Reckitt's Mead Hangover

Updated: Mar 4

Reckitt Benckiser Group is a British, multinational, consumer goods company headquartered in Slough, England. Its brands span the health, hygiene and home product sectors, and it is best known for brands such as Cillit Bang, Dettol and Durex. With its full-year results released today, in a year that has seen a significant increase in consumers’ desire for disinfectant cleaning products, this article aims to establish whether now is an opportune moment to invest in Reckitt Benckiser.

Reckitt Benckiser is split into three business segments: Hygiene, Health and Nutrition (some popular products from each segment are listed in the table below), with the Nutrition segment of the business incorporated into Reckitt Benckiser after the acquisition of Mead Johnson in 2017.

Reckitt has recently had a change of the guard, with the ousting of CEO Rakesh Kapoor and the replacement of Kapoor with Ex Pepsico executive Laxman Narasimham. In the latest updates from Narasimham, he described Reckitt as a ‘good house in a great neighbourhood — with the potential to become a great house again’. This justly summarises the position Reckitt finds itself in after years of 'running the engine too hotby focusing on driving margins with too little re-investment and also the destructive acquisition of Mead Johnson, which we will come onto later.

So in terms of recent performance, what has Reckitt delivered in recent years? More importantly, in a year that would be the perfect setup for a hygiene product powerhouse, how has Reckitt performed?

Over the last few years, Reckitt’s core business has struggled for growth. Although total sales have grown fairly significantly over the last five years, like-for-like growth (the key measure of underlying performance) has varied between +3% to flat (no growth) in the years 2016-2019. For those of you who follow the fast-moving consumer goods (FMCG) space closely, much of the growth for the sector in recent years has come from a few core product categories: snack food, pet food and coffee. In these sectors, a handful of FMCGs have done very well, such as Pepsico (with the largest global snack business Frito Lay), Mars (with its pet food business Pedigree and Whiskas brands) and Nestle (with global rights to Starbucks packaged coffee brands). Reckitt, on the other hand, has suffered due to weakness in its Health portfolio, with poor performance in Mucinex (the US cold and flu brand), underperformance in Scholl footcare and erosion in brand value for Nurofen. This poor like-for-like sales performance has been equally compounded by the terrible decision for Reckitt to buy Mead Johnson in 2017.

As ever with ‘transformative’ acquisitions, the risk is high. In this case, management failed to evaluate the synergies for the transaction, the ability to integrate the brands from Mead Johnson into Reckitt and, most importantly, the market opportunity. Birth rates in China (a key market for Mead Johnson) were falling at the time of the transaction and are still falling today. This has created a drag on performance for a business that requires growth in the number of toddlers requiring mashed food items and nutritional supplements. By the time Narasimham took the helm, the damage from this acquisition was already evident, with a balance sheet write down of £5bn,

which Narasimham wrote off the books. A further blow to the acquisition was an impairment to goodwill for the nutrition business at the latest 2020 full-year result to the tune of £1bn. Reckitt’s acquisition of Mead Johnson has failed to boost performance over the last few years, and the subsequent write-downs reflect how poor the strategy was behind the purchase. Reckitt is now exploring options to divest parts of the nutrition business, which is likely admission of the poor acquisition.

In terms of Reckitt's latest results, the pandemic has created a boom in sales for both the Hygiene and Health business lines, growing 19.5% and 12.1% respectively in 2020. Unfortunately, this result was weighed down by the problematic Nutrition business, thus, LFL sales ended up at +11.8%. Operating margin has slipped from its usual industry-leading high of 27% to 23.6%, as Reckitt invested in new growth initiatives such as a commercial cleaning venture to benefit from the opportunity of Covid-19. More positively, Reckitt is an industry leader in eCommerce sales and experienced a 56% growth in eCommerce channel sales in the year to a 12% of total group sales — impressive for products typically picked up at the supermarket.

However, the full-year report for 2020 was not exactly squeaky clean; growth in revenues flowed through to a meagre 0.7% comparative growth in adjusted operating profits for the year. This is primarily due to increased investment in the business and Covid-19 related costs, but given the blow-out year for Reckitt in terms of revenue, you would have expected a better flow through to operating profits. On an unadjusted basis, this figure was even worse, reflective of the impairment of the Nutrition business. Further disappointment can be derived from the outlook Reckitt provided of flat to 2% revenue growth in 2021, with a further dilution of operating margins. I think this shows that although Reckitt has benefited from pandemic-driven hygiene-related behavioural changes (which are arguably here to stay), post-pandemic, Reckitt is set to return to more sluggish growth. To fund any level of growth from this new higher base in 2020, margins will have to reduce, hampering the ability to turn revenues into profits for shareholders. On the brighter side, strategic progress is being made, with the divestment of slow-growing Scholl brands and the imperative to explore options for the IFCN China (Chinese nutrition business) — it does seem as though Narasimham is making incremental steps to improve the business’s prospects.

The Reckitt story is one of a good business bogged down by a terrible acquisition. At the end of 2020, the Nutrition business’s operating margin was 14%, almost half the profit margin of the other segments of the business. If new management can get rid of the Nutrition business in its entirety or reduce the less profitable areas of the Nutrition business, Reckitt may be able to move forward.

Looking at valuation, Reckitt trades at around 16-17x estimated earnings in 2021. This is probably reasonable given its recent struggles and more anaemic growth prospects. However, its valuation is significantly lower than its US-listed peer Church and Dwight, which operates in the same product categories (cleaning and condoms) and is valued at 26x earnings. Unfortunately, as a shareholder in Reckitt, I would not be recommending using the recent dip in the share price to initiate a holding. The challenges Reckitt must face in order to grow in the coming years are significant — it has weaker positions in emerging markets than its UK peer Unilever, and the business has been significantly damaged by the ‘transformative’ acquisition of Mead Johnson. For these reasons, I myself am looking to hold onto the shares till a respectable exit point introduces itself in the coming months.