In May, I took a look at shares of Kenvue (NYSE:KVUE) after it was spun off from its former parent Johnson & Johnson (JNJ) in an IPO. This move was well received by the market with demand for the world’s largest pure-play consumer healthy play being quite high.
Since the spin-off, which took place in the form of an IPO, shares of Kenvue have fallen back as valuations were high from the get go, as investors apparently were not too pleased with the composition of growth, and perhaps concerned about new litigation concerns.
The mix of all of this means that I see appeal emerging here, although I have some questions as well, making me gradually upbeat on levels at or below the $20 mark.
A Recap
Kenvue is better known as the consumer health business of Johnson & Johnson, generating $15 billion in sales in 2022 from every day consumer health products. This includes household names like Tylenol, Neutrogena, Listerine, Band-Aid, and many others.
Operating at the intersection of consumer goods and healthcare, the prospects for the business looked sound with spending on self-care, skin health and beauty being quite high. Holding leading brands in these categories, Kenvue is a very well diversified business, as the same can be said for geographic coverage (albeit that North America) is a bit overrepresented here.
The company went public at $22 per share, as Johnson & Johnson sold a 9% stake in the business with the public offering. With 1.89 billion shares outstanding, Kenvue was valued at $41.6 billion (equity that is) and that excludes a $7.7 billion net debt load.
This near $50 billion enterprise valuation was granted to a business which generated $15 billion in sales in 2022 (for the year ending January 2023). The company posted pro forma operating earnings of $2.5 billion and net earnings of $1.5 billion, equal to $0.77 per share. With EBITDA reported at $3.6 billion, leverage ratios came in at just over 2 times.
While a flattish revenue result in 2022 does not look too inspiring, the reality is that the company faced tough comparables coming out of the pandemic. Ahead of the IPO, the company revealed a 7% increase in preliminary first quarter sales to $3.85 billion, with minimal earnings improvements seen as well.
With earnings power likely trending at $0.80, or a bit higher, which coincidentally would be equal to the anticipated dividend, it was hard to get really upbeat. The resulting 3.6% dividend yield looked decent, but there were few remaining earnings to drive down leverage or grow the business, as a 27 times earnings multiple looked quite demanding.
The issue is that these valuations only expanded as shares rose to $26 on the first day of trading, as a 30 times earnings multiple was far too demanding in my view.
Coming Down
After trading in the $27s soon after the IPO, shares of Kenvue have gradually lost some ground, now trading at $21 per share, to thereby actually trade below the offer price.
The IPO closed early in May as the ownership share of Johnson & Johnson has fallen below 90% following its former parent exercising its green shoe option.
In July the company officially initiated a quarterly dividend of $0.20 per share, but this was not a surprise, as it was telegraphed at the IPO. Around the same time the company posted second quarter sales of $4.01 billion, up 5% as reported, but up nearly 8% on an organic basis with adverse currency moves explaining the difference between both growth metrics.
Growth was seen in all the three reportable segments although really driven by self-care, as growth in skin health and beauty, and essential health was underwhelming. The 7.7% number growth number looks quite strong, but the reality is that pricing was responsible for 9.4% of growth, with volumes down nearly 2 points.
Adjusted operating earnings fell from $1.08 billion to $1.03 billion, but this is ahead of general costs, separation costs and depreciation and amortization charges. GAAP earnings came in at $0.23 per share, with adjusted earnings reported at $0.32 per share.
For the year, the company sees reported sales up by a midpoint of 5% from 2022, with organic growth seen a point higher. This should result in adjusted earnings between $1.26 and $1.31 per share which obviously is a bit higher than I believed at the time of the IPO. Net debt already came down to $7.2 billion, essentially equal to 2 times leverage.
In the meantime Johnson & Johnson made strives to quickly sell down its stake in Kenvue. In July, it announced its intention to exchange 1.53 billion shares of Kenvue for its own shares, which once succeeded would cut down its stake to just about 9%. This transaction closed in August, with Johnson accepting nearly 191 million shares in its own business in exchange for the 1.53 billion shares to be exchanged in Kenvue.
And Now?
Since the IPO we have seen the initial enthusiasm on the shares come down, as shares are now trading below the IPO level. While the company has seen strong growth in the second quarter, the quality of that growth is underwhelming, as all (and some more) of the growth is attributed to strong pricing.
Moreover, the overhang from a majority shareholder (and controlled interest) has been eliminated now as well, as Kenvue has actually seen higher than expected earnings (at last higher than expected by myself).
This has compressed the valuation multiple to about 16–17 times adjusted earnings here which looks compelling as leverage has come down a little bit a well. While the talc litigation should be with Johnson & Johnson, there are some risks related to a potential class action suit over cold medicine drugs, involving Kenvue.
That being said, the overall appeal has improved quite a bit as shares have convincingly moved lower since the IPO, all while earnings power has improved (in my view). That however comes with some negatives as well, that includes the fact that current growth is driven by pricing rather than volumes. This observation and potential that the new business might be involved in some (new) litigation, is never a great sign.
Given all this, my overall conclusion is that I am warming up to shares of Kenvue here, making me inclined to buy the dip to the $20 mark or even high-teens.
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