Kenvue Stock: Portfolio Filled Of Market Leaders (NYSE:KVUE)

Investment Thesis

Kenvue (NYSE:KVUE) reigns as the world’s largest pure-play consumer health company, boasting 5 powerhouse brands exceeding $1 billion in annual sales each, and a roster of others surpassing $400 million.

You might recognize some of their household names: Tylenol, Listerine, Band-Aid, Nicorette, Aveeno, and Benadryl, to name a few. What truly draws me to Kenvue is the unwavering consumer loyalty and brand reputation they’ve meticulously built.

Kenvue’s dominance is undeniable, they have five brand that generate over a billion-dollar in sales and have a number of holdings leading their respective categories market shares in North American: Nicorette (48%), Listerine (45%), Imodium (36%), Band-Aid (34%), Johnson’s (26%), and Tylenol (16%). This reign has persisted for over a decade, cementing their brand mastery.

The recent spin-off from Johnson & Johnson (JNJ) feels like a shrewd move for the newly IPO’d Kenvue. With management at the helm, they can now steer investment with greater autonomy, strategically allocating resources to fuel their market share growth and profitability. This commitment is already on display in their disciplined capital allocation model, ensuring a strong foundation for their independent journey.

Kenvue’s Q3 earnings presented a mixed picture, with sales volume dips in some areas offset by a strong performance in self-care. This segment’s strength stems from Kenvue’s powerful brand awareness, enabling them to navigate price adjustments more effectively than most in the industry. As a result, I expect continued strong numbers from self-care, fueled by their commitment to innovation and ongoing investments in marketing and branding.

Kenvue’s appeal for portfolio inclusion lies in its powerful combination of product diversity and established brand reputation. Their products are not just household names – they’re staples in bathroom cabinets and safety kits across the globe. This brand equity translates into pricing power, a crucial advantage in today’s inflationary climate. With renewed focus on growth and a compelling valuation post-spinoff, Kenvue ticks the boxes for a promising long-term value play.

Fundamentals

Kenvue’s cash flow machine is humming. With $2.84 billion in free cash flow (FCF), they boast a remarkable 6.76% FCF yield—exceptionally high for a consumer staple. This historic dominance and consistent cash generation give me confidence in their ability to sustain and expand operations.

Their abundant FCF fuels their well-defined capital allocation plan. They’re already repurchasing shares to counterbalance stock-based compensation (SBC), steadily hiking the dividend, and strategically targeting M&A opportunities. Since May 2023, shares outstanding have already climbed 2.5%, and I expect this momentum to carry into 2024. Keeping SBC as a percentage of sales under control will be crucial for stock performance and adjusted EPS growth.

However, debt is a potential wrinkle. Kenvue carries $8.35 billion on their balance sheet, with $7.75 billion stemming from senior unsecured notes issued to finance the separation and acquisition, guaranteed by J&J. While the guarantee offers some comfort, managing this debt effectively will be paramount for Kenvue’s long-term success.

Kenvue’s balance sheet isn’t flawless. Liquidity concerns and financing questions will likely linger for the next few years. However, strong and improving cash flow could quickly extinguish these worries. With a defensive product portfolio, Kenvue stands as a reliable value stock, offering a haven in volatile times.

The resilient product portfolio drives slow but steady growth. While gross margins are trending upwards, higher debt rates still weigh on the bottom line. However, I expect operating and net income margins to reaccelerate once the environment stabilizes. Improving gross margins and shifting headwinds into tailwinds can easily expand margins and boost earnings.

Management’s focus on stabilizing supply chains and improving efficiency further bolsters my optimism. These efforts will ultimately strengthen the bottom line and cash flow. Kenvue is strategically positioning itself for long-term success. Bumps and concerns are inevitable, but the strength of its portfolio, anchored by household names, gives me confidence in recommending it for long-term investors.

Price Target & Valuations

Kenvue’s fresh IPO status makes valuation a tad trickier. However, leveraging industry peers and anticipated company growth allows for a ballpark estimate. The key question remains: Should its established brands and strong margins merit a premium, or do looming risks warrant a discount?

Currently trading at 16.6x forward P/E, Kenvue sits slightly below the sector median of 17.88x. Its impressive gross, operating, and net income margins, all exceeding the sector median, suggest potential undervaluation.

Analyzing the stock’s ideal valuation range and analyst estimates, I constructed a next twelve-month price target scenario with bull, base, and bear cases. My assessment places Kenvue slightly below fair value, close enough to consider it fairly priced at current levels. Additionally, the low 1.4x risk-to-reward ratio reinforces my ‘Hold’ rating for the stock.

Kenvue’s 19% rally since its October 30th all-time low of $17.82 has undoubtedly eaten into the previously attractive risk-reward (R:R) profile. Below $18, the argument for significant upside with limited downside held strong, considering the plunge from nearly $27 to under $18.

But with the recent climb, Kenvue finds itself at a crossroads. Will it retest the $20 mark or push back towards its initial IPO price? Analyst price targets currently range from $20 to $26, and continued upward trends in margins and cash flow could easily propel KVUE back to its $27 peak in 2024. Long-term, Kenvue possesses the potential to become a dividend aristocrat, and its post-spinoff status might contribute to its current undervaluation.

Risk

Before considering Kenvue, it’s crucial to acknowledge the potentially significant risks:

• Talc Litigation Liabilities: The shadow of talc lawsuits inherited from Johnson & Johnson looms large. While the full extent of these liabilities remains uncertain, future settlements or lawsuits could saddle Kenvue with substantial debt. These cases have dragged on for years, suggesting this risk could linger for the next 2-3 years.
• Lack of Investor Interest in Dividend Stocks: In 2023, the broader dividend stock market has struggled. With risk-free returns exceeding 5% in Treasury bills and certificates of deposit, many investors are unwilling to make riskier investments for Kenvue’s 3% dividend yield. Until interest rates decline, value plays, particularly those with limited track records like Kenvue, may face continued investor neglect.
• Margin Compression from Competition: Competitive pressures can squeeze margins in saturated markets. Strategic price-cutting and the influx of generic brands and product replicas could challenge Kenvue’s margins in certain sectors. Consumer behavior also plays a role. During economic downturns, customers may opt for cheaper store brands, abandoning premium names like Kenvue’s. While this threat is cyclical, it’s worth considering.

Conclusion

Kenvue has strategically built a product portfolio that earns unwavering trust from customers. They deliver reliable, effective products at accessible prices, earning their place not just in bathroom cabinets but also atop market share charts.

The spin-off proved advantageous, even if financials paint an imperfect picture. Freed from J&J’s shadow, management can now laser-focus on key growth areas and strategically allocate resources for Kenvue’s specific needs.

Organic growth, strategic M&A, and shareholder-focused capital allocation are now at the forefront of their agenda. This, I believe, will consistently drive top- and bottom-line growth, generating ample cash to fuel the dividend.

While the stock’s recent surge necessitates a gradual entry, I have no qualms about holding Kenvue long-term in an income-oriented portfolio. J&J has historically rewarded shareholders, and I expect Kenvue to follow suit. At current valuations, I still see significant value in holding Kenvue.