Reckitt Benckiser Cries Over $6.5 Billion of Spilled Milk

(Bloomberg Opinion) -- When Laxman Narasimhan cut the full-year outlook for Reckitt Benckiser Group Plc in October, the company’s new chief executive officer threw in everything but the kitchen sink.

On Thursday, he completed his demolition job of expectations at the maker of everything from Durex condoms to Dettol disinfectant, saying the operating margin would be much lower in the future and announcing a 5 billion-pound ($6.5 billion) writedown to the value of the Mead Johnson baby-formula business, which Reckitt bought just three years ago for $17 billion.

Easing back on Reckitt’s margin expectations was essential, as it gives it the space to make some much-need investments to boost sales. Even in 2019, when its results were hurt by a poor flu season and the continued underperformance of Mead’s infant nutrition products, its operating margin was 26.2%, well ahead of Unilever’s 19.1% and Nestle’s 17.6%.

Reckitt aims to invest about 2 billion pounds over the next three years to try to deliver mid-single digit organic revenue growth. It rose by just 0.8% in 2019. Part of this will be funded by 1.3 billion pounds of cost savings. But there will also be a hit to the margin of 3.5 percentage points this year, much bigger than the market had expected.

Relaxing the margin also leaves room to change Reckitt’s hard-driving culture, which has historically obsessed about controlling costs and short-term earnings. Martin Deboo, an analyst at Jefferies, anticipates an operating margin of 22.7% in 2020. The company wants to return to a margin percentage in the mid-20s eventually.

The new CEO has also signaled portfolio change. He has ditched a plan to split Reckitt into its hygiene and home business — owner of brands such as the Cillit Bang cleaner and Vanish stain remover — and its health arm, which owns Nurofen painkillers and Scholl foot products. Reckitt will now remain as a single company, but with three divisions: hygiene; health and nutrition.

This structure, together with the whopper writedown, suggests that the nutrition business — primarily Mead Johnson — might be for sale at the right price. That is wise, given the poor performance of baby milk since Reckitt acquired Mead. The foray into formula under former CEO Rakesh Kapoor looks like a colossal waste of money. Reckitt also missed out on buying Pfizer’s consumer health unit, a far better fit, because it was busy digesting Mead Johnson and needed to cut debt.

Narasimham says Reckitt’s problems are operational. Still, fixing them won’t be straightforward, particularly with any coronavirus related disruption to consumption and supply chains. Given the economic context, the new growth and operating margin targets look a stretch.

Also, an activist investor might be tempted to push for a breakup if his strategy doesn’t work, particularly if the shares, which fell about 5% on Thursday, decline further. The now abandoned plan to split the hygiene and home division from the health unit might have delivered value.

If Narasimham doesn’t clean up at Reckitt, a hedge fund may try to do the job for him.

To contact the author of this story: Andrea Felsted at afelsted@bloomberg.net

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Andrea Felsted is a Bloomberg Opinion columnist covering the consumer and retail industries. She previously worked at the Financial Times.

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