Well polished performer

Reckitt Benckiser is a company whose products are more familiar to us than the corporate entity which sits behind it. With the financial media typically focusing on the dramas of missed expectations it is also a firm which has kept a relatively low profile due to consistent performance. The defensive nature of its products, opportunities for continued growth through emerging markets and the mid-teens rating ensure we rate the group a buy.

Throughout the credit crunch certain business have seemed to carry on regardless of the downturn. One of these is the household cleaning, personal care and consumer healthcare business Reckitt Benckiser. In fact when pointing to the effects of Lehman’s collapse in late 2008 sales volumes growth slowed to “only” 3% for the base business in the first quarter of 2009.

It is also the case that Reckitt has had its P/E rating lowered in recent years as EPS share growth has outpaced the appreciation of the stock price. This reflects the slower earnings growth in the next few years but also presents, in our view, an opportunity for investors.

The proposed £2.5bn acquisition of SSL also looks set to boost earnings although clearly this is not hard given that Reckitt has low borrowing costs given its strong balance sheet. Meanwhile exposure to emerging markets will prove to be a significant driver in the years ahead. In fact developing markets provided 19% of operating profit for the base business (i.e. excluding pharmaceuticals) in the first half of 2010 and saw sales growth of 19% and operating profits rise 37%.

Looking at the weekly chart of Reckitt Benckiser we can see that the share price has performed well since hitting a low of 2097p in October 2008. The positive move higher since then has resulted in a new 52 week high of 3667p made on the 30^th of April. Since making this high the price action has pulled back to horizontal support at the 3050p level. The MACD which warned of this decline has recently turned higher and looks set to provide a positive reversal signal.

Looking at the daily chart of Reckitt we can see that the downtrend that has contained prices for the duration of the recent pullback has now been broken. The share price is once again testing the 50 and 200 day moving averages, with the former acting as support while the latter is providing resistance. We would expect to see a continuation of the move higher, a break back above the 200 day would be very positive. There is some overhead horizontal resistance around the 3350p level. A move through this resistance would likely result in a move back towards the 52 week high of 3,667p.

In terms of the group’s history, Reckitt Benckiser has its roots in the industrial chemicals business established by Johann Benckiser in 1823 and the starch business started in 1840 by Issac Reckitt. The US disinfectant brand Lysol was produced in the US in 1912 by a company the group later acquired. Harpic lavatory clearers was bought in 1932 and in the same year the germicide Dettol was launched.

In 1943 Air Wick was launched in the US and in the 1950s the dishwashing brand Finish was released. The water softner Calgon was launched in 1956 and a big breakthrough came in 1965 with the accidental discovery of Gaviscon which is a treatment for heartburn.

Other noteable dates include the launch of Vanish stain remover in 1972; the release of the first over the counter (OTC) ibuprofen, Nurofen, in 1983; the purchase of Airwick products in 1985; and lastly the launch of Cilit Bang in 2005.

On the corporate front Reckitt was merged with Coleman in 1938 and this group was merged with Benckiser to form Reckitt Benckiser in 1999. Boots Healthcare was bought for £1.9bn in 2006 and in 2008 the group completed the acquisition of Adams Respiratory Therapeutics, for $2.3bn, giving it Mucinex – the number one cough remedy in the US. The proposed acquisition of SSL for £2.5bn is also no small deal and would bring with it the leading brands of Durex and Scholl.

This product innovation and corporate deal-making has seen Reckitt become the world’s leading household cleaning company. The group is also strong player in personal care and consumer healthcare. The household items made by the firm are often necessities for general upkeep and therefore sales have been resilient in economic slowdowns.

The strategy of Reckitt can be described as “innovation marketing” which is management speak for product innovation to meet consumers needs combined with increased marketing spend. This focus has seen Reckitt develop what it calls “Powerbrands” which are defined as global leaders in their categories. They also have high growth potential and are a strong focus of the group in terms of being rolled out internationally.

Recent innovations include “no-touch” hand soap dispensers under the Dettol and Lysol brands which means that users don’t pickup germs as there is no pressing to dispense soap. A further interesting product is a fragrance candle branded under the Airwick label and a new Finish dishwashing rinse aid to remove water spots.

This history of innovation and strong marketing has left Reckitt with number one positions worldwide in 1) fabric treatment (Vanish) 2) water Softners (Calgon) 3) surface care 4)disinfectant (Dettol and Lysol) 5)dishwashing (Finish) 6) mediated soar throat products (Strepsils). The group has the number two position worldwide for Acne (Clearsil), cold/flu (Mucinex), air care (Air Wick) and strong positions in a host of other areas.

Looking at Reckitt as a whole and apart from cleaning, personal care and consumer health care the group is also involved in two non-strategic businesses. These are food and pharmaceuticals with the key one of these being the later.

The key pharmaceutical product is Saboxone which is expected to see generic competition in the US in the near future. The pharma division has had strong growth on the back of this product and contributed to 20% of EBIT in 2009. However, the introduction of generic competitors is expected to see this EBIT contribution fall into single digits.

Other investors concerns relate to sales growth, the competitive situation and future cash generation. The interim results, announced this week, saw negative like-for-like growth in Europe due to economic conditions while increased competition from the company’s arch rival Procter & Gamble may have also been detrimental.

As Reckitt has leading positions in a number of markets it is a prime target for its competitors. To date, though, the “innovation marketing” the firm has undertaken under the long-term leadership of CEO Bart Becht has allowed the group to stay ahead. Competitive threats also come and go and so it remains to be seen if Reckitt will see any substantive and remaining damage.

The recent interim results (for the half-year to 30^th June) were generally reassuring with sales up 6% and a rise in net income of 18% at constant exchange rates. A key sign of confidence is that the dividend was increased by 16%. The half year also saw margins increase with the gross margin hitting 60% and the operating margin at 23.7% which is impressive.

For the full year the group has reiterated its targets for its operations outside of the pharmaceutical division. This is for net revenue growth of 5% and operating profit growth of 10%. Not incredibly high but growth nevertheless.

In our view, the bottom line is that emerging market growth will become increasingly important and serve to offset developed market weakness and competitive pressures. The leading Powerbrands are great products for the new middle class in the developing world as higher quality products are purchased.

It is also the case that more white goods, dishwashers and washing machines, increase the market size. Lastly, some products made by Reckitt Benckiser are discretionary, such as the air freshener Air Wick, and so will be increasingly consumed in countries like India and China. Margins in emerging markets are low relative to developed markets and so have scope to expand further.

Clearly the potential acquisition of SSL introduces uncertainty but it is encouraging that this is expected to be immediately earnings enhancing. It is also testament to Reckitt’s financial strength that it is able to fund the deal easily as it had net cash at the end of 2009. With Reckitt’s P/E ratio at relatively low levels, in comparison to how it has traded in the recent past, now looks like a good opportunity to establish a holding in the group.

Accordingly, we recommend Reckitt Benckiser as a buy for all members at £31.80.