Reckitt Benckiser (RB.) is repositioning itself as less of a household cleaning company and more as a health and hygiene products firm. This strategy makes sense, in our view, as over-the-counter health-care products lend themselves to greater brand loyalty, innovation, and higher margins. This increased emphasis will make Reckitt even more of a target for its much larger, stronger rivals. As a sharp operator with solid brands in some very niche categories – which is the basis for our narrow moat, we view Reckitt's commitment to investing behind product innovation as a plus, but competitors are not sitting idly by.
It will be essential for Reckitt to ensure its products win with consumers. Reckitt is also shifting its people and capital investments to align with markets experiencing greater absolute growth, which strikes us as prudent, although Europe and North America still constitute about 50% of sales.
Beyond its consumer business, which makes up 92% of sales and 84% of operating profits, Reckitt operates a pharmaceutical division, RBP. However, after a nine-month strategic review, the firm plans to spin off the operations, which we view favourably given the lack of synergies we see. Within RBP, Reckitt owns Suboxone, a drug used to treat opiate dependency, which lost patent protection in 2009. As such, Reckitt has shifted its offering to a lower-margin patented sublingual film, but prospects for the pharma business are quite weak, as evidenced by the 8% decline in first-half sales and a 380-basis-point deterioration in segment operating margins to 53%.
Despite this, we view the opportunities for RBP as a standalone business in a more favourable light. We expect management to focus on ways to extend its portfolio of addiction treatment, beyond drugs to treat opiate dependence. However, given the number of near-term hurdles plaguing its operations – such as generic competition, uncertainty around health-care reform, and the timing of Medicaid reimbursements – the pharma business could be on a bumpy course for some time.
After reviewing the assumptions underlying our discounted cash flow model and adjusting our sales and profit forecast for the planned spinoff of the pharmaceuticals business, we are bumping up our fair value to £48.63 per share from £43.47, with additional cash generated since our last update accounting for about one third of the increase.
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