Sluggish sales progress bruises Reckitt Benckiser’s shares

“A return to sales growth in the fourth quarter, increased cost-saving targets and a higher dividend are not proving enough for shareholders in Reckitt Benckiser, whose shares are the worst performers in the FTSE 100 in early trading” says Russ Mould, AJ Bell Investment Director.

Source: Company accounts

“The problem may not be the numbers themselves, but the tepid sales growth guidance for 2018 and the reliance on cost-cutting for earnings surprises (as this is lower quality than growth for organic revenue increases) as neither help to support a valuation that already represents a big premium to the wider UK market.

“A forward price/earnings ratio of around 18 times for 2018, based on consensus earnings forecasts, compares to 14 to 15 times for the FTSE 100 and to justify that higher rating Reckitt needs to provide quality as well as quantity of earnings.

“Reckitt’s shares have already de-rated from 22 times earnings at their peak near £81 last summer to reflect investors’ concerns that relying on acquisitions and cost-cutting is not enough, especially as a target of 2% to 3% organic sales growth does not really argue in favour of a higher valuation for the stock.

Source: Company accounts. *2018E based on mid-point of company guidance for 2018

“Reckitt’s brand strength, lofty margins and record of consistent profit and dividend growth can justify a premium rating to some degree but using acquisitions to fuel growth raises the risks involved (owing to the debt associated with the Mead Johnson deal and the danger something goes wrong during integration) and lowers the quality of earnings (given the reliance on cost-cutting rather than top-line growth).

“In addition, Reckitt could also become involved in an auction for the consumer healthcare operations of Pfizer, which are up for sale with a rumoured $20 billion price tag straight after a year when the Mead Johnson deal has taken net debt at the company from £1.4 billion to £10.7 billion and the cost of borrowing has finally started to rise once more.”

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