Why I’ve sold Reckitt Beckiser after its recent post-Brexit surge

Reckitt Benckiser – owner of many famous brand names such as Dettol, Air Wick and Nurofen – is a company I like so much I’ve invested in it twice.

The first time I bought and then subsequently sold Reckitt Benckiser the result was an annualised return of 23% over a period of two years, ending in April 2013.

I then bought back into the company in February 2014 and second time around the results are almost identical, with annualised returns once again of 23% over a period of slightly more than two years:

• Purchase price: 4,811p on 07/02/2014
• Sale price: 7,585p on 07/07/2016
• Holding period: 2 Years 5 months
• Capital gain: 55.8%
• Dividend income: 7.3%
• Annualised return: 23.2%

The continued good results from this stock highlight two underlying trends that have been going on for a very long time:

First, Reckitt Benckiser is an outstanding company and has consistently grown its revenues, earnings and dividends at a rapid pace for many, many years.

Second, defensive companies that sell small ticket, repeat purchase items to consumers worldwide have become increasingly attractive to investors in the aftermath of the financial crisis and, as a result, have also become increasingly expensive.

Buying: An outstanding company at a reasonable price

Reckitt Benckiser is one of those consumer staple companies that have done so very well out of globalisation and the explosive growth of a global middle class.

In this context a useful definition of middle class is that it consists of people who have enough money to care about what brand of soap they use, rather than just buying the cheapest soap they can or not being able to buy a bar of soap at all.

Many of RB’s cleaning products, such as Vanish stain remover, Dettol or Cittit Bang, have very strong brands and as such have become almost the default choice across the globe as more people move away from a price-first mentality to a quality or brand-first mentality.

This massive increase in RB’s markets have fed through consistently into its results:

Back in 2014 the company’s revenues, earnings and profits had all more than doubled over the previous decade and so this was most definitely a growth company.

If Reckitt Benckiser was so obviously a good company operating in the sweet spot of globalisation, why was it cheap enough to interest a value investor like me?

The answer was that during 2013 there had been a general sell-off in relation to emerging markets and companies that were exposed to emerging markets. Although RB’s share price didn’t fall significantly, it was largely stagnant throughout 2013 and the early part of 2014.

That stagnant share price, combined with continued growth in the company’s revenues, earnings and dividends, caused the shares to look ever more attractive when viewed through the lens of my stock ranking system.

However, although the share price was becoming more attractive (the company’s rank on the my stock screen was 27 out of 233) it was not exactly cheap by traditional standards.

As the table below shows, RB’s valuation ratios were all above the market average, with the PE10 and PD10 ratios (price to 10-yr average earnings and dividends) both almost touching my “rule of thumb” maximums of 30 and 60 respectively.

In this case though, I was comfortable paying a somewhat premium price as I thought the quality of the company and its potentially bright future more than justified it.

Holding: Consistent dividend growth and a stress-free investment

Some investments are unreasonably easy and Reckitt Benckiser has on both occasions been just that. This time around the investment spent almost no time “underwater”, with the shares registering a capital gain almost from day one.

Other than the usual wobbles which are inevitable with any stock market investment, the shares went up in about as straight a line as any investor could reasonably expect.

The biggest peak-to-trough decline was less than 12% and while 12% may sound like a big decline, for an individual stock it is very small indeed, especially over a period of more than two years.

On the corporate side of things it seemed as if the going was somewhat tougher for RB than its steady share price gains suggested.

Through 2014 its quarterly updates spoke of “tougher markets” and “gaining traction from efficiency programmes”, with programmes to improve efficiency almost always being a sign that a company is struggling to grow.

In fact by the end of 2014 one of the company’s main strategic aims was to implement project “Supercharge”, a programme designed largely to reduce cost and drive efficiency across the business.

In line with this tougher environment the company’s expectations of growth dropped to around 5%, a long way below the 17% growth rate of the previous decade. Unfortunately, those lower expectations were met.

Through 2015 and 2016 tough markets continued to hold back the company’s growth despite its outstanding products and brands, and in 2015 growth slowed so much that the company failed to raise its dividend for the first time in more than a decade.

Perhaps this is the end of RB’s rapid growth phase? The drop off in growth shown in the chart below is certainly food for thought.

Selling: Slowing growth and a rising price are not a good combination

Although RB’s failure to raise its dividend in 2015 was a surprise (at least to me), a bigger surprise is the fact that the share price has continued to improve at a rapid rate.

Despite zero dividend growth last year and lacklustre revenue growth, the share price has increased by almost 50% since the start of 2015, with a large slice of those gains coming in the past few weeks as a result of the UK’s decision to leave the EU.

• Note: I’ve already written about my Brexit investment strategy and my initial thoughts on Brexit’s stock market impact.

One reason for the post-Brexit share price spike is that the pound has fallen in value by around 10%. A decline in the value of the pound means that companies like RB, which generate a significant portion of their profits overseas, are likely to see their profits rise in Sterling terms.

Another reason is that Brexit has induced fear in many investors and high quality defensive consumer staple stocks like RB are an obvious low risk place for cautious investors to hide.

However, this continued increase in the company’s share price relative to its economic fundamentals, combined with slowing growth over the last few years, means that Reckitt Beckiser is no longer as attractively valued as it was in 2014.

The final nail in RB’s coffin is that its stock screen rank has fallen to 120, which puts it more or less in the middle of the 236 consistently dividend-paying stocks that currently make it onto the screen.

As such I no longer think that RB is a suitable holding for my defensive value approach and so I have sold the entire position from my model portfolio and from my personal portfolio as well.

As usual the proceeds will be reinvested into a new holding next month.

Note: You can read the full pre-purchase review of Reckitt Benckiser in the February 2014 issue of UK Value Investor here (pdf).