In times of high inflation, genuine top-line growth carries a premium in a crowded consumer goods market. Therefore, pushing volumes ahead, in addition to prices, has afforded Haleon a higher valuation than peers such as Unilever and Reckitt Benckiser.
The FTSE 100 company, which was spun out of GSK last July, expects organic sales growth to be at the upper end of the 4 per cent to 6 per cent guidance for this year. Underlying sales over the first quarter were up 9.9 per cent, more than twice the 4.2 per cent that analysts had expected. A resurgent cold and flu season boosted sales of respiratory health and pain relief brands that include Beechams and Panadol.
The shares have moved in advance of a brighter outlook, now up 7 per cent on the float price after a lacklustre start. An enterprise value of almost 15 times forecast earnings is a record high against its own short history, but also higher than rivals like Reckitt and Unilever.
The former is harder to justify, but the premium to peers is less so. Haleon is not relying solely on rampant price rises to push the top line forward. Of the 9 per cent organic revenue growth recorded last year, 4.7 per cent came via volume and product mix. Both Reckitt and Unilever were in negative volume territory.
Haleon is less in need of making seismic changes in prices. Small packaging and product sizes mean that commodity costs typically account for less than 10 per cent of revenue. True, the balance shifted more towards price in the first quarter, a trend expected to continue throughout the rest of the year, but a 2.8 per cent increase in volumes was far better than the 0.3 per cent baked into market forecasts.
Cash generation is also impressive, with free cashflow last year rising to almost £1.6 billion, from just under £1.2 billion in 2022. That bodes well for its ability to quickly cut down weighty debts, which stood at £9.9 billion, or 3.6 times adjusted earnings before interest, taxes and other charges, at the end of last year.
Deleveraging even faster would be another big catalyst for the shares. Net debt is expected to fall below three times adjusted earnings during next year, rather than at the end, helped by strong cash generation. With cutting back debt a priority, mega-deals look unlikely. Instead acquisitions are limited to one bolt-on a year, producing revenue in the £50 million to £100 million range.
Two big risks hang over the stock. The first is the potential large liabilities from a wave of American lawsuits alleging that Zantac, an old GSK heartburn drug, caused cancer. Haleon rejected requests from GSK and Pfizer for indemnification last September and has said it was not a party to any Zantac claims. No provision has been made by the consumer health group in light of any potential costs, but then the risk has receded. A federal court in Florida dismissed tens of thousands of cases in December.
The second, more pressing, is the expiry of lock-up periods for large stakes held by Pfizer and GSK, amounting to 32 per cent and 13 per cent, respectively. Both plan to reduce their remaining shares at some point, which could prompt others to cut their holdings in advance.
Haleon’s higher price tag is also a reason to reserve judgment. Growing sales in the mature and saturated consumer goods market is tough. Haleon’s immaturity, together with the impact of the pandemic, makes for a paltry track record to judge it against. Organic revenue growth was 3.8 per cent in 2021 and 2.8 per cent in 2020. At the present price, there are more potential risks than reasons to spur the shares higher.
ADVICE Hold
WHY A premium valuation does not account for the risks of major share sales or slowing volume growth
WH Smith
Among the retailers in the FTSE 250, WH Smith’s geographic diversity sets it apart. Rapid growth in North American airports means it is less at the mercy of consumer demand in Britain.
Indeed, an ambitious push into global airports has propelled revenue for the travel division ahead of that made on the high street. By the end of the financial year in August, travel is expected to account for more than 70 per cent of total revenue and about 85 per cent of operating profit. Moreover, expansion isn’t doing all the heavy lifting. Even on a like-for-like basis, revenues in the travel division were marginally ahead of 2019 levels. That lead could widen further at the full-year mark; seven weeks into the second half, revenues were 59 per cent up.
In British travel, accounting for just over a third of total sales, revenue was 2 per cent ahead, despite airport passenger numbers remaining 15 per cent behind the pre-pandemic level. Factor in the return to full capacity planned by most airlines this year and there is room for revenue to recover even further. New openings included, analysts expect a pre-tax profit of £147.5 million this year, ahead of £135 million in 2019.
A jump in the number of new stores opening worldwide, which should total 112 this year, means capital expenditure is set to rise to £150 million, almost twice last’s outlay, before falling back in 2024 to roughly £100 million. Funding that with existing resources shouldn’t be an issue. After spending £60 million in the first six months of the year, Smiths had £270 million or so left in cash and available debt facilities at the end of February. Liquidity sitting on the balance sheet will be topped with cash generated by the existing business, which analysts at Peel Hunt forecast will come in at £240 million this year. That should leave enough spare to reduce debt, which stood at two times earnings before interest, taxes and other charges at the end of February, to the top end of management’s target range of 0.75 to 1.25.
Smiths is one of few British retailers with a clear line to sharper growth on the bottom line.
ADVICE Buy
WHY Expansion in North America could spur the shares higher
