johnsone/initiation · Datasets at Hugging Face

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29 May 2023 J PMORGAN
Summary of Investment Thesis
As the largest pure-play consumer health company in the world, reaching 1.2 billion
consumers daily, KVUE benefits from participating in large categories where reliability
and performance matter for consumers. As such, we highlight five KVUE attributes that underpin our positive view: (1) resilient top-line growth, (2) room for margin expansion,
(3) high cash flow conversion and shareholder-friendly capital allocation, (4)
management􀋖s strong background not only with JNJ but other blue-chip CPGs with solid
relationships with key customers, and (5) attractive valuation.
• Resilient Top-Line Growth in Large Categories. KVUE has strong leadership in
three main categories (self-care, skin health & beauty, essential health) that combined represent around $369bn in sales globally. The company boasts a portfolio
of seven #1 global brands and 37 #1 regional brands, with the top 10 brands above $400M in sales. Based on market data, KVUE􀋖s largest brands are Neutrogena,
Listerine, Tylenol, and Johnson􀋖s baby. Management expects the categories to grow
at a compounded annual growth rate of 3-4% globally through 2025 and for the company to drive growth competitive with the market, implying organic growth of
about 4%, which we believe is doable and somewhat conservative. Given the strong
start of 2023 with 11% organic sales growth (OSG) in Q123, we anticipate that KVUE will grow 6% organically this year, but as the company laps pricing, we expect it to decelerate (similar to most peers) to ~4% OSG in the following years.
• Accelerating Growth with Innovation, Digital Marketing, Omnichannel distribution... From an innovation standpoint, KVUE spends about 2.5% of sales on
R&D, introducing products that meet unsolved needs rooted in clinical trials. KVUE has launched roughly 100 new products per annum over the past several years, and
innovation introduced over the rolling preceding three-year period has accounted for
about $1.5 billion in net sales each year since 2020 (about 10% sales mix). As with
most CPGs, KVUE has been directing more of its marketing spend (~9-10% of
sales) into digital media (about 71% of total in 2022). With that and its increased
relationship with key e-commerce retailers, the company was able to grow its online sales at a +20% CAGR from 2020 to 2022 to 13% online and double its Skin Health
& Beauty e-commerce sales. In North America, for example, the digital marketing
spend accounted for 73% of total marketing spend in 2022, which was up from 59%
in 2020 and 49% in 2019 and drove a +29% increase in media ROI as of October
2022 and collective 13 points increase in U.S. household penetration from 2019 to
2021.The average consumer review on Amazon is 4.6 stars vs. category of 4.4 ,
including Neutrogena, Aveeno, Lubriderm, and Clean & Clear.
• ….and Through New Product Adjacencies & Introducing Successful Brands in
International Markets. Despite having many #1 positions, many of the sub-
categories are fragmented, as we discuss in the market share analysis later in this
report. For instance, Neutrogena is the #1 facial care brand in the U.S. but still the #3 facial care brand globally. In the facial cleansing category, Neutrogena is the #3
brand in the U.S. among Hispanics and the #2 brand in the U.S. among Millennials.
It is also the #1 most reviewed brand in the skin care category on Amazon in 2022.
This allows KVUE to build scale behind core priority brands that are not fully
distributed in all markets. While KVUE has presence in 165 markets globally, it prioritizes eight markets: the U.S. (#1 market), Canada (#3), the U.K. (#5), Germany
(#7), Brazil (#4), India (#6), Japan (#8), and China (#2). We think the company
could follow the CPG playbook of 􀋘lift-and-shift􀋙 successful products to additional Kenvue (KVUE)
Overweight
This document is being provided for the exclusive use of DAVID WANG at MARLOWE PARTNERS LP.
5
Andrea Teixeira, CFA AC
(1-212) 622-6735
andrea.f.teixeira@jpmorgan.com
North America Equity Research
29 May 2023 J PMORGAN
geographies over time.
• Optionality in M&A as KVUE Evaluates Acquisitions to Enhance Core Portfolio and Capabilities. The company has undertaken a number of acquisitions
and divestitures over the past seven years with 15 divestitures and 10 acquisitions
since 2016. While not necessary to achieve its growth algorithm, the company plans
to continue looking at M&A opportunities, although it sounds like management is
intent on remaining focused squarely on the consumer health space and would be looking more for tuck-in vs. transformational M&A. We expect M&A to be focused
on faster growing, premium categories, as has been the case with recent transactions
(e.g., Dr.Ci:Labo and Zarbee􀋖s). We do not include M&A in our P&L estimates, but we do budget around $500M for M&A in cash flow.
• Room for Profitability to Continue to Expand and Lead to Operating Leverage.
We expect the reorganization of brands, lower costs, better availability of key raw
materials (shortage of silicone impacted SH&B division), and supply chain
optimization will lead to better profitability ahead. While there are some 􀋘dis-synergies􀋙 from the separation (e.g., TSAs and TMAs – as we discuss below),
we expect the phasing out of these expenses to become a tailwind to margins. From an EBITDA perspective, however, we do see KVUE generating profit growth ahead
of sales growth from 2023-2025 with a three-year CAGR of +6.1% vs. top-line CAGR of +4.3%, implying EBITDA margin expansion to 25.4% in 2025 from 24.1% in 2022 (roughly +130 bps expansion) and 25.3% in 2021. For context,
KVUE has a good track record of 200 bps gross margin and 250 bps EBITDA expansion in the last three years.
• Reliable Cash Flow (~100% Conversion in 2023-25). We expect KVUE to
deliver>100% FCF conversion (% of adjusted net income) in each of 2023-2025,
and we model for free cash flow to grow at a three-year CAGR of +11% to $2.8
billion in 2025. The free cash flow outlook is supported by solid adjusted EBITDA growth (as described above) and some tailwind from working capital management as inventory normalizes following a step-up in 2022 (more below), which more than
offsets cash separation costs expected to be incurred from 2023-2025 (around
$595M post-tax) and some step-up in capital expenditures.
• Best-in-Class Dividend Yield. KVUE dividend policy post-IPO will be a quarterly
dividend of $0.20 per share beginning in 3Q23 (fiscal quarter ending October 1,
2023), which at the current price of $26.30 implies an annualized dividend yield of
about 3.0% (at the IPO price of $22, the annualized dividend yield was closer to
3.6%). Looking ahead, we expect the company to target an annual dividend payout ratio of around 55-65% (JPMe 2024E 64%), and we model for 3% dividend growth
in both 2023 and 2024 as the company targets moderate growth in dividend per
share.
• Management Has Strong Expertise in Categories, Already Operating
Independently for +3 Years. KVUE has a strong, seasoned management team that will benefit from continuity as many of the c-level executive ushered in the strategic transformation beginning in the 2019 time frame through the IPO. Moreover, the consumer segment largely operated independently within JNJ historically, and as
such, even after the separation, the organization should be well positioned to
continue life as a public company. The management team has around 18 years of
experience in consumer goods and healthcare on average and is a diverse group
including over 58% women and representing nine different nationalities.
This document is being provided for the exclusive use of DAVID WANG at MARLOWE PARTNERS LP.
6
Andrea Teixeira, CFA AC
(1-212) 622-6735
andrea.f.teixeira@jpmorgan.com
North America Equity Research
29 May 2023 J PMORGAN
Risks to Rating and Price Target
• Execution Risk Tied to the Separation from JNJ. While the separation started in
2019, KVUE has never operated as a stand-alone company, and there is inherent execution risk tied to the separation from JNJ. The company will operate under
transition services and manufacturing agreements ranging from two to five years,
and there is no guarantee that Kenvue will be able to exit the agreements in a timely
manner in order to drive cost savings. Moreover, Kenvue may be unable to
successfully develop internal systems from an operational, financial, administrative,
or IT perspective as a stand-alone company or may be unable to successfully source new manufacturing for regulated OTC products that are currently being produced by
JNJ under the TMAs. Currently, the TMA covers certain SKUs of Tylenol, Motrin,
Benadryl, and others that account for less than 10% of KVUE sales.
• Potential Talc Litigation outside North America. Kenvue could be subject to talc-
related litigation outside the U.S. and Canada relating to claims that talc causes
cancer. We note that JNJ released a statement on April 27: 􀋘As unequivocally and

29 May 2023 J PMORGAN

Summary of Investment Thesis

As the largest pure-play consumer health company in the world, reaching 1.2 billion

consumers daily, KVUE benefits from participating in large categories where reliability

and performance matter for consumers. As such, we highlight five KVUE attributes that underpin our positive view: (1) resilient top-line growth, (2) room for margin expansion,

(3) high cash flow conversion and shareholder-friendly capital allocation, (4)

management􀋖s strong background not only with JNJ but other blue-chip CPGs with solid

relationships with key customers, and (5) attractive valuation.

• Resilient Top-Line Growth in Large Categories. KVUE has strong leadership in

three main categories (self-care, skin health & beauty, essential health) that combined represent around $369bn in sales globally. The company boasts a portfolio

of seven #1 global brands and 37 #1 regional brands, with the top 10 brands above $400M in sales. Based on market data, KVUE􀋖s largest brands are Neutrogena,

Listerine, Tylenol, and Johnson􀋖s baby. Management expects the categories to grow

at a compounded annual growth rate of 3-4% globally through 2025 and for the company to drive growth competitive with the market, implying organic growth of

about 4%, which we believe is doable and somewhat conservative. Given the strong

start of 2023 with 11% organic sales growth (OSG) in Q123, we anticipate that KVUE will grow 6% organically this year, but as the company laps pricing, we expect it to decelerate (similar to most peers) to ~4% OSG in the following years.

• Accelerating Growth with Innovation, Digital Marketing, Omnichannel distribution... From an innovation standpoint, KVUE spends about 2.5% of sales on

R&D, introducing products that meet unsolved needs rooted in clinical trials. KVUE has launched roughly 100 new products per annum over the past several years, and

innovation introduced over the rolling preceding three-year period has accounted for

about $1.5 billion in net sales each year since 2020 (about 10% sales mix). As with

most CPGs, KVUE has been directing more of its marketing spend (~9-10% of

sales) into digital media (about 71% of total in 2022). With that and its increased

relationship with key e-commerce retailers, the company was able to grow its online sales at a +20% CAGR from 2020 to 2022 to 13% online and double its Skin Health

& Beauty e-commerce sales. In North America, for example, the digital marketing

spend accounted for 73% of total marketing spend in 2022, which was up from 59%

in 2020 and 49% in 2019 and drove a +29% increase in media ROI as of October

2022 and collective 13 points increase in U.S. household penetration from 2019 to

2021.The average consumer review on Amazon is 4.6 stars vs. category of 4.4 ,

including Neutrogena, Aveeno, Lubriderm, and Clean & Clear.

• ….and Through New Product Adjacencies & Introducing Successful Brands in

International Markets. Despite having many #1 positions, many of the sub-

categories are fragmented, as we discuss in the market share analysis later in this

report. For instance, Neutrogena is the #1 facial care brand in the U.S. but still the #3 facial care brand globally. In the facial cleansing category, Neutrogena is the #3

brand in the U.S. among Hispanics and the #2 brand in the U.S. among Millennials.

It is also the #1 most reviewed brand in the skin care category on Amazon in 2022.

This allows KVUE to build scale behind core priority brands that are not fully

distributed in all markets. While KVUE has presence in 165 markets globally, it prioritizes eight markets: the U.S. (#1 market), Canada (#3), the U.K. (#5), Germany

(#7), Brazil (#4), India (#6), Japan (#8), and China (#2). We think the company

could follow the CPG playbook of 􀋘lift-and-shift􀋙 successful products to additional Kenvue (KVUE)

Overweight

This document is being provided for the exclusive use of DAVID WANG at MARLOWE PARTNERS LP.

5

Andrea Teixeira, CFA AC

(1-212) 622-6735

andrea.f.teixeira@jpmorgan.com

North America Equity Research

29 May 2023 J PMORGAN

geographies over time.

• Optionality in M&A as KVUE Evaluates Acquisitions to Enhance Core Portfolio and Capabilities. The company has undertaken a number of acquisitions

and divestitures over the past seven years with 15 divestitures and 10 acquisitions

since 2016. While not necessary to achieve its growth algorithm, the company plans

to continue looking at M&A opportunities, although it sounds like management is

intent on remaining focused squarely on the consumer health space and would be looking more for tuck-in vs. transformational M&A. We expect M&A to be focused

on faster growing, premium categories, as has been the case with recent transactions

(e.g., Dr.Ci:Labo and Zarbee􀋖s). We do not include M&A in our P&L estimates, but we do budget around $500M for M&A in cash flow.

• Room for Profitability to Continue to Expand and Lead to Operating Leverage.

We expect the reorganization of brands, lower costs, better availability of key raw

materials (shortage of silicone impacted SH&B division), and supply chain

optimization will lead to better profitability ahead. While there are some 􀋘dis-synergies􀋙 from the separation (e.g., TSAs and TMAs – as we discuss below),

we expect the phasing out of these expenses to become a tailwind to margins. From an EBITDA perspective, however, we do see KVUE generating profit growth ahead

of sales growth from 2023-2025 with a three-year CAGR of +6.1% vs. top-line CAGR of +4.3%, implying EBITDA margin expansion to 25.4% in 2025 from 24.1% in 2022 (roughly +130 bps expansion) and 25.3% in 2021. For context,

KVUE has a good track record of 200 bps gross margin and 250 bps EBITDA expansion in the last three years.

• Reliable Cash Flow (~100% Conversion in 2023-25). We expect KVUE to

deliver>100% FCF conversion (% of adjusted net income) in each of 2023-2025,

and we model for free cash flow to grow at a three-year CAGR of +11% to $2.8

billion in 2025. The free cash flow outlook is supported by solid adjusted EBITDA growth (as described above) and some tailwind from working capital management as inventory normalizes following a step-up in 2022 (more below), which more than

offsets cash separation costs expected to be incurred from 2023-2025 (around

$595M post-tax) and some step-up in capital expenditures.

• Best-in-Class Dividend Yield. KVUE dividend policy post-IPO will be a quarterly

dividend of $0.20 per share beginning in 3Q23 (fiscal quarter ending October 1,

2023), which at the current price of $26.30 implies an annualized dividend yield of

about 3.0% (at the IPO price of $22, the annualized dividend yield was closer to

3.6%). Looking ahead, we expect the company to target an annual dividend payout ratio of around 55-65% (JPMe 2024E 64%), and we model for 3% dividend growth

in both 2023 and 2024 as the company targets moderate growth in dividend per

share.

• Management Has Strong Expertise in Categories, Already Operating

Independently for +3 Years. KVUE has a strong, seasoned management team that will benefit from continuity as many of the c-level executive ushered in the strategic transformation beginning in the 2019 time frame through the IPO. Moreover, the consumer segment largely operated independently within JNJ historically, and as

such, even after the separation, the organization should be well positioned to

continue life as a public company. The management team has around 18 years of

experience in consumer goods and healthcare on average and is a diverse group

including over 58% women and representing nine different nationalities.

This document is being provided for the exclusive use of DAVID WANG at MARLOWE PARTNERS LP.

6

Andrea Teixeira, CFA AC

(1-212) 622-6735

andrea.f.teixeira@jpmorgan.com

North America Equity Research

29 May 2023 J PMORGAN

Risks to Rating and Price Target

• Execution Risk Tied to the Separation from JNJ. While the separation started in

2019, KVUE has never operated as a stand-alone company, and there is inherent execution risk tied to the separation from JNJ. The company will operate under

transition services and manufacturing agreements ranging from two to five years,

and there is no guarantee that Kenvue will be able to exit the agreements in a timely

manner in order to drive cost savings. Moreover, Kenvue may be unable to

successfully develop internal systems from an operational, financial, administrative,

or IT perspective as a stand-alone company or may be unable to successfully source new manufacturing for regulated OTC products that are currently being produced by

JNJ under the TMAs. Currently, the TMA covers certain SKUs of Tylenol, Motrin,

Benadryl, and others that account for less than 10% of KVUE sales.

• Potential Talc Litigation outside North America. Kenvue could be subject to talc-

related litigation outside the U.S. and Canada relating to claims that talc causes

cancer. We note that JNJ released a statement on April 27: 􀋘As unequivocally and