A consumer giant living up to its price tag

This is precisely what GSK (GSK) did just over two years ago when it demerged the business that now trades as Haleon (HLN). US pharma giant Johnson & Johnson (US:JNJ) followed suit in May 2023, when its own consumer business floated as Kenvue (US:KVUE) on the New York Stock Exchange. It’s understood that France’s Sanofi (FR:SAN) is planning a similar divestment, and Germany's Bayer (DE:BAYN) is likely to do the same once its current debt and litigation issues are resolved. 

Power portfolio

Meanwhile, more traditional consumer packaged goods (CPG) companies have struggled to rationalise their sprawling portfolios, some of which contain health-adjacent products. Reckitt Benckiser (RKT), the maker of Lemsip cold and flu remedies, has come under fire in recent years for its high cost base relative to peers. It recently announced plans to get rid of its home care business as part of a streamlining drive. Mead Johnson, the troubled infant formula group Reckitt acquired seven years ago, is also under “strategic review”, meaning it too could be on the chopping block.

Like Unilever (ULVR) before it, Reckitt has promised to focus on its “power brands” – high-margin products that already hold leading market shares in growing categories. The group counts Strepsils throat lozenges and Nurofen painkillers among this cohort, as well as the Dettol disinfectant range.

On this front, Haleon is a shining example to its mainstream peers. The company has grown revenue and volumes thanks mostly to its own rationalised portfolio of power brands, which includes household names includig Sensodyne toothpaste and Panadol pain relief. 

The group generates some 60 per cent of its sales from these products, and management recently upped its full-year guidance on the back of the 5.6 per cent organic growth rate they achieved in the first half. Sensodyne delivered double-digit growth, as did Centrum vitamins and the Parodontax gum health range. While price rises are still driving group sales growth, volume and mix also turned positive in the second quarter of 2024.

Part of Haleon’s strength lies in its relatively narrow healthcare specialism. Unlike Unilever, it doesn’t make the likes of fabric conditioner and ice cream. Shoppers often look for cheaper, own-brand alternatives to these more discretionary items when faced with a cost of living squeeze. However, they are less likely to compromise when it comes to things such as cold medicine or dental health. Products such as Sensodyne – which are recommended by dentists and have relatively few competitors – therefore enjoy a degree of protection from macroeconomic headwinds. 

“The ability to innovate and create consumer solutions (that they will pay for) is a level higher than most categories in CPG,” says broker Jefferies. “Add to this the low penetration of private labels in many of Haleon’s categories and the relative price insensitivity, and we can start to see why the company's guide to organic sales growth... is realistic.”

In the medium term, management is targeting revenue growth of 4-6 per cent, which would be a tall order for a lesser consumer group. But Haleon’s commitment to building out its existing product range – as opposed to expanding into entirely new categories – should serve it well.

“Innovation and R&D don’t necessarily have to go into new brands,” says Morningstar analyst Keonhee Kim. “It’s about adding extra benefits to the current offering. Sensodyne, for example, also has whitening and gum health versions.”

While engineering these new products is nowhere near as costly or heavily-regulated as developing pharmaceuticals, that doesn’t mean it’s cheap: Haleon has a lot of debt (its net debt/adjusted Ebitda ratio was just under three times at the end of June). It was landed with this debt as a result of the GSK demerger, but the business does have some elevated costs of its own. According to Kim, Haleon’s R&D spend is equivalent to around 3 per cent of its sales – one of the highest in the wider consumer goods sector.

“The average R&D to sales in CPG is roughly about 2 per cent and we think the extra 100 basis points for Haleon fuels its innovation pipeline.” In other words, the larger outlays are necessary to ensure the company can reach its growth targets. 

Steadying the stock

Would-be shareholders should be aware that all this doesn’t come cheap. Haleon currently trades on 20 times consensus earnings for the full year, making it pricier than Reckitt and Unilever, which trade on multiples of 13 times and 18 times, respectively. Even Kenvue, widely held to be the world’s largest consumer health group in sales terms, trades on 18 times its estimated full-year earnings. 

Haleon’s edge over its US rival is partly down to weakness in some of the latter’s consumer-facing divisions. “We think the intangibles in Kenvue’s portfolio are as strong as Haleon’s, it’s just that some of its execution hasn’t been as great,” Kim says. “For example, Kenvue has a skin health and beauty category, which saw R&D and innovation really halt during peak-Covid times. This led to some loss in retailer shelf space.”

Some risk-averse investors may be reluctant to pick up Haleon shares at their current price because almost a quarter of the stock is still held by Pfizer (US:PFE). The arrangement is a legacy of the 2019 merger of its consumer health assets with GSK’s. Although the pharma company’s chief financial officer has pledged to reduce its holdings in a “slow and methodical” manner, there are lingering concerns around the size and timing of future sales. 

Analysts at Stifel expect the business to continue to deliver operationally, but say the continuing share price overhang from Pfizer puts “a cap on share price performance in the near term”. These fears might be overblown, however. In an attempt to shore up its stock, the group announced in February that it would allocate £500mn to buybacks across the current financial year, and proceeded to pick up £315mn of Pfizer’s stake in an off-market transaction. 

It has now commenced the buyback of the additional £185mn of shares, although management indicated on a recent earnings call that it has multiple ways of acquiring more shares. “One is on the open market, second is buying it back directly from Pfizer at a given discount and third is, of course, participating in a placing,” said outgoing chief financial officer Tobias Hestler. In other words, it has options for ensuring its buyback programme is completed on schedule, and for potentially doign more in the future. 

While none of this ultimately prevents Pfizer from offloading large swathes of its holding and eroding the share price, it does show investors that Haleon is serious about steadying the ship. Given competitors such as Reckitt are contending with potentially major litigation and Unilever is busy trying to hive off its ice cream unit, we think Haleon looks like a safe bet in an even safer niche.