EUR 850.00 For Business Accounts Only

Morningstar | Henkel Suffers Slowing Sales and Margin Compression in 1Q; Shares Remain Undervalued

Henkel’s first quarter was in line with our estimates on the top line, but as we stated at the company's full-year results of 2018, recent margin gains were proven not to be sustainable in the first quarter of 2019 as the gross margin came under pressure from rising commodity costs. Results were broadly in line with our forecasts, if a little weak at the gross margin, and we are reiterating our EUR 109 fair value estimate for the preferred shares. The inability to offset commodity inflation with price increases spotlights why we think Henkel is less competitively advantaged than some of its large cap competitors and supports our narrow economic moat rating.

First-quarter organic sales growth of 0.7% was exactly in line with our forecast, but is nevertheless disappointing, especially considering other large-cap consumer products companies such as Nestle and Unilever are beginning to reaccelerate growth. Weak sales were most pronounced in the adhesives technology (down 0.8% organically) and beauty care (down 2.2%). We think the adhesives business is fairly moaty, with switching costs in the industrial portion of that business, and we believe the current weakness is cyclical, driven by a slowdown in developed market industrial production. The beauty care business, on the other hand, is under structural pressure, particularly in Western Europe, where management said business was weak. With limited brand equity in commoditized consumer product categories, manufacturers are turning to increased spending on product development to drive growth. Over short periods, this strategy can succeed, as was evident in the solid 4.7% organic growth achieved in the laundry care segment in the first quarter. In the longer term, however, we think the sector's marginal cost is increasing, with customer acquisition costs rising. Pricing, therefore, is critical to offset this pressure, and Henkel's inability to raise prices is somewhat concerning.

On an adjusted basis, the first-quarter EBIT margin of 16.0% was 140 basis points below that of the previous year. This was roughly evenly split between slippage at the gross margin, as costs rose more than pricing, and higher spending behind the company's brands and selling infrastructure.

First-quarter results show that Henkel is continuing to underperform some of its close competitors. However, we believe this is fully reflected in the company's market valuation. Our fair value estimate does not relay on a strong rebound in sales--we assume normalized growth of 2.6%, below that of the large-cap peer group. It does, however, depend on margin expansion to the tune of one percentage point higher than that achieved this quarter, and we hope to see better margin performance from Henkel in the coming quarters.