Reckitt Benckiser is one of the world’s leading fast moving consumer goods companies, selling familiar products like Dettol, Durex, Nurofen, Vanish and Cillit Bang.
In recent years RB and similar companies like Unilever have become very popular with investors, largely because they offered a seemingly low risk way to invest in shares whilst still achieving attractive returns.
For a long time RB lived up to that promise, but more recently things have become less certain and RB’s share price has declined by almost a third since its 2017 high.
This share price decline has driven the company’s dividend yield up to 3%. That’s below average, but it’s still much better than the sub-2% yield RB was offering a couple of years ago.
So does this lower share price and higher dividend yield mean Reckitt Benckiser is good value again, or is it just an overpriced seller of cheap goods?
You can read the full review below, taken from this month’s Master Investor magazine:
Does Reckitt Benckiser’s 30% share price decline make it good value?
John, I guess a lot of this can be looked at in different ways.
As far as the borrowings are concerned, the figure at the end of the December stood at £9,670M against an operating profit of £3,047M or a ratio of just 3.17 – which is not a million miles away, considering there is likely to be anticipated growth if even only modest.
If you want to be more conservative, the after tax profit can be considered so then the number is £2,186M and the ratio is then 4.4X which is a bit on the heftier side.
However, this does perhaps need to be put in the context that RB generates significant cash flow and it’s interest cover is much more than adequate to service those debts.
This should also be taken in the context of the assets that RB sports, in terms of both property and intangibles (mostly brand value I guess).
These numbers now dwarf the debt.
In 2014 RB held £11,252M in intangibles and £757M in property
In 2018 these figures were now £30,278 (almost 3 times the 2014 value) and property of £1,858M.
OK you can argue that intangibles are incredibly difficult to value.
To counter that, I often think back to the value of these brands and how they can be grossly misplaced and mispriced from time to time.
The case in point was Cadbury – when Kraft bought Cadbury for $11.5Bn in 2010, Doctor Pepper was an afterthought brand considered as probably a few % of the overall value.
In early 2018 – less than 8 years later, Keurig Green Mountain paid $18.5Bn for Doctor Pepper.
The values locked in some of these companies are often not what they seem.
My guess is that RB will revert to over 8000 in the not too distant future.
Apart from one risk (or realistically there are many of course) and that is the fall out from Invidior’s legal position.
I bought RB at 56XX so I’m declaring a vested interest lol!
RB stands at 6192 as I type, so it has some way to go north to reach my target and a fair way south to reach yours.
Time will tell, as they say.
LR
Hi LR
To be honest I don’t expect RB to fall to my target price unless there’s a serious decline in how investors view these ‘bond proxies’. That might happen if growth remains stunted (ignoring one-off growth spurts fuelled by debt, as has been the case at both RB and Unilever recently), but I’m not holding my breath.
As for RB’s debts, I think they’re high but not necessarily a problem. They do reduce the company’s options though (I was going to say optionality, but I hate that phrase); it has effectively fired the debt cannon and now needs time to reload (i.e. de-lever).
I don’t hold Reckitt but it is starting to get interesting. In the long run, companies that have established brands and have a track record of navigating different economic scenarios, actually prove to be good buys when there is an air of negativity about them. Most of their value is embedded in qualitative factors which are not immediately obvious by number crunching alone.
Out of interest I looked up your past analyses on Unilever which i do hold a large position in. In 2015 you were predicting slow growth and marking a time to sell ( https://www.ukvalueinvestor.com/2015/01/unilever-dividend-growth.html/).
Well since exactly the same date, the IRR on my Unilever position is 16.1%, having come through :
– The Brexit vote
– Trump
– An own goal with a failed corporate reorganisation
– A brutal year in the markets in 2018
– A disposal of the slow growth spreads business and associated buybacks
– Continued growth in Emerging markets
That to me indicates a classic difference between concentrating on quality shares and searching for dividend income and shuffling in and out- the fashion in the UK apart from people like Nick Train and Terry Smith. A large part of this dividend style of investing is based mainly on financial metrics – which yield no edge since that information is available to everyone.
Hi Lemsip
I’ve owned RB in the past and it’s exactly the sort of company I like to invest in, but only at the right price. We all have different ideas about what that right price might be (see LR’s comment above) but for now the company’s current price is a bit too high as an entry point for me, although I reserve the right to change my mind as the situation evolves.
As for Unilever, it’s an interesting one. First though, I have to point out that I try not to predict anything, so in that 2015 article I wasn’t predicting slow growth or that it was time to sell. I just said that slower growth was a reasonable assumption and that the shares didn’t look any more attractive than the FTSE 100 average at that time.
Since that 2015 article Unilever has continued to grow, but revenue growth is still around 3% per year so I still have my doubts about its valuation.
Well done on your 16.1% annualised return since 2015, but I don’t think it’s indicative of anything. It’s over too short a period. For example, I made an 18% annualised return on Compass Group which I sold this month, but that was mostly luck. It was a good company and the purchase price was good, but the high returns were mostly luck as I only owned the company for just over a year.
As I see it:
outperformance over one day is 100% luck
over a week it’s perhaps 99% luck and 1% skill
over a year it’s say 80% luck and 20% skill
five-year outperformance might be 50% luck 50% skill
10-year outperformance is perhaps 20% luck and 80% skill
Buffett’s multi-decade outperformance is perhaps 95% or 99% skill and the remainder is luck
So a 16% annual return over five years is nice, and well done, but I think it’s probably 50% luck and 50% from investing in a good company.
Also, I disagree that there’s any meaningful difference between dividend investing, value investing and quality investing. The traits you favour may differ (growth over income, say) but the basic aim is the same: To buy stocks where the price appears to be attractive relative to the company’s expected future cash returns to shareholders.
Nick Train and Terry Smith have done well with quality companies, and lots of other investors have done well investing in cheap junk companies. One is not better than the other, but one may be better suited to a particular investor’s psychology or goals.
With respect, the driver of long term returns is the return on equity a business earns and how that is sustained over time.
Whether a 5 year performance is 50/50 luck or not is a complete guess on your part. I just mentioned the results since the date of your article. I have held Unilever since 2006 and my long term IRR on that is over 13% so it is the business that is responsible for the results, not luck or fortunate timing on my part.
It is easy to write off both good performance and inferior results as “luck” . Ultimately though the only thing that matters is the actual performance of the business and in the long run that is reflected in share performance. Good Luck !
Just on revenue growth, 3% is what should be expected for a global company in steady state- i.e roughly in line with or just above global GDP growth. The key issue is how the company uses its operating leverage to convert this into superior investment returns driven – amongst other things – by margin expansion and sustaining a high teens return on capital and ensuring excess cash ( about 5bn euros per annum) has opportunities for reinvestment at that rate.
All these boxes are checked off for Unilever where it has expanded margins, divested its low margin businesses and reinvested in emerging markets and faster growing categories like personal care.. These are the things that drive the fundamentals of long term returns.
Anyway i have less insight into Reckitt but am tempted to take a look.
John, you did not mention the pension obligations of RB. Anything noteworthy?
Hi Ken, RB has a defined benefit pension obligation of about £2bn, but that’s peanuts given that RB’s 10yr average earnings are also about £2bn. The pension is also in surplus.
Hi John,
In all fairness, I do consider myself a beginner in FMCG sector it’s taken me the best part of two years to get my head around the tobacco industry. I do focus more on understanding the business and the industry to analyse a company objectively and understand the business risk. Rather than just looking at company annual report which is likely to put a favourable spin.
For this reason, I’m still not really up to speed with the FMCG sector but I will say one thing the stock price for RB is too high in my humble opinion to provide a superior return. At the current price, it would have to be achieving CAGR of 10% or more to achieve a decent return. I just don’t think RB a large mature business can do this on its own. To a certain extent, the price has appreciated due to an enthusiastic market not because the business has been phenomenal this decade.
I think the only FMCG company to have been reasonably priced was Procter and Gamble and Unilever where the dividend yield was nearly 4% last year. However, I missed the boat because like said if I don’t understand something I stay away from it. I hope in the coming years another opportunity like this presents itself.
Hi Reg
I agree. I know enough about these companies to invest, but a lot of the time the price just isn’t attractive. I’ve owned RB twice before, but ended up trading in and out rather than holding. But that’s okay; I got lucky with 50% returns in about 2 years in both cases.
As you say, Unilever was interesting with a 4% yield, but I didn’t invest at the time because there are lots of other fish in the sea. I think if the stars align and the timing (i.e. price) is right, I’ll end up owning Unilever at some point, and possibly RB for a third time.
The low dividend yield seems to be a major factor in the valuation of RB. I wonder if RB is buying back shares with free cash (John mentions that the dividend is well covered).
I did a superficial web search which revealed buybacks in 2016. If a buyback program was announced for 2019 then the shareholder yield (dividend yield plus buyback yield) might improve the attractiveness of RB’ valuation.
I’d be grateful for any comments by John or other readers about shareholder yield.
Hi Ken, in the last few years RB has been reducing the number of shares outstanding, but not to any significant degree. Over 4 years the reduction is about 3%, so less than 1% per year. In fact, the last couple of years the reduction has been less than half a percent.
So RB’s shareholder yield is just north of 3% (2.8% yield plus e.g. 0.4% buybacks). That isn’t terrible, but I don’t think it’s especially attractive either given the uncertainties around RB’s growth prospects.
I held RB from 2011 until 2016 and I would have liked to carry on, but the £12 billion acquisition did not play well for me. In fact it took the ROCE from high 18% down to 10% the next year.
Yes, the lower price is more tempting, but before I will buy I need proof that ROCE comes back to 15% at least. It is probably undervalued now, and someone could make a quick 10% over one year or two, but I am interested to buy a company which uses capital well, and the high dividend does not help either. I tend to be adverse to high dividends companies!
Not at this moment, but something to keep an eye on, if that milk could be sold more expensive and in higher volume. For me Enfamil was a bust!
Hi Eugen, I mostly agree. I’m not a fan of large acquisitions as the price paid is usually too high. Let’s give RB a bit of time to integrate and complete its RB 2.0 restructuring and then we might have a better idea of what it’s worth.
Hi John,
I thought it was worth revisiting this post given the recent update RB gave on the £5 billion impairment charge for Mead Johnson. I am glad I stayed out of RB because I think the acquisition of Mead Johnson was a big mistake not because of the recent underperformance but due to the general shift in the milk formula industry.
In the past it was not regulated therefore potentially there was a difference between milk formula products. This allowed certain companies to charge a premium because they went through the effort of developing a superior milk formula.
However it seems to me that the product has been going through standardisation. Therefore all most all milk formula have to reach specific standard this begs the question where does Mead Johnson have a competitive advantage? Without this advantage or lack of moat it seems that it will invite significant competition.
Perhaps the key to its success is focusing on aggressive marketing? To me this is a slightly concerning issue as did the management not consider the flaw in acquisition of Mead Johnson?
In 2019, Channel 4 Dispatches highlighted the issue and the BMJ for example confirmed that it will no longer accept paid adverts from the milk formula industry. To me this suggests that RB may not have made the most logical acquisition clearly the milk formula industry is being commoditised and thanks to the internet anyone can find out a cheaper equivalent made by supermarket.
Is FMCG a doomed sector? I don’t think so but it suggests that the best type of FMCG company is one that dominates a niche which is not under regulatory scrutiny and due to limited profit pool is unlikely to attract the attention of a disruptor. WD-40 is an extreme example it focuses in specialty lubricant products and completely dominates the market. However the profit pool is enough to support just one substantial company therefore it is unlikely that a new competitor would even endeavour to try to take a market share. On the other hand the Milk formula industry is worth a cool $62.5 billion. Therefore this is likely to be under the gaze of Walmart, Costco, Supermarket chains and Amazon.
This worries me a lot. Personally I don’t think I would be too keen to invest in RB at any price until it clearly articulates how it will protect this profit pool. On the other hand WD-40 is an idiot proof company which is essentially the kind of company Warren Buffett would approve and if the price was right I would happily invest in all my capital.
Hi Reg, thanks for the detailed comment.
Without having looked into the baby milk formula market in any detail, the key takeaway for me would be that companies selling small ticket repeat purchase items do not have some sort of inalienable right to produce consistent high single digit growth for decades to come.
The truth is that all companies face competitive pressures, and those pressures can’t be ignored just because a company sells soap or cola.
I also don’t think Fast Moving Consumer Goods companies are dead just yet, but in many cases their valuations are pricing in high single digit growth until the end of time and that seems a tad optimistic to me, especially with Amazon’s own brands on the horizon.
Hi John,
As a general overview I think the most important asset of an FMCG company is the goodwill value of the company. For example RB is facing an environment where milk formula is being commoditised however confectionary chocolates are defined by their brand. The brand itself defines the product this is why you don’t see Tesco pushing a Tesco version of Mars bar. The same can be said of Gillette shaving blades and WD-40. This is why within reason its worth paying a reasonable premium for certain FMCG companies where the brand defines the product line as these companies can continue to grow single digit income growth through pricing. Since most competitors stay away from such environment even Dollar Shave Club for example it went for direct mail order because it knows trying to take on Gillette via retail route is just suicide.
However if your product can be easily replicated and there is no scale of economy then the situation changes suddenly. I believe Kraft-Heinz is at the receiving end of this trend.