Henkel's Recent Rerating Might Not Be Sustainable

Includes: HENKY, HENOY
by: Véronique Adam

Stock price: €29 (US$42.3)
Conclusion: Multiples almost in line with HPC peers, which might not be sustainable. Our valuation range (€24-26 per share) suggests some downside risk.

H1: Sales down 6% like for like (down 1.3% reported to €6.7bn), adjusted net earnings down 34% to €292m. Guidance Q3: HPC growth could decelerate while adhesives should perform in line with Q2.

We think that the recent rerating of the group might not be sustainable.

1) Top line growth in consumer could decelerate in the second half of the year.

  • Performance in laundry and home care was essentially driven by pricing which rose by 5% in H1, while volume were up only 1%. We expect the pricing impact to gradually diminish and be only partly offset by higher volume.
  • The balance between volume (+1%) and pricing (+2.4%) looks more bearable in cosmetics.
  • The current downturn seems to favor Henkel given its exposure to “basic” hygiene and cleansing products. It remains to be seen whether Henkel will continue to outperform peers when the economy picks up. We also expect L’Oreal to become more aggressive in the hair color sector in order to regain the lost ground.

2) Turnaround in adhesives could take some time
Cyclical adhesives account for 45% of Henkel sales. According to management, sales trend in second half of the year could be “similar to or only slightly better” than Q2 which was down by 15.4%. Visibility remains limited in electronics, automotive and construction segments, notably in Europe.

3) Henkel profitability in HPC compares unfavorably with peers.

  • We expect margins to achieve around 12% in home care and cosmetics in 2009 which is well below average in the sector (18-22% EBIT margin). Bridging the gap will be challenging given the lack of global scale in cosmetics, the focus on value products and the risk of rising marketing expenses.
  • At the group level, we do not expect Henkel to reach its 14% margin target by 2012. First, management has a mixed track record and failed in the past to achieve previous profitability goals. Second, it would need to retain 100% of its savings program, which is well above the average 50% rate seen in the sector. As a result we are looking for only 12% margin by 2010.

Henkel is up 36% YTD, trading at 20x and 16x P/E based on 2009 and 2010 estimates. We believe that a 20% discount to HPC is justified by the business mix of Henkel. Adhesives trade at lower multiple than HPC. Our SOP based on 9.5xEBITDA in cosmetics and 8x EBITDA in adhesives leads to €25 (US$36.5) per share, in line with our DCF valuation.