Energizer (NYSE:ENR), best known from its famous battery bunny, is in part reversing the spin-off from last year. The company became a stand-alone business in the summer of last year, allowing it to focus on batteries and portable lighting products.
Spin-offs make sense, allowing management teams to focus on a single market or business. What is somewhat ironical is the fact that Energizer is already moving away from this strategy, as it is expanding into the auto fragrance market.
Energizer is still a pure play on batteries, deriving 50% of revenues from the sale of premium alkaline batteries. Performance products, such as rechargeable batteries and lithium-based batteries, make up a sixth of sales. The same goes for specialty batteries and lights, as well as carbon zinc batteries.
Energizer typically holds leading market positions in those markets in which it operates. This includes North America, parts of Europe, parts of Latin America as well as Asia. The substantial overseas presence, with 50% of sales being derived abroad, has resulted in quite severe currency headwinds in recent times. These currency losses stem from both revenue translation losses as well as higher cost of production.
The issue with batteries is that they can be thought of as a declining segment, although volume declines have stabilized a bit in recent time. The company cites continued demographic growth, an increase in the number of devices being used, and natural disasters as reasons for potential growth.
While these factors might add to demand, the reality is that usage of these batteries is still declining. As a matter of fact, I would not be surprised if technological developments could bypass batteries for multiple applications in the future.
A Sluggish Cash Cow
When Energizer presents itself as a potential growth play, this is not very realistic in my eyes. For now, the company continues to report fat margins and provides decent cash flows. The trouble is that I cannot reasonably project a decent revenue growth going forward for the core battery business.
Energizer reported sales of $1.63 billion in the fiscal year of 2015, which ended in September of last year. Sales fell by more than 11%, in part thanks to the strong dollar, as organic sales were down by 3.6%, reinforcing my belief that the long-term outlook is not so pretty.
GAAP earnings were severely impacted by the impact of the devaluation of the currency in Venezuela, restructuring efforts and the spin-off costs. The company itself reported adjusted EBITDA of $345 million and adjusted earnings of $177 million. It seems somewhat reasonable to use this earnings number, as it really excludes truly one-time items other than a $6 million restructuring item and the cost of the devaluation in Venezuela.
Even if I use this generous adjusted earnings number, profit trends are not very good either as these adjusted earnings still came in at $208 million in 2014.
In May, Energizer reported its second-quarter results. So far in 2016, reported sales are down 2%, but organic sales trends have actually trended positive. The contribution of cost cuts and the improvements in terms of organic growth rates were offset by the further strengthening of the dollar. Based on these trends and the outlook, sales could come in at $1.6 billion in 2016. While top-line sales are expected to be pretty flat, profitability metrics face further pressure. The company guides for adjusted EBITDA of $290 million, with adjusted earnings seen around $135 million.
The company ended the second quarter with plenty of liquidity, holding $576 million in cash and equivalents, with debt standing at $1.0 billion. The resulting net debt load of $425 million is equivalent to a 1.5 times leverage ratio, being very manageable.
Shares of Energizer have seen a big run-up, having risen from $30 at the start of the year, towards to $45 by now. With 62 million shares outstanding, equity is thereby valued at $2.8 billion, equivalent to 20 times the projected anticipated earnings for this year. The higher multiple (for a declining business) clearly indicates that expectations have risen with regards to a continuation of organic growth rates or a softening dollar.
Improving The Growth Profile
Energizer was spun off in order to create a pure play, but less than one year after the completion of the split, the company is already diversifying. With the growth picture of batteries being sub-optimal, Energizer announced the $340 million cash purchase of HandStands.
HandStands produces automotive fragrance and appearance products. This is an entirely differing business as batteries, yet real back-end and distribution synergies could be achieved. This results from the fact that Energizer's batteries and these auto fragrance products are shipped to the same stores and distributors. As matter of fact, cost synergies could total $5 million per year, with revenue synergies being unspecified at this time.
HandStands generates 80% of the $128 million in annual sales in the US, with EBITDA coming at $34 million. This suggests a 10 times multiple being paid. This seems reasonable in the light that Energizer itself trades at 11 times projected EBITDA while the growth outlook for the core looks challenged. If you include the synergies projected by Energizer, the deal multiple drops to 8.7 times EBITDA. The relative discount and the fact that auto fragrance sales are projected to rise make it a relatively nice deal.
Following the purchase, Energizer will operate with a net debt load of roughly $750 million. As pro-forma EBITDA will improve towards $330 million, leverage is seen at 2.3 times EBITDA.
It seems that Energizer is realizing that it needs to transform the business to ensure the long-term viability. The deal to diversify into fragrances makes sense from that perspective, but "kills" the rationale for the decision to split the business last summer.
In essence, Energizer is now combining both declining and growing business under one umbrella again, although real synergies in terms of costs can be achieved. This deal means that 7-8% of pro-forma sales are now derived from automotive fragrances and related products, indicating that the business is still heavily reliant on batteries.
The real issue is that leverage ratios are increasing a bit, limiting the real potential to make similarly-sized deals in the near term without hurting credit ratings too much. This limiting factor, as well as the very full valuation, makes me cautious. While earnings multiples could drop if the dollar loses some strength and organic sales momentum continues, the bull case does not look to be very sustainable.
While I like the deal, much more work is ahead in order to fix the situation. The declining core, full valuation and increase in leverage leave few triggers which can send shares higher in my eyes. Consequently, I would urge for real caution at the current levels.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.