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Reckitt Benckiser - Further growth in margins but sales slow

George Salmon | 10 February 2017 | A A A
Reckitt Benckiser - Further growth in margins but sales slow

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Reckitt Benckiser Group Plc Ord 10p

Sell: 6,494.00 | Buy: 6,498.00 | Change -34.00 (-0.52%)
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The group has reported strong growth in operating margins, but like for like (LFL) sales growth across the group has slowed in the fourth quarter. In a separate announcement, the group also confirmed the acquisition of Mead Johnson for $16.6bn. The shares rose by 1.8% on the news.

Our view

Having spent the last few years slimming down its portfolio of brands, some may be surprised to see Reckitt splashing out. However, RB's chief executive Rakesh Kapoor has previously spoken of the potential for Reckitt to act as a consolidator in consumer healthcare, and the deal comes two years after a failed bid for the consumer healthcare division of Merck.

Mead Johnson (MJ) specialises in child nutrition, generating around half of its sales in Asia. With Reckitt comparatively under-weight here, the deal adds diversification and brings exposure to a market that should have demographic and economic tailwinds. Mr Kapoor's vision is for MJ's flagship brand Enfantil to become the RB's leading brand. There is the potential for cost savings too, with RB targeting £200m of annual savings by the end of the combined group's third year.

However, including MJ's debt, it's costing RB $17.9bn and no deal of this size comes without risks attached. The group is taking on debt to fund the deal, but Reckitt's substantial free cash flow should help the combined group quickly deleverage.

In our view the main issue is that MJ's brands have struggled in recent years. While this means Reckitt has been able to swoop in with the shares almost a third down on their 2015 highs, work will need to be done to get the acquired brands back on track. Fortunately, Reckitt has an excellent track record of building brand strength and growing profit margins.

The good work is most clearly evidenced by the returns its 19 Powerbrands have generated. These products, including Dettol and Nurofen, are sold the world over and account for more than 80% of sales. Every year RB invests more behind marketing these brands and introducing new innovations. This both drives sales higher and facilitates price increases, meaning that next year's marketing budget can be higher still. Consistently repeating this cycle has led to impressive profit growth, facilitating higher returns to shareholders, though of course this is not guaranteed to continue.

Its stellar performance has helped the shares rise in recent years, and they now change hands for 21.4 times expected earnings, a 20% premium to their long run average. The prospective yield is just 2.4%, but the potential for a rising payout is clear.

Q4 and full year results

For the full year, net revenue was £9.9bn, an increase of 2% at constant exchange rates. Group operating margins improved from 26.8% to 28.1%, driven by cost savings and pricing. As a result, operating profit rose 8% to £2.8bn, before £367m of exceptional costs which primarily relate to charges associated with the tragic HS issue in Korea, where a product Reckitt sold until 2011 has caused multiple deaths.

In Europe and North America, fourth quarter LFL sales fell 2%, impacted by a significant decline in the Scholl/ Amopé franchise and continued tough conditions in Russia. Other European markets continue to perform well, driven by new product innovations.

LFL sales growth in developing markets was 6%. Demonetisation in India, and the negative impact of the HS issue in Korea held back growth in the quarter. Brazilian sales of Hygiene brands, including Dettol, Harpic Mortein and Veja, continued on a positive trend.

The final dividend has risen to 95p per share, resulting in a 10% increase in the full year dividend to 153.2p. Looking ahead to 2017, the group expects trading conditions to remain challenging, and is targeting like-for-like revenue growth of 3%, with continued improvement in operating margins.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.


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