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Morningstar | Thesis Playing Out as Formula Rebounds for RB; Limited Upside Remains

RB delivered a welcome beat and raise in the second quarter, amid signs that the company is getting close to returning to the above-industry average rate of organic growth that we think it can achieve in the medium term. Particularly pleasing was the fact that the upside came from the former Mead Johnson business infant formula business--a controversial acquisition, but one that we think will help deliver the upside to the stock. Management raised its full-year sales growth guidance slightly, and now expects reported sales to grow 14%-15%, a percentage point higher than the initial guidance. We are reiterating our GBX 7,300 fair value estimate and our wide moat rating, and we think some upside remains for RB, despite its outperformance over the last quarter.

Even considering that RB was cycling last year's cyberattack, which disrupted operations and shaved around a percentage point off the organic growth rate, this quarter feels like a big step in the right direction. Underlying sales growth was 5%, and 4% excluding the Mead Johnson acquisition. The infant formula child nutrition segment grew by 7% on a like-for-like basis in both the second quarter and the first half, driven by a midteen growth rate in China. In our comments on the first quarter, we had identified the formula business as the potential catalyst to reigniting growth, and given that Danone also posted an upside surprise in its formula business, the industry appears to be normalizing after a period of weakness. It was also pleasing to see that other segments chipped in with 3%-4% organic growth, at least in line with the industry.

While this was a good quarter for RB, it is noteworthy that the first-half adjusted operating margin deteriorated by 28 basis points year over year. This is also in line with our thesis, as we think emerging channels and a fragmenting consumer base are likely to increase the customer acquisition cost in the near to medium term. However, we think consumer health has some defenses against this threat, as its superior pricing power should enable it to offset these costs over time. Our valuation is dependent upon margin expansion of 150 basis points over five years, and we remain optimistic that this will be achievable primarily through price/mix.