Reckitt Benckiser Group plc (RKT) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by and welcome to the RB Half Year 2020 Q&A session. [Operator Instructions] I must advise you that this conference is being recorded today, Tuesday, the 28th of July 2020. I would now like to hand the conference over to your speaker today, John Dawson. Please go ahead, sir.

Thank you, Heidi, and welcome, everybody. Thank you for joining us on our Q&A conference call for our half year results 2020. With me today, we've got Laxman Narasimhan, our Chief Executive; and Jeff Carr, our CFO. Before we kick off with the Q&A, I'm just going to ask Laxman to give a few opening comments, and then we'll go into the Q&A session after that. Laxman, over to you.

John, thank you. Thank you all for joining, and I hope you and your families and friends are safe. There are 4 key messages I will quickly recap from today's presentation. First, consistent with our messaging on our Q1 trading update, RB is off to a stronger-than-expected start for 2020. Importantly, in addition to the demand tailwind from COVID-19 on several key brands, we are pleased that our underlying sales trends are also performing above our plan. Second, RB is making good progress regarding the strategy outlined in February designed to rejuvenate sustainable growth. I believe we have made significant strides in improving our execution. We're also making good progress building an organization with the right capabilities and culture to realize the long-term opportunities for the company. Third, COVID-19 is having a profound effect on consumer behavior, not just for a few months or quarters. Our research suggests that the increased interest in hygiene and health is likely to be sustained over time, albeit at more moderated levels, and our portfolio is well positioned to benefit and navigate the additional macroeconomic challenges we expect. There is no question that our purpose and fight, which we announced at the end of February 2020, are even more relevant in these times. Fourth, we plan to leverage our strong outperformance in early 2020 by increasing the level and expanding the scope of our investment spending. Those are our summary messages. I'd like to hand this back to John, and we'll be glad to take your questions.

Thank you very much, Laxman. So what we'll do is we'll open the call now to questions. For those of you participating, I know you love your calls, why don't we open it up and ask Celine to kick off with the first question.

It is about the acceleration in underlying sales growth, you said it's above plan. I noticed in your presentation, strong market share gains. So I wanted to understand, why do you think in such a short period of time this has been delivered? And/or whether you have seen also the underlying growth coming from better demand in some areas? And also, if you could, on that front, talk about the white space opportunity and quantify it that you see in professional hygiene. My second question is on Nutrition. And I noticed that you seem that -- more positive about the underlying performance in China in the second half of this year. Can you talk a bit about the Chinese market, where the growth opportunity is and how you have developed in terms of lower-tier cities as well as understanding the performance? You said that you had a local product, I heard that in your presentation. So I would like to understand in terms of innovation and production capabilities where you stand on local production.

Well, thank you very much, Celine. Let me talk to the first question around the acceleration. There's no question, first of all, that we have benefited from COVID-19 overall. But if you look at what has happened over the last year or so, there have been 6 areas that the focus has been in terms of driving much better execution. The first area is supply chain. I think if you recall, in October last year, we talked about some of the challenges we faced in the supply chain, something I amplified in February when we spoke. We've been working on this since September itself, improvements in planning, improvements in forecasting, improvements in customer relationships. And while we did have some challenges with our fill rates through September, October, November, what we've seen since then is a steady improvement in that. And coming to the end of February, we actually saw material improvements in how we were serving our customers. Clearly, post-February, and the demand has been quite excessive, we have seen a drop off in that. But overall, I would say, underlying, the supply chain has done very well. And even in the time of the pandemic, you're seeing evidence that the team has really stepped up in the way they performed on the supply chain. So I feel very grateful for what they've been doing while ensuring our people are safe. The second area is in sales execution. I mentioned this briefly in February. But one of the big skills or capabilities that RB had before was in the way that it actually drove sales. Unfortunately, over the last few years, that had been cut back. We've been investing in this since September. And our sales execution program, our sales stimulation program has now rolled out to over 50 countries. The third area is marketing spend. This is still work in progress. We spend healthily in the area of marketing. One of the things that we have said in February was it will be good for us to adopt some of the more advanced tools in terms of really embracing marketing spend optimization, and that has happened in several markets. It hasn't happened all over, there's still work to be done. But I feel good about the progress we're making in marketing spend as well as the establishment of our marketing excellence capability, which is housed in our Hygiene business and will be scaled up over the course of our entire company. The fourth area is productivity. If you look at productivity, we had announced the fact that we were stepping up productivity, and we did. In the first half of the year, we're above plan on productivity. And this, despite the fact that we had to resequence some of the programs in productivity in order to ensure that we can make things happen at a time of the pandemic and the challenges that it actually produces in its own way. The fourth area is really in the organization, the purpose and the fight. We evolved to the new organization structure of 3 global business on July 1. The purpose that we articulated, "We exist to protect, heal and nurture in the relentless pursuit of a cleaner and healthier world." is something that our organization has truly embraced, and the fight is deep inside the company. The level of engagement that we have in the company is at an all-time high. Pride in the company is about 11 points higher than the peers, based on surveys that we have done and benchmarks that we have done. And so the purpose fight in the organization has taken hold. And the final area of step-up is really in e-commerce, something I'll touch on as well in the case of the infant formula business. But our e-commerce business is one that we have invested in capabilities over the last many years. And as we came into September and January this year, we amped up the investments even more in e-commerce, and you see that in the performance of the business. So consequently, when you start looking at the underlying performance of the business and the acceleration, it is driven by what has happened along those 6 fronts. On your question on the white space with professional. Clearly, consumers are anxious. They want to feel safe, not just at home, but also where they go. The second is our brands are a large trust mark at this time, and we try to highlight for you just the scale of some of these brands. The retail sales of just Dettol and Lysol are over GBP 4.5 billion. And then on top of that, you have brands like Sagrotan in Germany and Central Europe. You've got brands like Napisan in Italy, Australia and use in Japan. So our brands are a large trust mark at this time. Our partners like this. We've been very selective with whom we partner and we are moving with speed. Some of our partners have independently done work on which brands are the right trust mark in this time, and they have highlighted, they have highlighted that Dettol and Lysol are very strong trust marks. And so if you look at the partnerships we've announced with Delta, which we did yesterday; or Hilton Hotels started with the U.S., then, of course, the rest of the world, including China; the Avis Budget Group; or Grab, which is a shared service -- a shared riding service across many markets; Uber in some countries; or PVR Cinemas in India, what you see is the breadth of the different sectors where bringing this kind of trust mark really matters. Other companies have talked about this business being a mid-single-digits part of the overall portfolio. We see that. What we are thinking very much, of course, is that this is about front-of-house appeal. And we are building supply for this business and ensuring that we have partnerships and logistics capability for this business. So we see the headroom and we are approaching this, and approaching this, of course, with the usual caution, ensuring that the execution of this is consistent with our brands, the standards of our brands and the trust mark that they deliver to our consumers at this point in time. On Nutrition, which is your second question, to go to the underlying performance. Let me just touch on China and your question there. Firstly, let me talk about the challenges. Hong Kong, the Hong Kong market has been a challenge for us. We didn't expect, of course, the situation to continue like it has, and it has impacted us. And we are more exposed to Hong Kong than most. And so that has been a negative drag on our business. Now we have offset this with the performance in mainland China, and I feel positive about the performance in mainland China in the way that we have grown this business and grown the -- our market share and customer acquisition as well as the way we've been expanding the business and the way we're executing off-line in stores as well as online with e-commerce. Our business in some of the lower-tier cities has grown, and it has grown with a combination of what we're doing with e-commerce as well as what we are doing as we look at off-line distribution to those different cities. With regard to your question on local production, we've introduced the brand that is made in our factory in China, and that is the transition that we have been going through. Early results are -- or early interest is good, and we're looking to see how this brand does. It clearly is a complement to what we have at Enfinitas, which is our super-premium brand that continues very well and that continues to grow and take share.

Thank you very much, Celine. Thank you, Laxman. Let's take the next question from Richard Taylor at Morgan Stanley.

I've got 3 questions from my side, and they're on professional, penetration and profitability, so they're 3 Ps. So on professional, can you give us a little bit more color on how big size-wise you think that opportunity is? And also, should we assume that it's margin-neutral? And then secondly, on penetration and distribution. You said in the past the opportunity is huge. Can you give us an idea of the progress you've made on this? And then on profitability, you said in your own slides that the operating leverage in the first half was 360 basis points. If we take your full year guidance of 8% to 10% for the full year, that implies another 4% to 6% top line in the second half. So broadly, that should be another 150 basis points of operating leverage. And then you'll get more from raw materials and lower media rates. So if we add all that up together, that 750 to 800 basis points of investment that's implied for the second half. So can I clarify that you're spending over GBP 650 million in P&L investment in 2020, please?

Richard, let me take the first and the second question and leave the third question for Jeff, if that's okay. All right. So on professional, we have -- we clearly recognize the fact that our brands play very well in areas where they need to communicate a trust mark to our consumers. So we're approaching this business cautiously and building it out steadily. We have moved with speed though with some pivotal partners and feel good about the type of arrangements that we have set up with them. These are not sort of short-term contracts, these clearly are longer-term contracts. And given our focus, which is really on front-of-house brands and front-of-house propositions, and given the different mix of costs and brand building that we have, these businesses are largely margin-neutral. And again, that gets back to how we're trying to build this business. On your second question on penetration. The sales execution program that I mentioned earlier is now in over 50 countries. There is a very clear focus on the different points of distribution, what SKUs are available at what store, how we're executing at point of sale, challenging, by the way, in these times with a pandemic. And what you are seeing is actually an increase in the points of distribution. If you look at India, we've seen increases in points of distribution, and the overall India business grew high single digits in this time. So it's further complemented by the fact that even with this pandemic, you are seeing shifts in consumer behavior. There are more consumers entering these categories. And you saw that with a brand like Lysol in the U.S., where we gained over 600 points of share, that is driven by a combination of increase in penetration as well as an increase in frequency with our core consumers. And so penetration is an area of great emphasis for us because, at the end of it, what we have to do is drive category building, and we believe that this is an area that the entire company is very focused on. On your third question of profitability, let me hand this over to Jeff. Jeff?

Yes, thanks, Laxman, and thank you for your question, Richard. Yes, look, I can confirm we are making considerable investments in 2020, even though as we've said in our statement, those investments to date are a little behind where we expected them to be, and they'll be more heavily weighted to the second half of the year, and some of those investments will actually cross over into 2021. So we will be making significant investments in the key areas in terms of price and investments in price. We'll be making investments in marketing execution, opening up new white spaces and new categories like professional. We'll be making investments in commercial fixed costs which run into many areas, but they're areas which are focused on developing the muscle for long-term sustainable innovation and top line development, areas such as R&D, regulatory; investments in sales execution; investments in digital and e-commerce, which you're already seeing success from. So we'll be making investments well over GBP 500 million. I'm not going to get into the specific number, but well over GBP 500 million. And you can see from the margin bridge that we provided in the presentation that we had significant leverage in the first half of the year. Now in addition to the investments, which come from both the productivity program, which we're reinvesting and which is delivering on schedule, is slightly ahead of schedule in the first half of the year, and then also in terms of the transformation cost and the margin reset. But against that, we also have significant COVID costs. We incurred around GBP 69 million of COVID-related incremental charges in the first half, which is around 100 basis points. We talked in February about the headwinds that we have on margin, and these are a little higher than we anticipated. This is largely variable pay, running at around also 100 basis points. And then we have the impact from various one-off costs, which partly include the margin effect of the revenue recognition adjustment, but also, as I mentioned in the trading statement, some legal charges and various onetime charges which we've incurred in the first half. So if you sum that together, yes, we have room to invest well over GBP 500 million this year. And that will be stepped up with significant investments in the second half of the year as we invest to make sure that we capture the growth opportunities and build increased confidence in delivering mid-single digits in the medium -- top line growth in the medium term, which is in line with our guidance. So thank you, Richard.

Thank you. So let's take the next question from Iain Simpson, please.

A couple of questions from me, please. Firstly, I'd be interested to understand the phasing of the step-up in Dettol and Lysol. I think manufacturing, not end demand, has been the limitation there thus far. And just to help us think about Q3, what was the shape of your second quarter for those brands? Was June stronger than April as you ramped up demand? Or anything along those lines would be very helpful. Secondly, just thinking about your margin guidance. You've talked about 350 bps of investment versus 2019 for 2021. Now given your commentary around COVID-19, it's pretty clear you're going to have a bigger business in 2021 than we would have assumed 6 months ago as consumer behavior has shifted. So how much of that 350 bps of investment could be offset by operational gearing? And then sorry to get overly detailed, but thinking about variable pay. Now top line is presumably coming in well ahead of expectations this year. So variable pay is likely to be more than the 100 basis points of headwind that you previously guided for. But then thinking about 2021, your top line guidance is pretty disappointing. So presumably, an element of that variable pay unwinds. I just wondered if any commentary on what you're doing there and how should we should think about that as the moving part.

Laxman, would you like me to take a couple of these questions?

Yes, go ahead, Jeff. Yes.

So thank you, Iain. Let me take on your question about 2021 being larger and what does that mean in terms of the 350 basis points. We're committed, as we say in the guidance, to deliver the full 350 basis points of investment. And what we've also said is we'll increase the investments by reinvesting available leverage this year. So what that message is, is clear that we are -- we see opportunities to invest in growth. We have real potential at this point, and we don't want to constrain our businesses, so we will be making the full investments of the 350 basis points. We'll be monitoring that very carefully to make sure we're making the best investments and we're getting the right returns for those. But within the areas that we described in terms of professional, in terms of the white spaces, clearly, we see significant opportunities. And of course, with the economic outlook and the uncertainty around health, we need to be cautious about what that can deliver. We'll get into that in more detail as we go through later. As we have some more quarters under our belt, I think we'll be able to have a clearer understanding. But clearly, we're in strange times. So putting together more changes to the forecast other than what we're giving, I think, would be unwise. In terms of variable pay, we accrue based on expectations. And for 2021, we'd expect variable pay to be at a mean level. That's how we start the planning for each year. Obviously, we're below the mean level last year, and we'll be above it this year. So yes, there'll be a bit of a giveback in 2021. And the way we organize that is obviously, as we outperform, we accrue the variable pay to a higher level. In terms of the first question, which was how the run rate is. For the disinfectant franchises, we continue to see a strong performance. So for example, again, in the presentation this morning, we mentioned that Dettol was around 60% for the half, but it stepped up to 80% in the second quarter. So clearly there, you can see a step-up in the second quarter. Now we're making estimates of how that's going to play out for the second half of the year and for 2021, the same as everyone else. It's clearly very uncertain times and we need to have a level of caution about our estimates of how that's going to play out. But clearly, we see an opportunity to continue to develop those brands, and that's where we'll be investing as we go forward. I hope I answered all of your questions, Iain.

Just very quickly, how did June compare to April for Dettol?

As I said, the second quarter -- the run rate in the second quarter was higher than the first quarter. I'm not going to get into month-by-month interpretation of individual brands. But clearly, the second quarter run rate was higher than the first quarter. As we look to the third and fourth quarters, we have to have an element of caution about us. And we -- I'm not going to get into a quarter-by-quarter guidance. I think it's clear in our full year guidance that we expect the total franchise to be at high-single digits. That takes into account not just the disinfecting brands, but also how we see the development of areas like OTC, where we're predicting there's going to be quite a weak cold and flu season.

Thank you very much, Iain. Let's take the next question from the line of Tom Sykes.

Just firstly, on the supply side and your use of co-packers in contract manufacturing that you mentioned in the presentation. How should we think, given the demand, potential volatility, potential second wave, how will you be maintaining your flexibility at the same time as looking to bring on additional capacity? And is there any sort of number that we should think about in terms of how much you may be internalizing externally produced revenue at all or -- and the degree to which you'd be internalizing co-packer produced product? And then in terms of the SKU reductions that you spoke about in the presentation, those obviously were relatively meaningful points. Will you be getting behind a fewer number of SKUs going forward? And how does that square them with the innovation cycle that you have? And how important may have the tail of SKUs been historically when people were trading down in a cycle at all, please?

I think it's a very good question, Iain, thank you. Sorry, Tom, thank you for it. On the supply side, we're being -- clearly approaching this in the short-term with arrangements that help us bridge the demand-supply gap with partners that we have worked with over the years. And by the way, at the same time, investing in lines, simplifying what we do in order to increase our own throughput from our own manufacturing factories. So we're doing both. If you look at the CapEx guidance that we had given in February, and you look at what we are telling -- saying now, we are clearly looking at increasing the CapEx from February by about GBP 100 million. And what that will do for us is give us some flexibility around where we believe it's the right for us to make it on our own versus how we think about partners and others in order to get supply with the flexibility that it also brings. So we're watching this very carefully and balancing both, recognizing, of course, that there is demand to be met and quality standards to be tapped. And so given all of that, that's the extent to which I can give you a sense of how we're thinking about it. So it's clearly an area of focus for us. On your question of SKU rationalization, I'll give you an example. In the factory in Wuhan in China, we actually eliminated 80% of the Dettol SKUs when we were at the peak of the pandemic, largely to increase capacity or to increase the throughput of some of the core SKUs. We're now up to only a 20% reduction. And we've been very cautious about things that we bring back in order to ensure that they meet consumer demand, they have the right turns and they're innovation that actually works. We also have a whole pipeline of innovation that we need to overlay on all of this. And we're working that. Some of that has been delayed to the back half of the year, to the early part of next year, just as we focus on meeting the core. It's not that we don't have a pipeline, we do. But again, we're being very thoughtful. And your point about the tail of SKUs is correct. We are focused on them. We understand the cash contribution of the SKUs. We also recognize the complexity that some of these SKUs bring. And we also understand your point about the role of these SKUs in meeting lower price points or pack sizes for channels as the case may be. So we're balancing all of that as we look ahead.

Thank you very much. Let's take the next question from Guillaume Delmas.

Two questions for me. The first one, going back to your medium-term like-for-like sales growth expectations. In the press release this morning, you talked about the increased relevance of your categories that will remain at a higher level than pre-COVID-19. You also talked about incremental investments of GBP 100 million to accelerate growth in disinfectants, e-commerce, professional services. So basically, putting all that together, it seems you're talking about higher category growth, the higher level of outperformance going forward led by these additional opportunities. So should we then conclude that you now see some upside relative to the medium-term like-for-like sales growth outlook you provided back in February, and particularly when you were talking about reaching 3% like-for-like sales growth by 2023? And my second question is on e-commerce. Expanded very fast in the first half, now 12% of your sales, and it seems like a clear priority going forward. How should we think about the level of profitability of your online business today? And I appreciate this is not a homogenous business, but overall, is e-commerce, at least today, accretive to your gross margin? And I guess more importantly, how do we -- should we think about the profitability of e-commerce going forward?

Guillaume, thank you for both questions. Let me address the first one because it is obviously the big question. You are correct, we are reporting better-than-expected performance of the underlying business. We do see structural shifts in consumer engagement in hygiene and health that favor some of our categories. We are expanding investment. And so your question is correct, why aren't we increasing our medium- and long-term growth expectations? As I said in the presentation, the answer to this question really has 3 parts. We unquestionably have greater confidence in achieving our medium-term growth and margin goals. And second, while we feel confident, even perhaps leaning towards, if I might say, being more bullish, we recognize that we are operating in a highly uncertain time. There are significant public-health challenges out there. There could be economic dislocations that happen and happen, frankly, with very little notice. And we're only 6 months into the implementation of our strategic plan and transformation. I'd like to tell you that, hey, it's all done. But the reality of this is this is early progress, and we are pleased with it. But we do not want to get ahead of ourselves. And so what I'd like to do is to suggest to you that we will update you next February on our journey. So that's the first question on guidance. The second question on e-commerce. As I said in February when we talked about our growth agenda and what we would invest in, we had highlighted in February that e-commerce was, in fact, an important area of growth for us. In the first 6 months, our gross merchandise value, GMV, for e-commerce was around GBP 1.5 billion in the first 6 months. Now this business has multiple models in it, and therefore, it's actually very complex. And as you rightfully put it, it is not homogenous. We have be big. We have be bold and fast. And finally, we have be open, which essentially includes as well several of the rocket brands that we're incubating, including the partners. As we look across the mix of those 3, what I would tell you is that if you look at the gross margin level that we're able to achieve, particularly with mix, and particularly if you look at categories like sexual well-being, which are very sensitive to e-commerce given the privacy concerns, and if you look at the assortment that we have, what we have over here is a mix that on the gross margin side is not dilutive. We watch that and manage that very carefully.

Excellent. Let's take the next question from the line of Alicia Forry.

Two questions from me. First, on the underlying 3% to 4% like-for-like growth. Can you give us some indication how this breaks down between Health and Hygiene? Are they running at similar rates now? Or is Hygiene still performing a little bit better than Health, ex COVID? And then secondly, I wonder if you could dig into India a little bit more, especially now that it is out of lockdown. I think you said it was up high single digits in H1, which is quite impressive. Is there any further detail you can provide on how that business is performing?

Let me give you a little bit around the 3% to 4% and then on to India. The underlying 3% to 4% at the end of the day is a judgment. We run multiple analytic models, 3 different analytic models to try and understand what the underlying growth is. We recognize that we have certain brands that have benefited from this, certain brands that have not. We're also dealing with lap issues in certain parts of the business. And if I were to, therefore, look at it across the board, we've ended up with 3% to 4% as being the right judgment in what we believe is happening in terms of the underlying business and its performance. At this point in time, I would say to you that if I look at the operating part of the business, the Hygiene business is clearly doing well, no question about it. And I think Health is improving but is not at the same level as Hygiene. So we're clearly working to improve that. And it goes back to the things I talked about, about the things we're doing in an underlying level to improve it. But there's really been an improvement in Health, but it's going to take more time. So that's the underlying 3% to 4%. On your comment in India, let me give you a couple of things. First of all, it did perform -- it did grow high single digits in this period. Dettol, as a brand, is a power brand in India and in fact achieved the #1 share in soaps in India for the first time. It bores down certainly to the fact that there are tailwinds that you get from COVID in India, but it also boils down to some of the execution improvements we are seeing in both the Health business as well as the Hygiene business. What we are seeing there is a focus on distribution, a focus on ensuring availability, which hasn't been easy given all the lockdowns in India in various places and at various points. But I really compliment the team for its resilience in working through all these different challenges and achieving the result that they have. It also gets down to brand building. I think you've seen some of the work we've done on brand building. And the Dettol TikTok campaign in India is a great example of it. We had 124 billion views of this campaign. And so what we are doing there is not just a focus on financial results per se in the short term but also building the equity of the brand. And the Dettol brand equity is at one of its highest points. We're also heartened by the progress we're seeing in Lysol as well as in Harpic in India and the continued scale-up of that business. I also feel good about the fact that we're doing this in the right way, and some of the investments we have made as well with the public health authorities to communicate the lessons of hygiene in India, the product donations that the team has done. We've donated 10 million units of soap in India with Dettol. We've also donated over 1 million liters of Lysol and Harpic in the market. So it's a pretty holistic view around how we're committed to India. We do recognize, of course, that it is a country that is going through a lot right now, and the team is focused on ensuring that we are as supportive as we can to the country. It is clearly an important market for us.

Let's take the next question from Martin Deboo at Jefferies.