Reckitt Benckiser Is On Track For Great Long-Term Returns

Summary

• Reckitt Benckiser delivered what was outlined in their transformation plan a year ago.
• The FCF conversion was strong, the productivity program is ahead of plan, investments were made to drive growth and the balance sheet was strengthened.
• There is evidence that increased hygiene habits are likely to remain elevated after the pandemic.
• The company's footprint will be expanded to 70 new markets by end of 2021, unleashing further growth potential.

Investment thesis

Reckitt Benckiser (OTCPK:RBGPF) delivered a strong FCF conversion, the productivity program is ahead of plan and was even extended, investments were made to drive growth, the portfolio is under review and the balance sheet was strengthened. There is evidence that increased hygiene habits are likely to remain elevated after the pandemic. The company's footprint will be expanded to 70 new markets by end of 2021, unleashing further growth potential.

Motivation for this article

Reckitt Benckiser reported full year 2020 results on the 24th of February. A year ago the company outlined a strategy to rejuvenating sustainable growth. You can find more details in my previous article. Now it's time to have a look at the progress and if the company is on track.

In this article I want to discuss the most important / relevant aspects by looking at the targets that were defined a year ago. In addition, the outlook and current valuation of the stock are discussed.

The good

When talking about full year results, we need to have a quick look at some numbers.

Source: full year 2020 results presentation

RBGPF delivered a strong 11.8% revenue growth and a record free cash flow of £3.052B. The adjusted earnings per share are well above the original expectations. eCommerce sales increased by 56%, representing now 12% of the total revenue. The business saw a broad based global growth with 15% average growth across its top 10 markets.

The productivity program is running ahead of plan with savings of £407M in 2020. Due to the good progress, the 3-year goal was raised from £1.3B to £1.6B. This means that £600M productivity savings need to be delivered in 2021. These savings support growth initiatives but are also needed to off-set increasing commodity price, transportation inflation and on-going Covid costs.

A record £745M investment was made to drive significant global expansion, increase eCommerce, improve underlying business and go to market capabilities, add significant increases in supply chain capacity and strengthen R&D and innovation pipeline. All of this is partially funded by the productivity program discussed previously.

Source: full year 2020 results presentation

The strong FCF generation was used to significantly reduce the net debt (-17%), down from £10.7B in 2019 to £9B in 2020. This results in a leverage reduction from 2.9x to 2.4x net debt to adjusted EBITDA.

Decisive actions were taken on the portfolio. The nutrition business in China is under review and the Scholl brand was sold. It evolved less compelling than other brands and the money will be invested into higher growth niches, better aligned with other parts of the portfolio. The acquisition of BIOFREEZE is such an example and there is more to come in the future.

The bad

The Nutrition segment, contributed 23% of net revenue in 2020, is still the problem child. The status in its biggest market China seems to be stable, you can also say it's not progressing, and the overall performance is flat. The other two divisions Hygiene and Health have clearly outperformed Nutrition.

Source: full year 2020 press release

The management describes challenges with the Hong Kong border closure and that local competitors invest heavily to drive growth. In addition, there are changes in the regulatory environment and a further decline in birth rates. The entire segment is currently under review and I can imagine that even a drastic step like selling the business is under discussion.

The operating margin dropped from 26.2% in 2019 to 23.6% in 2020. That sounds pretty significant, but the net movement year on year is just 70bpts when one-time costs are ignored. COVID and other costs, investments and finite-life transformation costs created a negative impact of 740bpts on the operating margin. On the other hand operating leverage and enhanced productivity created a strong +580bpts. The 2021 guidance suggests another drop of the adjusted operating margins between 40 and 90bpts due to continuing investments.

Normally people don't invest in a consumer goods company due to its stellar growth rates, but for a reliable dividend income. RBGPF's dividend is maintained at a constant level and that was already communicated a year ago. Personally I have no problem with this decision as long as the management has a clear plan that the money can be used for actions (e.g. reduce debt, invest in productivity, ...) that create greater long term returns for investors.

Outlook

Looking at the numbers, revenue guidance is flat to +2% due to the strong FY 2020. A fate that Reckitt Benckiser shares with many tech stocks this year. Adjusted operating margins are expected to be between 40 and 90bpts lower in 2021 than 2020 due to continuing investments. Margins will benefit again as finite-life transformation costs fall away in 2022. Additionally, stronger FX headwinds on EPS are expected to be around 4%.

OK, we talked about the numbers, but the big question for investors is "Is Reckitt Benckiser just a short term winner, a one trick pony, due its disinfectant products? What happens when the pandemic is over?"

First, the virus had a negative impact on some parts of the portfolio. Social restrictions have led to a weaker cold and flu season, impacted birth rates and reduced the need for sexual wellbeing products. Second, there is a growing demand for specialty nutrition and immunity, another preventative area that will continue to strengthen. Third, increased hygiene habits are likely to remain elevated after the pandemic. Behavioral science says that our habits stick after 60 days.

Source: full year 2020 results presentation

In China 86% of people are washing their hands more than before the crisis. That is down only 4% from the peak. In a survey 79% of people say that improved hygiene habits are likely to stay.

In addition, the company expands its footprint to 70 new markets by end of 2021 and we are talking about big ones like Turkey, Brazil, Spain, Vietnam and Ukraine. Moreover, the supply capacity should be in line with demand around middle of 2021.

Current valuation

The dynamic fair value calculation from DividendStocksCash is used to calculate the fair value based on historical valuation. More details about the method and procedure can be found here.

Source: DividendStocks.Cash

The historical multiples for adjusted earnings per share and dividend yield, based on the time period between 2013 and 2024 (estimated by analysts), are used to analyze the current valuation of the stock. The calculated multiple for P/E adj. is 20.1 and the average dividend yield is 2.5%.

Right now I consider Reckitt Benckiser as fairly valued. The predicted annual yield of 8.8% is solid and offers a good entry point for a long term position in a conservative business.

Company risks

There is strong competition in the nutrition business particularly in China. In addition, the closed Hong Kong border, declining birth rates and regulatory changes create uncertainties for the business. As an UK based company, FX headwinds due to a stronger pound are expected. Increasing commodity price, transportation inflation and on-going Covid costs are additional burdens for the company.

Conclusion

Reckitt Benckiser delivered what was outlined in their transformation plan a year ago. The FCF conversion was strong, the productivity program is ahead of plan and was even extended, investments were made to drive growth, the portfolio is under review and the balance sheet was strengthened.

The nutrition segment is the weak spot of the company. Strong competition, regulatory changes, decline in birth rates and political uncertainties are a burden for the business. Further investments have a negative impact on the operating margin in the short term.

There is evidence that increased hygiene habits are likely to remain elevated after the pandemic. The company's footprint is expanded to 70 new markets by end of 2021. We are talking about countries like Turkey, Brazil, Spain, Vietnam and Ukraine, which offer a lot of growth potential. In addition, the supply capacity should be in line with demand around middle of 2021.

Right now I consider Reckitt Benckiser as fairly valued, offering a predicted annual yield of 8.8%. That's a good entry point for a long term position.

Analyst’s Disclosure: I am/we are long RBGPF. 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.