Why Reckitt Benckiser Seems Fully Valued

In spite of upgraded guidance for Reckitt Benckiser Group (RBGPF.PK), we stick to our valuation range of £32-33 ($52.2-$53.8) per share. The 15% return we were looking for is now behind us and we feel that the stock looks fairly priced. Further re-rating would require improved visibility in household products.

Nine months: sales up 20% reported (£5.7billion or $9.3 bn), up 7% like for like. Net earnings up 29% reported, up 13% like for like. Guidance raised for 2009: revenue growth +6-7% like for like, +12-13% adjusted net income, +22-23% at actual exchange.

A mixed bag in Q3 with excellent growth in health care and pharmaceutical but a sharp slowdown in household and home care.

-Reckitt’s health care brands (Nurofen, Strepsils, Mucinex..) performed strongly (+16% in Q3, +14% 9m)

-Growth in pharmaceuticals reached 41% in Q3 (+42% 9m) thanks to increased penetration of Suboxone in the U.S.

-Sales in household and home care products were clearly disappointing, notably fabric care and dishwashing (2/3 of sales), which dropped by 4% and 5% respectively in Q3. It seems that the premiumisation strategy which has been working very well in the past, is now struggling at a time when consumers are looking for value. As a result of the economic downturn, Reckitt has to invest more than in the past into promotional spending in order to maintain its share of the European market.

Operating margin progressed by 130bp of sales to 22.6% helped by higher gross margin (+90bp) and lower media expenses (-170bp to 11.5% of sales), implying a negative impact of other charges, notably promotions, of -130bp.

Going forward, investors will be increasingly looking at the performance of the household division, as management reiterated that 80% of the revenues and profits of the pharma business might be lost following the expected launch of generic competitors in the US. As a result, Reckitt will need to show a return to growth in fabric care and dishwashing.

Management might have to further increase promotion while the fall in media rates should decelerate, leaving less room for maneuver from a margin standpoint.

Reckitt trades at 16.5x P/E based on 2010 estimates, which seems fair considering the lack of visibility in pharma. Our DCF model confirms our valuation range of £32-33, following the loss of the U.S, Suboxone business next year.

Stock price: £30.7 ($50)