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Give Reckitt the brush off

The household goods supplier is in transition and that process could be stressful
April 12, 2012

Reckitt Benckiser's new chief executive, Rakesh Kapoor, has a tough act to follow. His predecessor, Bart Becht, spent 11 spectacularly successful years at the helm of the household products group, during which time group sales tripled, profits increased nearly 10-fold, and the share price climbed 600 per cent while equity markets flatlined.

IC TIP: Sell at 3494p
Tip style
Sell
Risk rating
High
Timescale
Long Term
Bull points
  • Focus on fast-growing markets and categories
  • Industry-leading profit margins
Bear points
  • Weak household products market
  • Competition from generics suppliers could hit profits
  • Limited exposure to emerging markets
  • Shares expensively rated versus peers

But speculation soon surfaced that Mr Becht quit before events took the shine off his immaculate record. Some blemishes have started to appear. For starters, there is nagging suspicion that Reckitt has overpaid for SSL, the condoms maker it had been pursuing for years. Although Reckitt's bosses believed cost synergies could be wrung from the business, a multiple of 18 times cash profits was significantly higher than similar deals, yet there were already signs that SSL's growth was slowing.

However, the biggest unanswered question remains what to do with the highly-profitable pharmaceuticals business. The patent on its one product, opiate-addiction treatment Suboxone, expired in 2009 and, although generic alternatives have been slow to materialise, launches are expected soon. Reckitt has said that this could see as much as 90 per cent of Suboxone's tablet sales lost along with a fifth of Suboxone films, an alternative delivery mechanism that's harder to copy and which accounts for 42 per cent of its revenues. That means that, after peaking in 2011 at £762m (8 per cent of the group total), pharma sales will go sharply into reverse in the coming years, putting a fifth of group profits at risk. In February, the new boss's plan for Reckitt, which he revealed alongside 2011's results, appeared to relegate pharmaceuticals to 'non-core' status. There have even been suggestions the pharma arm could be sold, but analysts don't think the price tag will be enough to offset the loss of profits.

Concerns over generic competition don't stop there. Mucinex, a decongestant that forms the core of Reckitt's US over-the-counter (OTC) medicines business, stands to lose as much as 30 per cent of its market share when rival products are launched this year, after competitors won long-running legal battles with Reckitt.

RECKITT BENCKISER (RB.)

ORD PRICE:3,494pMARKET VALUE:£25.5bn
TOUCH:3,494-3,496p12-MONTH HIGH:3,624pLOW: 2,960p
DIVIDEND YIELD:3.9%PE RATIO:14
NET ASSET VALUE:784pNET DEBT:31%

Year to 31 DecTurnover (£bn)Pre-tax profit (£bn)Earnings per share (p)Dividend per share (p)
20097.751.89199100
20108.452.14217115
20119.492.38240125
2012*9.542.32236136
2013*9.862.47250137
% change+3+7+6+1

Normal market size: 700

Matched bargain trading

Beta: 0.6

*JPMorgan forecasts

What's more, Mr Kapoor's plans suggests that Reckitt needs some heavy capital spending. He said the group's enterprise resource planning systems needed upgrading, at a cost of £150m. That will generate cost savings of £10m a year, starting in 2014. A restructuring of its management team, which will see more resources allocated to emerging markets, will save another £30m a year. That means an exceptional charge of £75m this year. With savings being reinvested in driving sales, profit margins will be flat in 2012.

Reckitt argues that operating margins – already an industry-leading 26 per cent – will start to climb again in 2013, and that the plan to shift more effort into developing countries will help it outperform the markets in which it operates by 2 per cent. However, the bulk of Reckitt's sales still come from developed markets, which are growing at less than 2 per cent a year.

What's more, Reckitt wants to reinvent itself as a health and hygiene business, but around a quarter of its revenues come from branded household cleaning products – such as dishwasher tablets and laundry detergents – that face stiff competition from private label alternatives. According to research from AC Nielsen, Reckitt's household sales slipped 3.7 per cent in February, with price increases failing to offset heavy volume declines in air fresheners and surface cleaners. That's a worry because volumes are an important driver of profits. Meanwhile, Procter & Gamble has announced a huge cost-saving programme that could see it lower prices of homecare products in western Europe; the US giant is also upping its exposure to the health-and-hygiene segment, recently announcing a joint venture with generic medicine maker Teva for OTC products.