picture

In August 2021 and October 2021, Reckitt Benckiser was not only trading close to the previous lows around GBP 55, but we also saw a pullback to the black declining trendline. And we were close to the lower end of the sideway range in which Reckitt Benckiser is caught for several years now. The combination of these strong support levels made me confident that a rebound was likely and so far, it actually worked quite well.

Reckitt Benckiser is still in a sideway range

TradingView

In the last few months, the stock could increase from about GBP 54 to GBP 65 but was not able to break above the 200-week simple moving average. When looking at the bigger picture, the stock is still in a huge sideway range and within that range, stock movements can be pretty erratic. At least when looking from the perspective of a long-term investor, the downside potential is limited as I don’t assume Reckitt Benckiser will drop lower than GPB 50.

Right now, I don’t have any recommendations about Reckitt Benckiser from a technical point of view. The stock could increase, but it could also decline to the low 50s again. Aside from the technical picture, we can also look at the fundamental picture and see signs of improvement although the full-year results for fiscal 2021 seem not so great.

Fiscal 2021 Results

In fiscal 2021, Reckitt Benckiser generated GBP 13,234 million in revenue and compared to GBP 13,993 million in the previous year this is a decline of 5.4% YoY. And while Reckitt Benckiser reported an operating income of GBP 2,160 million in 2020, it had to report an operating loss of GBP 804 million in fiscal 2021. And finally, diluted earnings per share declined from 166.3 pence in fiscal 2020 to a loss of 4.5 pence per share in fiscal 2021.

Reckitt Benckiser: Net revenue, adjusted operating profit

Reckitt Benckiser Q4/21 Presentation

However, we can also look at the adjusted numbers – excluding IFCN China. In this case, we have a revenue of GBP 12,851 million – 2.1% lowered than GBP 13,132 million in fiscal 2020 (in constant FX, revenue increased 3.3%). Adjusted operating profit also declined from GBP 3,216 million in fiscal 2020 to GBP 2,944 million in fiscal 2021. And including IFCN China again, this leads to a total EPS of 288.5 pence in fiscal 2021, which is still 11.8% lower than in 2020.

Reckitt Benckiser: Free cash flow

Reckitt Benckiser Q4/21 Presentation

Free cash flow in fiscal 2021 was GBP 1,258 million – resulting in a decline of 58.8% compared to a free cash flow of GBP 3,052 million. The free cash flow is lower due to the partial unwind of significant working capital favorability experienced in 2020. When excluding one-time costs and tax costs for IFCN China, free cash flow is around GBP 1.5 billion.

Problem: High Inflation

A major problem Reckitt Benckiser is facing – like many other companies – is the cost inflation of several products and services, which has a huge impact on Reckitt Benckiser’s business. In fiscal 2021, cost inflation was about 11% with material costs increasing in the low double digits and being responsible for 70% of total cost inflation. Aside from materials, conversion and logistics also contributed to rising costs.

Reckitt Benckiser: Cost inflation 11% in 2021

Reckitt Benckiser Q4/21 Presentation

And while inflation will remain an important aspect in the quarters going forward – the word “inflation” was mentioned 19 times during the earnings call – Reckitt Benckiser is quite positive that the business can handle it. Chief Financial Officer Jack Carr stated:

We’re targeting growth in adjusted operating profit margins from a base of 22.9%, and this is despite the significant inflationary pressures. We’ll be applying appropriate pricing and net revenue growth management actions in ’22 to offset these pressures.

And it was also not very surprising, that Reckitt Benckiser used its pricing power to offset increased costs and the wide economic moat the company has based on its brand names will enable Reckitt Benckiser to increase prices further, if necessary, without losing customers (in my opinion).

(Long-term) Strategy

And while inflation is an issue Reckitt Benckiser must deal with right now, the strategy of the last few years was especially focused on undoing the mistakes made in 2017 by the acquisition of Mead Johnson (since then, the stock has also been in a sideway range). But we are seeing signs of improvement in the last fiscal year and when looking at fiscal 2022 guidance, like-for-like net revenue growth is expected to grow 1% to 4% and – as mentioned above – adjusted operating profit margin is expected to grow compared to fiscal 2021 despite inflation pressures.

Reckitt Benckiser 2022 outlook

Reckitt Benckiser Q4/21 Presentation

And while seeing only moderate, low-single digit revenue growth for fiscal 2022, the company is more optimistic about its long-term growth. It is expecting low-to-mid-single digits growth rates for most of its brands with the health segment expected to grow even 4-6% annually.

Reckitt Benckiser growth expectations for hygiene, health and nutrition

Reckitt Benckiser Q4/21 Presentation

Right now, over 70% of the portfolio is already growing in the mid-single digits and 62% of the company’s core CMUs are either holding or gaining market shares, which is a good sign and one of the reasons why management is optimistic about growth in 2022 despite inflationary pressures. Reckitt Benckiser is also continuing to actively manage the portfolio: this is including the disposal of the IFCN China business and Scholl business during 2021, but it is also including the acquisition of the skin-care product brand E45 (which is expected to complete in the second quarter of 2022) as well as the acquisition of Biofreeze. In total, Reckitt Benckiser repositioned 9% of its portfolio in 2021 (measured by 2020 net revenue).

And – not very surprising – Reckitt Benckiser will also focus on ecommerce, which should be one of the drivers of growth. This is not a revolutionary strategic idea, but it is an important step for the business. In 2020, ecommerce was responsible for 6% of total sales, in 2021 for 12% of total sales and its share will continue to grow. Ambitions are, that 25% of net revenue are stemming from ecommerce.

Reckitt Benckiser continued to report strong e-commerce growth

Reckitt Benckiser Q4/21 Presentation

Balance Sheet

In case of Reckitt Benckiser, we also must take a look at the balance sheet as the business has higher debt levels and extremely high levels of goodwill due to the above-mentioned strategic mistakes in the past. As of December 31, 2021, Reckitt Benckiser had GBP 2,485 million in short-term debt and GBP 7,078 million in long-term debt resulting in GBP 9,563 million in total debt. Compared to one year earlier (GBP 10,557 million), this is a reduction of GBP 1 billion. When comparing the total debt to the total equity of GBP 7,453 million, we get a D/E ratio of 1.28. Usually, Reckitt Benckiser could generate about GBP 3 billion in operating income annually and it would take a little more than 3 years to repay the outstanding debt. Both metrics are a little higher than we would like to see but are acceptable.

A huge problem is GBP 18,868 million in goodwill and other intangible assets on the balance sheet. But we must relativize this statement. First, Reckitt Benckiser could decrease the amount from GBP 22,979 million one year earlier. Second, when looking a bit closer at the number, we can see that only GBP 5,328 million are goodwill, while the biggest part (about GBP 13.1 billion) are brand names, which certainly have value. Finally, we also can mention cash and cash equivalents on the balance sheet of GBP 1,261 million. All in all, Reckitt Benckiser’s balance sheet is not perfect, but we also must not be worried about solvency or liquidity issues.

Dividend

Reckitt Benckiser will pay the same dividend as in the previous year. The company already paid an interim dividend of 73 pence and will pay a final dividend of 101.6 pence, which is resulting in an annual dividend of 174.6 pence and a dividend yield of 2.8%. This dividend is making Reckitt Benckiser not extremely interesting for dividend investors, but it is a solid dividend. If approved, the dividend will be paid on June 9, 2022, to shareholders registered on April 29, 2022.

About two years ago – in February 2020, Reckitt Benckiser stated, that it will maintain the dividend at 2019 levels until the company has improved its underlying business and reduced debt levels. The company is aiming for a payout ratio around 50% and once that payout ratio is reached, Reckitt Benckiser will resume dividend growth in line with the growth rate of adjusted net income per share.

Intrinsic Value Calculation

Reckitt Benckiser’s business has been a bit choppy in the last few years and as a result, simple valuation metrics like the P/E ratio or P/FCF ratio are showing numbers we can’t really use. The P/E ratio in the last three years for example is showing numbers as high as 40, but also negative numbers as high as 200. And right now, the P/E ratio is negative again.

It makes much more sense using a discount cash flow calculation to determine an intrinsic value for the business. In my last article, I calculated several different scenarios for Reckitt Benckiser. And in my opinion, the most realistic intrinsic value for Reckitt Benckiser was GBP 76.60 back then. In this article, we can provide an update, but the assumptions are more or less the same as back then.

When looking at the growth assumptions for Reckitt Benckiser, we can still assume a growth rate of 6% till perpetuity (due to the wide economic moat around the business) and when being a bit conservative, we might also assume 6% growth for the next ten years (Reckitt Benckiser is expecting mid-single digit growth in the medium-term). I usually take the free cash flow of the last four quarters (which was GBP 1,258 million) as basis for our calculation. But I don’t think this number is representative for the business – a better number might be GBP 1.5 billion in free cash flow (which is excluding one-time costs and tax costs for the IFCN business in 2021). And while this amount might be more realistic, it is still not the free cash flow I would use. In the last few years, free cash flow was fluctuating heavily and therefore I will take the average amount of the last five years (which was GBP 1,883 million) as basis. When calculating with these numbers and assume a 10% discount rate, we get an intrinsic value of GBP 65.93, and the stock is almost fairly valued at this point.

However, we can probably be more optimistic and assume that free cash flow will be higher than the average of the last five years – the business has been clearly struggling during that time and we see strong signs of improvement. So, I would take at least GBP 2 billion as realistic free cash flow assumption and we can also be a bit more optimistic about the growth potential and assume 7% growth for the next decade. This would lead to an intrinsic value of GBP 75.17 – like the intrinsic value calculated in my last article.

Conclusion

Reckitt Benckiser seems like a great buy-and-hold-forever stock as the business is not only 200 years old, but also has a wide moat around its business and is recession proof. And although the stock is still trading a bit below its intrinsic value in my opinion, I would not see Reckitt Benckiser as bargain. It is however a solid investment with the positive trends we are seeing for Reckitt Benckiser to return on the path of growth again and deliver not only growing earnings per share, but also more stability and consistency. And it will also result in an increasing dividend in the mid-term future (not in 2022 and probably also not in 2023).

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.



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