In an article earlier today, I explained why I think industrial technologies conglomerate Smiths Group could be undervalued by 50%+. And also why I think the value could soon be outed. It’s all to do with a demerger of one of its divisions, which I believe will prove value-enhancing for shareholders.
Smiths isn’t the only such stock on my radar at the moment. Here, I’ll explain why I believe a similar story could unfold at FTSE 100 consumer goods giant Reckitt Benckiser (LSE: RB), where I see a potential valuation uplift of 37%.
The power of brands
Companies with strong brands are highly prized by investors. This is particularly true for those selling fast-moving consumer goods. Brand loyalty and regular repeat purchases make for predictable and growing revenues, while premium prices make for high profit margins and returns on capital.
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Reckitt Benckiser has been one of the best in the business for many years. It’s traded at times on a mid-20s earnings multiple, which I consider reasonable for a really top-notch operator in the sector. However, it’s fallen somewhat out of favour with investors of late.
At a current share price in the region of 6,500p, compared with nearer 8,000p at its peak two years ago, we’re looking at a rating of 18.3 times forecast 12-month earnings. If it were to re-rate to a mid-20s multiple, the share price would rise to 8,900p (37% upside from the current level).
I don’t think there’s been a change to the fundamental story that companies with high-quality stables of powerful consumer brands merit a high valuation. And I see a catalyst for Reckitt re-rating.
RB 2.0
Following the sale of its food business and acquisition of Mead Johnson Nutrition (MJN) in 2017, Reckitt embarked on what it called RB 2.0— the creation of two structurally independent business units: RB Health (incorporating MJN) and RB Hygiene Home. Implementation of this began at the start of 2018 and is expected to be complete by mid-2020.
RB Health’s brands include Nurofen, Gaviscon and Durex, as well as MJN’s infant formulas, while RB Hygiene Home has the likes of Air Wick, Cillit Bang and Finish. Now, I think these two business units housed under the same roof can do a perfectly decent job for investors. And new chief executive Laxman Narasimhan, who will take up the reins on 1 September, knows all about managing two different product categories. He comes from PepsiCo, which has a big snacks business in addition to its classic sodas and beverages.
However, I see a strong argument for progressing RB 2.0 to a full separation of RB Health and RB Hygiene into two independent companies. When such separations occur, we tend to see a heightening of management focus, entrepreneurial drive and growth in the two unleashed businesses, with a higher valuation being the happy consequence for shareholders.
Reckitt’s chairman Chris Sinclair has said, the company, “will continue to evaluate opportunities to maximise shareholder value from RB2.0” — which suggests to me the option of a full split is certainly very much on the table. I’d be happy to buy Reckitt’s shares today at 18.3 times earnings, for the company as it is. But I think a demerger or other break up of the business is on the cards, producing a valuation uplift that will reward investors at today’s share price with strong returns.
