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Reckitt Benckiser - remains confident despite challenges

George Salmon | 21 April 2017 | A A A
Reckitt Benckiser - remains confident despite challenges

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Reckitt Benckiser Group Plc Ord 10p

Sell: 7,766.00 | Buy: 7,768.00 | Change 90.00 (1.17%)
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Group like-for-like (LFL) sales in the first quarter were flat, slightly behind analyst consensus as negative LFL sales in Europe were offset by growth in Developing Markets and Foods. The shares dipped 1.5% 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 to buy Mead Johnson (MJ). However, RB's chief executive Rakesh Kapoor has previously spoken of the potential for Reckitt to act as a consolidator in consumer healthcare. The deal comes two years after a failed bid for the consumer healthcare division of Merck.

Mead Johnson 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 RB's leading name. 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 Reckitt $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 21.3 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, if not guaranteed.

First quarter results

Reckitt's Hygiene business (43% of group revenue) saw LFL sales growth of 3%, boosted by a strong performance from Dettol. LFL sales in the Health business (34% of group revenue) were flat, as the Scholl/Amopé brand continues to drag on performance.

There has been no change in the group's expectations surrounding the tragic HS issue in South Korea. However, Reckitt says that it continues to have an adverse effect on sales in the Home (17% of group revenue) and Portfolio (6% of group revenue) categories. LFL sales fell in these divisions by 4 and 6% respectively.

Brazil remains a tough market, while the impact of demonetization in India is still being felt. The UK and France saw positive momentum and Russia returned to modest growth, but these improvements were more than offset by declines elsewhere in Europe, including in Italy and Germany. LFL sales in North America were flat.

Reckitt says macroeconomic conditions remain challenging, but the group expects growth to improve through the year, and is confident of hitting its full year target of 3% growth in LFL net revenue.

The acquisition of Mead Johnson is progressing well and the group expects completion by the end of Q3. The strategic review of the 'non-core' Foods business is underway, however no decision on its future has yet been reached.

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 disclosure for more information.