I rather like the owner’s manual that Terry Smith provides to investors
interested in his fund, it gives a clear explanation of his approach to investing.
I find myself attracted to this approach, and his results are impressive – according
to the Fundsmith website, from inception in November 2010 to February 2019 the
fund had generated a 302.5% total return, an annualised 18.2% growth.
I should probably invest in his fund and spend my time doing
something else, but I rather enjoy the process of analysing stocks. Since I’m
principally after defensive investments of the sort advocated by Mr Smith, I
thought I would take a look at a FTSE consumer goods stalwart, and part of the
Fundsmith portfolio – Reckitt Benckiser.
Reckitt Benckiser was formed in 1999 when the UK’s Reckitt
& Colman merged with the Dutch firm Benckiser. Over the years they have repositioned
their portfolio to focus on household, personal care and over the counter
healthcare products, including well known brands such as Calgon, Finish, Durex
and Strepsils (Thankfully in 2014 Reckitt Benckiser decided that the somewhat
cumbersome naming would be known as simply RB going forward). In 2017, RB acquired the infant formula maker Mead Johnson
and sold it’s remaining food brands to exit the food industry. It’s products
are sold in around 200 countries.
It has certainly proven a sound investment historically, £1000
invested in January 2009 would be worth £2847 (including dividends) in January
2019, an average return of 11% per year. Since I like a dividend, I’m also
pleased to see the dividends increasing by around 8% per year too, only 1 year
out of the last 10 was the dividend not increased. The dividend has also been
comfortably covered by free cash flow, averaging 2x FCF cover over the last ten
years. This has fallen from nearly 3x cover 10 years ago to below 2x more
recently, but I don’t see that as an issue, I suspect as the business has grown
and future growth looks more difficult to come it makes more sense to pass the
cash back to investors through the dividend.
Since the ceiling of any growth is revenues it’s good to
know that these too have been pretty consistently grown – although in 2014 saw
a 12% dip and 2015 they were flat, since 2009 they have grown from £7.7bn to £12.6bn,
a total of 62% or an annualised growth rate of around 5%. Adjusted earnings
have progressed at a similar rate, with adjusted earnings per share moving from
194.7 pence to 341.4 pence, a total increase of 75% or an annualised growth
rate of around 6%.
So the headline numbers above show that RB tick a number of
boxes, but before I invest some of my money into the business, I'd like to know how
effective is the business at turning that investment into profits? To try to
get a feel for this we should take a look at the capital invested, and the
returns on that capital (ROCE – Return On Capital Employed). Taking a
simplified view of capital as total assets – current liabilities we can see
that from 2009 to 2018 capital increased from £5.7bn to £30bn, that’s a 421% increase,
or over 40% per year. If we then take a look at their earnings before interest
and tax (EBIT – the other part of the ROCE calculation) we can see that over
the same 10 year period it increased from £1.9bn to £3bn, a 61% increase. So
investment in capital has significantly outpaced returns, an ROCE of 32.8% in
2009 has reduced to 10.1% in 2018.
 |
| Return on capital employed |
The chart above shows these ROCE components and we can see
more clearly what has happened. From 2016 to 2017, assets rocketed whilst
liabilities increased a little, with EBIT also showing a slight increase.
This coincides with the acquisition of Mead Johnson for
$16.6bn (£12.3bn), which whilst contributing to earnings, has pushed up capital
far more and therefore brought the ROCE down. RB’s average ROCE over the last 10ys
is 22%, but that may not now be an accurate reflection of the business given the
downward move in the numbers over the past couple of years. Whilst RB work
through the Mead Johnson integration it’s probably reasonable to expect a hit
to business efficiency.
Another metric I like to check is net profit margin – net profits /
revenue, which effectively shows how much of every £ is actually profit, i.e. a
10% net margin tells me that for every £1 of revenue, the business has made 10p
profit. Obviously a higher number is better, it is a useful indicator of a
margin of safety should the business run into hard times – whether self
inflicted or as a result of the broader economy. Slim margins could leave the
business in trouble if they start to get eroded – nice fat margins would help
the business ride out those downturns. These average 24% over the past 10
years, most years being in the upper teens.
As well as the Mead Johnson acquisition increasing assets as
noted above, RB’s borrowings increased to fund the purchase:
|
|
2009
|
2010
|
2011
|
2012
|
2013
|
2014
|
2015
|
2016
|
2017
|
2018
|
|
EBIT (£m)
|
1891
|
2130
|
2395
|
2442
|
2345
|
2164
|
2241
|
2269
|
2737
|
3047
|
|
Borrowings (£m)
|
136
|
2644
|
2508
|
3274
|
2767
|
2572
|
2420
|
2389
|
12861
|
11879
|
|
Borrowings vs. EBIT
|
0.1
|
1.2
|
1.0
|
1.3
|
1.2
|
1.2
|
1.1
|
1.1
|
4.7
|
3.9
|
Debt as a multiple of EBIT was around 10% of earnings in
2009, and tracked roughly in line with earnings until 2016. But by 2017, after
the Mead Johnson purchase, had increased by £10bn and sat at a multiple of 4.7x
earnings in that year. A year later the debt has had £1bn sliced off, hopefully
new combined business will see increased inflows of cash which will enable the debt to
be managed, rather than becoming a burden.
With the announcement of the retirement of CEO Rakesh Kapoor earlier in the year the share price dipped, and the business will undoubtedly be subject to a little more turbulence as his successor
takes the reins and puts their stamp on the business. I’m hoping that as we approach the conclusion to chapter 1 of Brexit, in any stock market wobbles the share price of RB will take another dip. Working through it's acquisition of Mead Johnson, and managing it's increased borrowings has increased the risk of owning a slice of RB, but I think it looks like a decent long term investment. I'm off to learn more as it’s certainly on my radar.
