Update on Reckitt

-30% vs 49%

Consumer staples have always been a feature in the 8% eco-system because the revenues are recurring, the businesses easy-to-understand and generate good cashflows and dividends.

We have discussed Reckitt (RKT) in the past. This post serves as an update with the following framework: review, update, value and decide. The stock has performed terribly since 2020 and while the substack portfolio added at the lows in 2023, we have not seen a strong recovery. The position today is slightly underwater.

Hence, this update today. Let's start with the review of the investment thesis.

1. Review Thesis

The following is the original thesis:

Reckitt is one of the strongest consumer staples companies in our times with best in class margins for OPM at 20-25% over the last 20 years and has generated consistent growth on the back of strong brands in strong categories. 

Reckitt's portfolio of Power Brands ensures that the stock in defensive in volatile times and compounds nicely over time as it has done. Reckitt's overall geography split has also geared towards developing markets which contribute to 40% of its total revenue. Its strong brands allow its products to establish themselves as premium products, with pricing power but continues to enjoy volume growth. 

While Reckitt has 33% exposure to Europe & ANZ and 27% to US, revenue growth for developed markets had also been stable. The company has generated consistent and strong FCF to the tune of GBP2bn and this should continue and reach GBP3bn in the future.

The thesis has broadly remained unchange. Reckitt continued to deliver the high margins and cashflows in the recent 1H results. The company grew its emerging markets (EM) business in single digit which was not too different from US and Europe. Its portfolio does have products that are more catered to developed economies such as dishwashing powder and air fresheners. Going forward, growth might have to come from both EM and US/Europe.

Reckitt also continued to manage its cashflow well growing its FCF and returning via dividends and share buyback. Its dividend is now at a very palatable 4.4% today. Being listed in UK, there is also no withholding tax. Due to the collapse in its share price. FCF yield is close to 7%.

2. Update

The biggest elephant in the room today related to the looming litigation in its infant milk business. Earlier this year, Reckitt and Abbott were sued because its specialized milk formula allegedly caused the deaths of premature babies fed with their products. Verdicts ruled against both companies stated that they failed to warn of the risk of necrotizing enterocolitis (NEC) which has fatality rate of 15-40%. 

Reckitt was ordered to pay USD60m to a mother while Abbott also subsequently lost another case and was order to pay USD495m! There are c.3,000 cases filed against both companies and the legal liabilities could be GBP3-5bn or more for Reckitt. Reckitt has another trial with important dates starting in end Sep 2024 lasting into Mar 2025 which would provide more datapoints. 

3. Valuation

It is worth noting that Reckitt's market cap fell from GBP38bn to GBP31bn today, more than the abovementioned legal liabilities. Although we cannot rule over future revenue impact and more litigation, the share price collapsed have broadly discounted this NEC issue. Let's look at how valuations are:

Taking the average intrinsic value (IV) from the table above, Reckitt has c.49% upside with IV at GBP67 per share, c.10% lower than the previous GBP70 calculated 18 months ago. However given the litigation is not over, it might be risky to do anything now. 

Peers have largely rerated in the last 18 months with average EV.EBITDA at 17x vs a more reasonable 15x when the last exercise was done. RKT does look exceptional cheap here.

4. Decision 

While there is good margin of safety, it would be prudent to buy more today as litigation could be very detrimental as we had seen with Bayer (share price dropped 50% and never recovered). The 2024 low at GBP40 would be broken should the verdict be unfavorable. If so, Reckitt could fall further to GBP35. This means the risk reward is -c.30% downside (GBP45/35) vs 49% upside (GBP45/67).

As such the decision would be to HOLD for now.

Huat Ah!