Stock story: Reckitt Benckiser (now RB)

October 2018

Reckitt Benckiser, a UK-based consumer-goods giant now called RB that as recently as 2015 achieved comparable annual sales growth of 6%, could well symbolise how tough conditions are for Big Brands in the age of rising ecommerce and private label penetration.

The company that boasts Clearasil acne treatment, Dettol antiseptic products, Finish washing detergent and Nurofen painkillers among its brands posted zero sales growth in 2017, its worst annual performance since it was formed in a merger in 1999. That result included RB’s first-ever declines in comparable quarterly sales; they dropped 2% and 1% in the second and third quarters last year respectively.

The problems for a company that earned 11.5 billion euros in revenue in fiscal 2017 from brands stocked in more than 180 countries, were many over a year during which it divided itself into two businesses – health, which provides 50.5% of sales, and hygiene home, a split the company dubbed ‘RB 2.0’. RB, which changed its name from Reckitt Benckiser in 2014, was hit by the ‘NotPetya’ ransomware cyberattack that hurt production and distribution for up to six months. The Scholl Amope foot care product launch flopped. A boycott in South Korea over deaths from a noxious humidifier sanitiser lingered. A new goods and services tax in India slowed consumer spending there. RB shares fell 11% over the last six months of 2017 as the company cut forecasts for sales growth.

While like-for-like revenue has risen so far in fiscal 2018 – it gained 2% and 4% in the first and second quarters respectively – and RB shares rose 3.2% over the first nine months of 2018, the company faces a challenge to regain the trust of long-term investors.

And RB is well primed to do just that. The company in recent years has turned to health because it is a high-growth segment due to favourable demographics and one that provides opportunities for consolidation due to its fragmentation. A benefit of the move to acquire health brands is that it helps insulate RB against the ecommerce and private-label threats harming many ‘Big Brand’ companies. RB’s bet on health brands is that they will maintain their higher margins, are harder to disrupt, promise faster growth, offer greater scope for innovation and are ripe for consolidation.

With the shift to health, the well-managed RB is among the most-disruption proof of Big Brand companies because nearly two-thirds of revenue (net of what suppliers get) comes from brands that are number one or number two in their categories and RB’s goods are popular in fast-growing emerging markets, especially China. We invested in RB early in 2018 because we judged the stock to be attractively priced, especially when considering that many of the growth impediments in 2017 were one-offs.

RB, to be sure, has challenges. There is no escaping that all Big Brand household-good companies are losing pricing power as retailers consolidate and shoppers move online, though those brands outside the top two leading positions are most vulnerable. Another risk is that RB, which is always eyeing takeovers, might pay too much to expand. So far so good; management this year pulled out of a bid for Pfizer’s consumer health arm due to concerns about overpaying and taking on too much. Emerging economies, which provide nearly half of revenue, are also higher-risk markets on which to depend. RB’s management team under Rakesh Kapoor since 2011, which is regarded among the best in the industry on operations and strategy, is managing these risks. Such a team overseeing stellar health Big Brands is likely to keep RB investors happy enough for the foreseeable future.

Well insulated

In 1819, Isaac and Thomas Reckitt built a mill in the UK. In 1823, Johann Benckiser founded an industrial chemicals business in Germany. After nearly 200 years of business and innovation, which included the invention of Mortein fly spray in 1880, Lysol disinfectant in 1899 and Disprin in 1948, the surnames were joined atop one company 19 years ago when Reckitt & Colman merged with the, by then, Netherlands-based Benckiser.

The consumer giant that emerged from this union largely sold ‘home products’ such as laundry detergent, bar soap and insecticides. In the next two decades, RB expanded into health via takeovers, asset sales, a spin-off and organic growth.

The pivotal takeovers started in 2005, when only 5% of the company’s sales were derived from health. In that year, RB bought Boots, and that came with Nurofen and Strepsils. In 2008, the company purchased Adams Respiratory Therapeutics, which owned Mucinex. In 2010, RB acquired SSL International, which came with Durex and Scholl. In 2012, it purchased Schiff Nutrition to branch into vitamins and supplements. The last big swoop was on Mead Johnson in 2017 that signalled the entry into baby formula. Amid these takeovers, RB spun off the pharmaceutical business Indivior in 2014 and sold its food brands to McCormick in 2017.

The strategy RB has for its two business units is clear. Within the best categories, the company aims to offer innovative market-leading products and market these products at prices significantly above the competition. RB calculates that, even though it charges higher prices, it can boost volumes by applying to pharmaceuticals the marketing techniques it honed to sell ‘fast-moving consumer goods’.

What sets RB above competitors is how well the company is managed. RB has pursued categories that allow it to achieve the highest margins of all its counterparts. With a culture of controlling costs, streamlining supply networks, developing staff and robust management performance targets (that led to Kapoor having his pay package reduced in 2016 and 2017 due to the company’s disappointing results), we expect RB to provide decent returns in coming years.

RB’s revenue is diversified from a geographic point of view. About 47% of RB’s revenue is derived from fast-growing emerging markets; mainly from China (13%), Brazil (5%) and India (4%, a number that should grow as India builds 110 million toilets as part of a five-year ‘Clean India’ campaign). About 32% of RB’s sales come from the US and 22% from Western Europe.

About 44% of RB’s global sales are in categories that we consider to be at moderate or high risk of being replaced by private labels. About 40% of global sales face moderate risk of migrating online. These products include baby food and vitamins.

Given such product positioning and management’s nous and strategy, we expect RB to achieve a 3% to 4% p.a. annual revenue growth rates in coming years while modestly improving its profit margin from about 27%. While the growth rates would be half or a third below what RB achieved only three years ago, such results would rank as feats in the disrupted world of Big Brands.

Sources: Company filings and website.