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Reckitt Benckiser - Profits up, but conditions look challenging

George Salmon | 24 July 2017 | A A A
Reckitt Benckiser - Profits up, but conditions look challenging

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Reckitt Benckiser Group Plc Ord 10p

Sell: 5,806.00 | Buy: 5,809.00 | Change -59.00 (-1.01%)
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Although medium term guidance was maintained at the half year stage, the group says current tough conditions have made hitting its growth target more challenging. The shares fell 2% on the news.

Our View

CEO Rakesh Kapoor has done a sterling job at the consumer goods giant in recent years. His strategy has seen the group invest in promoting a select group of leading powerbrands, such as Dettol, Neurofen and Finish dishwasher tablets, with regular innovations and a chunky marketing budget boosting sales and profitability.

Recently however, conditions have been looking more difficult. First half like-for-like sales were negative in all parts of the business. A cyber-attack, together with a pair of £300m+ provisions, relating to customer redress in Korea and an ongoing US Department of Justice investigation haven't helped matters, but shouldn't merit longer-term concern.

Despite the challenges, RB still expects to see a return to growth in the second half. However, investors should also be keeping an eye on the performance of the recently acquired infant nutrition business Mead Johnson, which came with a $17.9bn price tag.

The rationale behind the deal is sound enough. Around half of its sales are generated in Asia, and these emerging economies should be capable of growth for years to come. We can expect £200m per annum of cost synergies by 2020, while Reckitt's impressive cash generation should mean it can easily stomach the extra debts taken on to fund the deal, although this does clearly bring extra risk.

The main worry is that Reckitt has bought a business whose brands have struggled recently, and Mead Johnson's margins were a touch disappointing at the half year. However, it's still very early days, and RB has an excellent track record on margin growth.

The group trades on 21.4 times expected earnings, a slight premium to its 5 year average, and offers a prospective dividend yield of 2.2%. The potential for a rising payout is clear, with analysts expecting the dividend to rise by around 10% a year in the next three years.

Second quarter and half year results

Net revenue in the first half was £5.0bn, up 14%. This was aided by recent acquisitions (including that of Mead Johnson) and the weak pound. On a like-for-like basis, revenues fell 1%.

Adjusted operating profit rose 16%, to £1.2bn, boosted by margin expansion of 0.3 percentage points to 23.7%, but is only up 1% at constant currency. The dividend is raised 14% to 66.6p per share.

As anticipated, LFL revenues in the second quarter were -2%. LFLs in North America were broadly flat, while a cyber-attack that halted production, shipping and invoicing in a number of sites, together with slower trading in Scholl, dragged European sales down 6%. Developing Market LFL sales rose 2%, with strong performances from China, South Africa, Nigeria and Pakistan. The HS issue in South Korea also impacted trading in the quarter, albeit to a lesser extent than Q1.

Q2 LFLs in the group's two largest divisions, Hygiene and Health, were down 1% and 4% respectively, both weaker than Q1. LFL growth was also negative in the Home and Portfolio Brands businesses, collectively responsible for 20% of revenue. However these results were better than the declines seen in Q1.

The Food business, which delivered net revenue of £208m, is to be sold to McCormick & Co for $4.2bn, and is therefore not included in headline results. The group also reported an exceptional cost of £318m relating to the demerged Indivior Pharmaceuticals business.

Looking ahead, RB continues to target moderate margin expansion in the near term, with full year LFL net revenue growth of 2% for the RB business this year. Mead Johnson is expected to deliver LFLs of -2% to flat in H2. While operating margins were slightly weaker than initially expected, the group is confident of growing margins over the medium term.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.