In May, Kenvue Inc. (KVUE, Financial) successfully concluded its separation from Johnson & Johnson (JNJ, Financial); however, its stock has experienced a decline about 25% since the completion of this process, likely driven by Investors nervousness about Tylenol litigation. The drop in value appears to be excessive even if the company may have to settle some lawsuits. I think this represents a good opportunity for investors to buy this high-quality company. It has a portfolio of leading brands, a solid balance sheet and large industry merger and acquisition and consolidation opportunities.
Despite this share price downturn, the company's financial performance reveals consistent margins and decent growth, presenting an appealing future prospect for investors. Kenvue is presently trading at a discount compared to its peers, indicative of mispricing likely stemming from the separation from its former parent as well as litigation jitters. This situation implies a potential for future growth, making it an opportune moment for investors to consider the company.
The company
Kenvue is the largest pure-play consumer health care company with sales of roughtly $15 billion in 2022. The company and its industry (consumer health care), which is still relatively new, holds a position at the intersection of fast-moving consumer goods companies like Procter & Gamble (PG, Financial) and Unilever (UN, Financial), pharmaceutical companies like J&J and Pfizer (PFE, Financial) and beauty companies like Estee Lauder (EL, Financial) and L'Oreal (LRLCY, Financial). Many of the companies and brands in this consumer health products industry emerged out of pharmaceutical companies as these companies divested non-core operations to focus on higher-margin patented prescription pharmaceuticals. Unlike pharma companies, which depend on patents for the their economic moats, these companies' moats depend on brands. The following are some of Kenvue's leading brands:
Kenvue operates with three primary product segments : Self Care, Skin Health & Beauty and Essential Health, each encompassing well-known brands familiar to consumers.
The Self Care category includes cough, cold and allergy medicine, pain care and other self care (digestive health, smoking cessation). Notable brands in this segment include Tylenol, Nicorette and Zyrtec.
The Skin Health and Beauty division encompasses face and body care as well as hair, sun and other. Major brands in this category are Neutrogena, Aveeno, Lubriderm and OGX.
As for the Essential Health segment, this category includes oral care, baby care and other essential health (women's health and wound care), featuring brands such as Listerine, Johnson's Baby, BAND-AID, Neosporin and Stayfree.
These well-established brands have demonstrated a robust market presence, as reflected in the company's recent financial performance. In the most recent quarter ending in September 2023, the company generated approximately $3.91 billion in quarterly revenue, up about 3.3% from last year. This translates to around $710 million in operating profit. Out of this, about $438 million was reported as net income, reflecting impressive financials.
The adjusted operating margins stood at over 20%, with net income margins at 11%, showcasing commendable performance for a company operating in the consumer staples sector. Kenvue's return on equity is15.87% and the return on invested capital is 9.49%. The company has guided for about 5.5% revenue growth this fiscal year.
The company is also global in reach with operations around the world and approximately 22,000 employees.
Balance sheet and cash flow
Kenvue's balance sheet is well balanced with a debt-to-equity ratio of 0.78 and a debt-to-Ebitda ratio of 3.08.
The schedule of principal payments required on the company's long-term debt for the next five years, including 2023 and thereafter, is as follows:
(Dollars in Millions) | |||||
Remainder of 2023 | 2024 | 2025 | 2026 | 2027 | Thereafter |
| $____ | $____ | $750 | $750 | $____ | $6,250 |
Source: 10Q
Cash flow is very healthy and above net income on a trailing 12-month basis.
Valuation
Based on GuruFocus data, the company's forward price-earnings ratio is currently 15.56. Its closest competitor, Haleon (HLN, Financial) (which itself separated from GSK (GSK, Financial) last year), sports a multiple of 17.45. Other comparable companies, like Prestige Consumer (PBH, Financial), has a forward price-earnings ratio of 13.5 while Reckitt Benckiser Group PLC (LSE:RKT, Financial) has a ratio of 15.17. Larger semi-competitors that also have a consumer health business, like Procter & Gamble, Unilever and Colgate-Palmolive (CL, Financial), sport comparable or higher forward price-earnings ratios. So based on the trading multiples, with comparable companies I think Kenvue is about 20% undervalued. I also think consumer health companies like Kenvue and Haleon are underpriced as compared to other FMCG companies like P&G and Colgate, even though they have brands with comparable strengths and operating margins.
I think these companies are most closely related to the S&P's consumer defensive sector. This sector has a price-earnings ratio of around 23. Kenvue's earnings multiple of 15.5 is about 33% lower. I honestly think it should be higher given the quality of its brands.
Sector | Number of Stocks | Shiller P/E | Regular P/E |
| Financial Services | 67 | 15.60 | 13.60 |
| Consumer Defensive | 37 | 23.70 | 23.00 |
| Utilities | 30 | 24.70 | 22.00 |
| Basic Materials | 22 | 25.00 | 18.10 |
| Industrials | 73 | 25.70 | 20.90 |
| Energy | 23 | 27.70 | 10.10 |
| Healthcare | 65 | 28.00 | 24.40 |
| Communication Services | 22 | 30.90 | 27.20 |
| Real Estate | 31 | 38.80 | 39.70 |
| Consumer Cyclical | 59 | 42.10 | 31.90 |
| Technology | 74 | 45.10 | 40.30 |
| S&P 500 | 500 | 31.1 | 25.2 |
When I use the GuruFocus discounted cash flow calculator with a starting point of earnings per share of $1.31, I get a fair value comparable to the current stock price. On reflection, given the company's market-leading brands and global reach, this appears to be overly conservative. The stock should be trading at a premium.
Risks
One lingering concern affecting the stock is the apprehension surrounding litigation linked to the safety of Tylenol. Ongoing legal proceedings specifically focus on the potential impact of Tylenol on fetuses. Lawsuits allege that Kenvue is liable for neurological disorders in children born to pregnant women who took the painkiller during pregnancy. The plaintiffs contend the company failed to include a warning about these potential risks on the product's label. In response, Kenvue asserts that acetaminophen, the active ingredient in Tylenol, is extensively studied and regarded as one of the safest medications in history by U.S. health regulators and medical organizations. The American College of Obstetricians and Gynecologists, for instance, deems acetaminophen as "one of the only safe pain relievers for pregnant individuals during pregnancy."
Despite this litigation being in its early stages, the plaintiffs have scored several procedural victories in recent months. The upcoming year will lap a crucial phase as the lawsuits advance, with courtroom battles over the admissibility of expert testimonies. If the judge approves the plaintiffs' chosen experts, investors will need to closely monitor developments. While Kenvue shares may experience short-term volatility, its expanding dividends and solid financial fundamentals are poised to provide a stabilizing effect amid the uncertainties.
Another issue investors have to contend with is the relatively anaemic top line (revenue) growth. Based on published figures, Kenvue's revenue has only grown by 1.44% per annum since 2019. While the company's recent growth has been in the mid-single-digits, this top line growth will have to be sustained and increased if the company hopes to attain a premium valuation.
Conclusion
Kenvue has lots to recommend it, even amid litigation concerns. The company recently initiated a quarterly dividend of 20 cents a share, which equates to a yield of about 3.95%. The company has inherited its former parent, Johnson & Johnson's, Dividend King status and is part of many dividend growth exchange-traded funds, like the SPDR S&P Dividend ETF (SDY, Financial) and ProShares S&P 500 Dividend Aristocrats ETF (NOBL, Financial).
Several value-oriented guru investors like Yacktman, Tweedy Brown and the T. Rowe Price Income Fund have established positions in the company. Johnson & Johnson still owns about 9.52% of the outstanding shares and is currently the largest shareholder. It is expected that it will sell its holdings in the near future.
I also think it is undervalued by 20% to 30% based on a consumer packed goods company comparable. As a FMCG company with strong self medication/self care product profile and brand portfolio, it has recession-resistant characteristics and is a hedge against the gyrations of the economic cycle. Its not often you get to buy such a high-quality consumer staples company at a price-earnings ratio of around 15.
