Life after Laxman looks far less certain for Reckitt Benckiser. The company’s shares fell by 5 per cent on the day Laxman Narasimhan announced his surprise departure as boss of the consumer goods group, the worst one-day fall in six months. Yet that reaction should not be neatly interpreted as a glowing testimony to his tenure; it’s also a recognition of the uncertain medium-term prospects for sales growth and profit margins.
Narasimhan’s predecessor set a low bar to vault. Rakesh Kapoor’s time in the top job was mired by one-off problems, such as a botched Scholl product upgrade, an American investigation into Indivior, Reckitt’s former pharmaceuticals business, and the ill-judged acquisition of Mead Johnson, the American baby formula maker for $17 billion in 2017.
With underlying revenue growth also disappointing, in February 2020 Narasimhan set out a strategy to increase investment in marketing and research and development, to sell non-core businesses such as its infant formula operations in China and to generate more consistent sales growth from its health, nutrition and hygiene businesses.
Under Kapoor, Reckitt’s performance was choppy and annual sales growth frequently missed forecasts; initially, Narasimhan’s turnout in three years looks far superior. Like-for-like sales growth has not dipped below 3 per cent over the past ten quarters and guidance for this year has been raised to between 5 per cent and 8 per cent net revenue growth, ahead of a medium-term target of “sustainable mid-single-digit net revenue growth”.
Job done? Not quite. The impact of the pandemic on sales of health and hygiene products has hugely skewed sales. Those of Lysol and Dettol, the disinfectant products, accounted for 22 per cent of group sales last year, up from 14 per cent in 2019, according to estimates from Jefferies. Sales of the former have started to ease, but a further slowdown in growth against pre-pandemic comparators looks likely.
Investors aren’t entirely convinced, either, that a recent improvement in organic sales growth is sustainable. Since Narasimhan’s appointment in September 2019, Reckitt shares have underperformed both the FTSE All-Share and the Stoxx Europe 600 Personal and Household Goods indices, even if the company has considerably outperformed Unilever, its rival, during the same period.
Reckitt points to mid-single-digit growth in the 70 per cent of products that were less affected by Covid-19. A baby formula supply slump in the United States has boosted sales for the nutrition business, which were 26.8 per cent up during the second quarter, but over the longer term the infant formula business, excluding China, typically was capable of annual growth more like 1 per cent to 2 per cent, according to Bernstein’s analysts. The American supply turmoil also could complicate plans to dispose of the rest of the infant formula unit, particularly if it prompts politicians to reform what is a regulated market in America. That could make it harder to get an attractive sales price.
Bernstein’s team expect an organic growth rate of 2 per cent for next year and reckon that underlying revenue growth averaging 4 per cent over the longer term seems more likely, coming in as low as 3 per cent in some years. Aside from selling the rest of the infant formula business, other targets for disposal are less obvious, which makes acquisitions in higher-growth parts of the health and hygiene markets a more likely method of lifting sales growth. Vitamins and supplements, more advanced pain medication and sexual health are three potential categories that could be prove good hunting grounds, according to Bruno Monteyne, an analyst at the broker.
Price inflation has provided another boost to revenue growth, which will dissipate. Narasimhan’s long-term successor might need to prepare for more heavy lifting.
ADVICE Hold
WHY Sustained improvement in sales growth is not assured
Dechra Pharmaceuticals
Dechra Pharmaceuticals should have a softer landing than most other pandemic darlings that have fallen from a height since the start of this year. Shares in the veterinary medicine specialist trade at a forward price earnings ratio of 29, at the lower end of the five-year range and down from a peak multiple of 48 this time last year. That rating, a fitting premium to the sector that reflects higher growth and scale, should make investors feel more at ease.
Rising spending on pets has put Dechra in an expanding market and revenue growth is the evidence; it has increased at a compound annual rate of 14 per cent over the past five years, yielded by carving out a niche, prescription-only drugs business primarily for dogs, cats and horsesthat has helped to differentiate Dechra from large players focused on mass-market products such as flea and worming treatments.
An underlying operating profit of £174 million for the 12 months to the end of June, up 9 per cent on the previous year, was broadly in line with consensus.
So why have investors become more wary? In a word, margins. Revenue growth is slowing from the heightened levels achieved during the pandemic, returning to a normal level of 14 per cent for the full year, down from 21 per cent during the year before. Then there is the impact of higher wage and raw materials costs. The $210 million acquisition of Piedmont, the drug developer, not only will add eight novel mediciness to the group’s pipeline, but also will mean that research and development spending increases to about 7 per cent of revenue, up from 4.8 per cent last year. Analysts at Numis have forecast an operating margin of 23.9 per cent this year and 24.7 per cent in 2024, below last year’s 25.6 per cent.
Ian Page, the chief executive, reckons that the launch of more novel drugs from 2025 should push margins north of 25 per cent. But until there is more progress on margins, the shares could struggle to move higher.
ADVICE Hold
WHY Pressure on margins could see the shares flounder in the medium term
