The Long and Short

Implications of a possible spin-off at Reckitt Benckiser

Dan Bruzzo, CFA | May 10, 2024

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Some investors anticipate that UK home products company Reckitt Benckiser (RKTLN: A3/A-) might spin off its nutrition business, the old Mead Johnson. It is not the first time investors thought the company might pursue this course particularly since developments in Enfamil baby formula litigation in March raised concerns about potential long-term liabilities for the company. If management were to spin off the business, it would help bondholders not just because it could mitigate direct exposure to future lawsuits. It would also help because proceeds from the transaction would almost certainly be used to reduce existing debt at the remaining RKTLN. In such a scenario, legacy Mead Johnson debt outstanding would remain with RKTLN, as the debt was fully and unconditionally guaranteed back when the Mead Johnson acquisition closed in 2017.

Exhibit 1: RKTLN versus high-quality household product peers

Source: Santander US Capital Markets LLC, Bloomberg/TRACE G-spread indications

To be clear, management has not commented publicly about a possible spin-off of the nutrition business and at this time those perceptions remain speculative. Nutrition makes up about 16% to 17% of the company’s total annual revenue, which was a little under $19 billion in US dollars in fiscal 2023. It could be difficult for RKTLN to execute such a transaction while litigation exposure remains so uncertain for the company. Some analysts predict a spin-off would likely only be for the majority of the company, with RKTLN possibly retaining a minority share of up to 49% of legacy Mead Johnson.

Outside estimates for total legal liabilities range from the low single digit billions to the high single digit billions. Meanwhile, management contends that the costs relating to product liability are not considered probable and therefore cannot be reliably estimated. As of year-end 2023, the company had only a provision of GBP137 million held on the balance sheet in relation to regulatory, civil and criminal investigations.

In March, an Illinois state court found RKTLN liable and awarded the plaintiff $60 million in damages. Management refutes the outcome of the case and hosted an investor call in which they stated their intentions to seek to overturn the verdict. In that particular case, the court found that a premature baby died from necrotizing enterocolotis or NEC after using Enfamil baby formula. If all outstanding cases were to result in a similar outcome, RKTLN’s total liability could possibly land toward the higher end of the range of estimates.

Bond spreads have drifted about 20 bp or so wider of where they were trending prior to the verdict. It does appear that the potential downside risk of this single, isolated case is properly reflected in spreads at current valuation, given the host of other variables and unknowns for long-term liabilities. Furthermore, with solid ‘A’ ratings and a very strong liquidity profile, RKTLN does appear well positioned to absorb losses that fall at the lower end of the range of estimates with minimal impacts to its overall credit profile. As of year-end 2023, the company has $1.6 billion in cash and equivalents on the balance sheet. In addition, RKTLN has access to another GBP1 billion ($1.254 billion) revolving credit facility that remains untapped. If necessary, management could also choose to suspend its existing $1 billion share repurchase program, which is in effect until this fall.

Cash flows also remain strong and consistent, as the company generated about $4.9 billion in EBITDA last year, and similar results over the previous two years. RKTLN has been operating with low leverage for its rating category over the past two years with gross debt-to-EBITDA of under 2.5x throughout fiscal 2022 and 2023, and is projecting to remain there in the current year. This level is roughly on par with gross leverage of higher-rated peers Colgate-Palmolive (CL: Aa3/A+) and Kimberly-Clark (KMB: A2/A) over the same period of time.

RKTLN’s other business lines besides nutrition include consumer hygiene (around 42% of revenue) and health (42%). Some of the company’s top brands in the former include Lysol, Finish and Air Wick. In the health category, top brands include Dettol, Durex and several over-the-counter treatments, such as Mucinex. Enfamil is the top revenue generator in the Nutrition business, and was a cornerstone of the 2017 Mead Johnson transaction. RKTLN boasts high EBITDA margins the 24% to 25% range over the past two years, which was in-line or better with peers CL and PG over that period.

Dan Bruzzo, CFA
dan.bruzzo@santander.us
1 (646) 776-7749

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