We’re staying bullish on Durex-to-Dettol brands owner Reckitt Benckiser (RB.), the consumer goods colossus on the cusp of a transformational deal in consumer health.
At £70.96, shares in the maker and distributor of household, toiletry and pharmaceutical products are more than 7% north of the £66.24 at which we urged buying last March.
Yet we remain positive, excited by the upside to follow if Reckitt succeeds in buying US baby formula maker Mead Johnson Nutrition (MJN:NYSE) for $16.7bn.
ATTRACTIVE ASSET
Talks are underway regarding a takeover of Mead for a mooted $90 a share in cash. The deal fits with CEO Rakesh Kapoor’s strategy of moving Reckitt further into higher margin consumer health, albeit the target isn’t one the market was expecting.
A buyer with a £79 price target, Berenberg explains: ‘Mead is not the immediate choice for RB but it is an attractive asset with gross margins of more than 60%, operating margins of c24% and market-leading positions in global infant nutrition (number three) and formula (number two).'
‘We see infant nutrition as an attractive category with low price elasticity, consolidation, high barriers to entry and strong profitability,’ continues Berenberg. ‘Short-term headwinds from the US and China have dampened Mead’s organic top-line, but we expect an improvement next year with a return to positive organic growth.’
Liberum Capital remains a buyer with a £76.50 price target. The broker argues the Mead deal would ‘in one swoop, enable RB to reach the group’s 2020 targets for Health & Hygiene (80% of group net revenue) and emerging markets (40% of group net revenues). Adding Mead would transform Reckitt’s operations reducing exposure to low growth and constrained margins at the group's Home division while pushing the group substantially towards faster growing categories with higher margins long-term.'
REASSURINGLY EXPENSIVE
Berenberg says a counterbid is possible but unlikely: ‘We argue that Nestle (NESN:SWX) and Abbott (ABT:NYSE) would both face significant antitrust issues, while we also see regulatory hurdles for Chinese operators acquiring a highly US-exposed business. Mead remains a good fit with Danone (DANO:PA), but the c$17bn price target would be prohibitive due to the latter’s WhiteWave (WWAV:NYSE) deal ($12.5bn deal).'
As for Shares, we certainly acknowledges Reckitt’s rich rating - it trades on a prospective price-to-earnings ratio north of 20 times based on Liberum’s 339p earnings per share forecast for 2017 - and headwinds in markets such as Russia, India and South Korea, where a humidifier sanitizer scandal has damaged its reputation.
However, Mead would bulk up the business in China and Latin America and for long-term investors prepared to pay up, we continue to champion Reckitt’s story of relentless product innovation, high margins, brand strength and pricing power. Throw in dependable cash flow and dividends and Reckitt remains a compelling stock to own given the increasingly uncertain global environment.
