Announced late last year, the spin-off of Kenvue Inc.NYSE:KVUE) as an independent company was spun off in May 2023. Formerly a division of Johnson & Johnson (YNJ), this The leading consumer business didn’t have an easy debut on the public stock market: Its shares are down tremendously since the IPO, which is always an interesting indicator that there may be potential value to be unlocked. Spin-offs are often coldly received by investors, and it’s not uncommon to see shares of these newly formed companies go bad. A recent example has been the IBM spin-off Kyndril (KD), which is currently down 55% since its IPO.
However, despite the decline in Kenvue’s share price, I feel the company is fairly valued at these levels and does not represent a particularly attractive entry point.
A real giant in their market
It’s easy to forget how big Kenvue really is, considering that it wasn’t that long ago that it was part of another business. The company positions itself as the largest consumer health company by revenue, thanks to net sales of $15 billion in FY2022.
At a higher level, Kenvue’s business model is quite simple. They carry an impressive catalog of extremely popular brands across three major consumer product categories. Thanks to the power of branding and marketing, they manage to generally charge their customers more compared to generic or lesser known brands, and this results in impressive gross margins. Some of the most famous consumer brands that belong to Kenvue’s portfolio are Tylenol, Nicorette, Band Aid, Aveeno, Listerine and many more.
Slow and steady
Since the company’s last results, the stock is actually up about 5%, which is indicative of overall positive sentiment in the short term. Third quarter results saw Kenvue improve their revenue by 3.4% to $3.92 billion, while already large margins even improved modestly to 57.47% gross margin and 21.51% operating margin.
Net income of $438 million was down from $586 million a year ago, but that’s not really an apples-to-apples comparison since last year Kenvue wasn’t yet a fully independent company. Overall, the net income margin at 11.19% was somewhat in line with previous quarters (14.19% for the second quarter and 8.57% for the first quarter). Free cash flow for the quarter was about $560 million. The company ended the quarter with about $1 billion in cash and cash equivalents, while long-term debt was $7.6 billion. All debt was issued during the IPO as part of the spin-off process. A series of unsecured notes were issued by Kenvue with variable maturities (from 2025 to 2063) and a weighted average interest rate of approximately 5%.
Most of the growth in the quarter came from the Self-Care and Essential Health segments, which grew organically by 6.7% and 3.8%. Organic Growth is a metric provided by the company that measures net sales excluding external factors such as acquisitions, sales and currency impact. The laggard this quarter was the Skin Health & Beauty division as its organic growth was modestly negative (-0.4%). One of the reasons highlighted for this segment’s poor performance was an overall softness in consumer demand in China for Kenvue’s products. from last earnings call:
As I shared last quarter, we have been expecting a slower recovery in China. And unfortunately, this is what we see happening. However, we remain positive about the long-term outlook in China. We have operated there for many years and are confident in the long-term potential of the market, but we need to be patient as we expect continued softness in the market in the fourth quarter, and our field teams will continue to be agile and allocate resources according the opportunities they see in the market.
As shown in the slide above, despite overall healthy organic growth, sales volume actually decreased quite significantly in response to the price increase. Only a company with strong brands can adopt this kind of tactic, and that’s why consumer staples generally do better in tough macro environments, simply because their customers are reluctant to change their consumer habits. However, I still consider it a red flag to see volume drop as much as 6.8% in the case of the Skin Health & Beauty division because consumer demand for these products is not entirely inelastic and there is only so much a company can charge without driving away their customers. Definitely something to monitor going forward.
In terms of guidance, unfortunately, management has already revised down their guidance for the full year. The previously set growth target of 4.5% to 5.5% has been lowered to 4% to 4.5%, in part due to unseasonably mild weather that caused a delay in the start of the flu season, which in turn caused a decline in sales of some over-the-counter pharmaceutical products.
Return of capital to shareholders
Overall, Kenvue looks like a classic consumer business without any particular surprises, and investors would usually expect a degree of shareholder friendliness from businesses that don’t actually promise explosive growth, but just slow steady and reliable growth. Indeed, the company recently initiated a quarterly dividend of $0.20, which was also confirmed for Q4 2023. At the current price, this translates to an annual dividend yield of around 4%. To cover the dividend Kenvue needs $383 million each quarter, while in the last quarter net interest expense was also $100 million. This seems generally well covered by FCF as shown above.
In addition, the board has authorized a share repurchase program of up to 27 million shares, or about 1.4% if the shares are outstanding. There are no clear details on what this will actually look like, but it’s definitely better than nothing.
Valuation: Valuation at current price only
I see nothing wrong with Kenvue as a business. I’d like to see less debt, but that’s one of the baggage of the spin-off, and management has expressed its desire to use their reliable cash flows to reduce their debt over time. In my opinion, with a business like Kenvue it’s even more important than ever to pay the right price for it, because it’s likely that there won’t be any particularly sexy narrative for their business, nor any very specific catalyst that can push the stock price to abundance. levels.
We have already seen their stock price around 25% since the IPO. Does that mean the bad times are over?
Management has only guided on adjusted earnings which is a noisy metric in my opinion. If we consider their headline guidance of about 4.25% growth (at the midpoint) applicable to FY2023 net income as well, this would translate to about $2.17 billion in net income for an upcoming FY2023 ratio Price to Earnings of 17.3 which isn’t exactly cheap for a slow growing company.
I built a quick Discounted Free Cash Flow model to gauge what scenario the market is currently implying. I used as a base the $2.4 billion of FCF that the company reported in the trailing twelve months. Assuming 4% growth over the next 10 years and a terminal P/FCF of 15x, for an expected annualized return of 10%, the intrinsic value would be about $34 billion market cap, roughly 10% down from the current level.
My feeling is that Kenvue at these levels is pretty well valued for around 4% annual growth, which frankly isn’t good enough for me. It is an interesting business to follow because of the quality of their brands, the resilience of their core consumer businesses in difficult economies, and their impressive free cash flow generation. But the current price in my opinion implies a lot of risk because I do not perceive the current level to be discounted at all, while any slowdown in growth or further deterioration of the economy could affect the ability of the business to achieve its growth target.