Reckitt Benckiser

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.