johnsone/initiation · Datasets at Hugging Face

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$500
$1,000
$1,500
$2,000
$2,500
$3,000
2019 2020 2021 2022 2023E 2024E 2025E
Net Working Capital Net Working Capital % of Sales
Source: Company reports and J.P. Morgan estimates.
Capital expenditures begin to step up slightly in 2023 (we model for 2.7% of sales from
2.5% in 2022 and 2.0% in 2021) and a bit more in 2024/2025 (3.0% of sales), although
the historical level is not necessarily apples to apples as the 2.0% range didn􀋖t allocate
enterprise-level costs that are now incurred as a stand-alone company. Capital
investments will likely continue to focus on digitization of the supply chain and also
building out capacity for growth.
This document is being provided for the exclusive use of DAVID WANG at MARLOWE PARTNERS LP.
32
Andrea Teixeira, CFA AC
(1-212) 622-6735
andrea.f.teixeira@jpmorgan.com
North America Equity Research
29 May 2023 J P M O R G A N
KVUE􀋖s capital expenditures are generally lower than peers historically, although we do
expect a step-up ahead as the company works to build capacity and capabilities as a
stand-alone company. As of 2022, KVUE􀋖s 2.5% capital expenditures as a percent of
sales benchmarks below peer average of 3.1% and median 3.3%, but we also note that
KVUE is relatively more asset light vs. HPC peers with 44% of volumes produced
externally. For comparison CLX has returned to a more normalized 80/20 split between
in-house and external manufacturing from around 50/50 during the pandemic.
Figure 50: Capital Expenditures vs. Peers
CY22
0%
1%
2%
3%
4%
5%
6%
7%
BEI EL KMB CL PG COTY OR CHD NWL CLX RKT HLN ULVRKVUE ENR HNST ELF OLPX
CapEx % of Sales Average Median
Source: Company reports and J.P. Morgan estimates.
KVUE announced its intention to pay 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.
Figure 51: KVUE Dividend Yield Compares Favorably to Peers Even after Share Rally
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
ULVR KMB NWL KVUE CLX RKT PG CL HLN OR EL CHD BEI COTY ELF HNST OLPX
Dividend Yield Average Median
Source: Bloomberg Finance L.P. and J.P Morgan estimates.
Other capital allocation priorities include likely bolt-on M&A. We see management
budgeting roughly $500-750M per annum for acquisitions, although we don􀋖t build in
any benefit from M&A into our model, and as such the M&A 􀋘placeholder􀋙 could lead
to increased cash returns to shareholders. At this point, we expect share repurchases to
be limited to offset share creep from stock-based compensation expense, although the
company could look to evaluate opportunistic share repurchases over time.
This document is being provided for the exclusive use of DAVID WANG at MARLOWE PARTNERS LP.
33
Andrea Teixeira, CFA AC
(1-212) 622-6735
andrea.f.teixeira@jpmorgan.com
North America Equity Research
29 May 2023 J PMORGAN
Valuation
KVUE Deserves Premium to HLN with Potential to Converge to CL over Time
Initial Discount Is an Opportunity, in Our View Should Fade Post Spin/Split
KVUE shares were priced at $22 at the IPO (toward the high end of initial $20-23
range) and closed +22.3% higher on its first day of trading on May 4, 2023. As of May
26, KVUE shares remain +19.5% above the IPO price. From a valuation perspective, at the IPO price KVUE shares implied around 13.3x/12.7x our 2023E/2024E EBITDA estimate and 19.9x/19.3x our 2023E/2024E EPS including amortization of definite life intangible assets (or 17.7x/17.4x 2023E/2024E EPS excluding amortization of definite life intangible assets as the company reports its adjusted earnings). Following the IPO,
KVUE now trades at 15.5x/14.7x our 2023/2024 EBITDA estimates and 23.8x/23.1x
our 2023/2024 EPS estimates.
We view the discounted valuation implied at the IPO price and attractive dividend yield
(~3.6% at IPO) as compensating investors for potential overhangs arising from 1) JNJ
still owning ~89.6% of KVUE shares post-IPO with the intention to make a tax-free distribution of additional shares likely by the end of 2023 (i.e., reduce ownership below
20%); and 2) KVUE retaining potential outside–North America liabilities tied to talc litigation. We also believe JNJ wanted to set KVUE up for a successful offering given it would still own such a meaningful stake in the business (i.e., price the ~10.4% well so it would have better monetization on remaining ownership).
De-Consolidation Process on a Tax-Free Spin-Off or Split
On the potential overhang from additional liquidity coming to the market, we highlight a few items to consider: 1) there are a number of ways ways JNJ could effect reducing its
stake – a spin-off (i.e., pro-rata distribution of KVUE shares to current JNJ shareholder)
or a split-off (i.e., exchange of JNJ shares for KVUE shares often at a discount), with a split-off more of an 􀋘active􀋙 decision to hold KVUE shares and thus may limit selling
pressure; 2) JNJ could decide to delay and/or not pursue a distribution of shares pending
market conditions; and 3) while there is a 180-day lock-up on selling/disposing of
shares post-IPO, our understanding is that the provision can be waived by the underwriters. There are a number of precedent transactions including recently the split-
off of Elanco (ELAN) from Lilly (LLY) in 2019 whereby LLY offered exchange for
ELAN shares at a 7% discount and in 2013 the split-off of Zoetis (ZTS) from Pfizer
(PFE) whereby PFE offered exchange for ZTS shares at a 7% discount.
Talc Liability Outside the US & Canada
On the potential talc liability, JNJ management on April 27 stated, 􀋘As unequivocally and unambiguously stated, Johnson & Johnson has agreed to retain all the talc-related
liabilities – and indemnify Kenvue for any and all costs – arising from litigation in the United States and Canada.􀋙 KVUE will retain potential liabilities relating to talc litigation outside of North America, but our understanding is that as of now there are only a handful of active claims outside of the U.S. and Canada, but to date KVUE management has not recorded any reserve liabilities relating to these claims, and the tort laws and consumer protections outside of the U.S. and Canada are not as robust. KVUE plans to discontinue the sale of talc-based Baby Powder globally this year (already

$500

$1,000

$1,500

$2,000

$2,500

$3,000

2019 2020 2021 2022 2023E 2024E 2025E

Net Working Capital Net Working Capital % of Sales

Source: Company reports and J.P. Morgan estimates.

Capital expenditures begin to step up slightly in 2023 (we model for 2.7% of sales from

2.5% in 2022 and 2.0% in 2021) and a bit more in 2024/2025 (3.0% of sales), although

the historical level is not necessarily apples to apples as the 2.0% range didn􀋖t allocate

enterprise-level costs that are now incurred as a stand-alone company. Capital

investments will likely continue to focus on digitization of the supply chain and also

building out capacity for growth.

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

32

Andrea Teixeira, CFA AC

(1-212) 622-6735

andrea.f.teixeira@jpmorgan.com

North America Equity Research

29 May 2023 J P M O R G A N

KVUE􀋖s capital expenditures are generally lower than peers historically, although we do

expect a step-up ahead as the company works to build capacity and capabilities as a

stand-alone company. As of 2022, KVUE􀋖s 2.5% capital expenditures as a percent of

sales benchmarks below peer average of 3.1% and median 3.3%, but we also note that

KVUE is relatively more asset light vs. HPC peers with 44% of volumes produced

externally. For comparison CLX has returned to a more normalized 80/20 split between

in-house and external manufacturing from around 50/50 during the pandemic.

Figure 50: Capital Expenditures vs. Peers

CY22

0%

1%

2%

3%

4%

5%

6%

7%

BEI EL KMB CL PG COTY OR CHD NWL CLX RKT HLN ULVRKVUE ENR HNST ELF OLPX

CapEx % of Sales Average Median

Source: Company reports and J.P. Morgan estimates.

KVUE announced its intention to pay 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.

Figure 51: KVUE Dividend Yield Compares Favorably to Peers Even after Share Rally

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

ULVR KMB NWL KVUE CLX RKT PG CL HLN OR EL CHD BEI COTY ELF HNST OLPX

Dividend Yield Average Median

Source: Bloomberg Finance L.P. and J.P Morgan estimates.

Other capital allocation priorities include likely bolt-on M&A. We see management

budgeting roughly $500-750M per annum for acquisitions, although we don􀋖t build in

any benefit from M&A into our model, and as such the M&A 􀋘placeholder􀋙 could lead

to increased cash returns to shareholders. At this point, we expect share repurchases to

be limited to offset share creep from stock-based compensation expense, although the

company could look to evaluate opportunistic share repurchases over time.

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

33

Andrea Teixeira, CFA AC

(1-212) 622-6735

andrea.f.teixeira@jpmorgan.com

North America Equity Research

29 May 2023 J PMORGAN

Valuation

KVUE Deserves Premium to HLN with Potential to Converge to CL over Time

Initial Discount Is an Opportunity, in Our View Should Fade Post Spin/Split

KVUE shares were priced at $22 at the IPO (toward the high end of initial $20-23

range) and closed +22.3% higher on its first day of trading on May 4, 2023. As of May

26, KVUE shares remain +19.5% above the IPO price. From a valuation perspective, at the IPO price KVUE shares implied around 13.3x/12.7x our 2023E/2024E EBITDA estimate and 19.9x/19.3x our 2023E/2024E EPS including amortization of definite life intangible assets (or 17.7x/17.4x 2023E/2024E EPS excluding amortization of definite life intangible assets as the company reports its adjusted earnings). Following the IPO,

KVUE now trades at 15.5x/14.7x our 2023/2024 EBITDA estimates and 23.8x/23.1x

our 2023/2024 EPS estimates.

We view the discounted valuation implied at the IPO price and attractive dividend yield

(~3.6% at IPO) as compensating investors for potential overhangs arising from 1) JNJ

still owning ~89.6% of KVUE shares post-IPO with the intention to make a tax-free distribution of additional shares likely by the end of 2023 (i.e., reduce ownership below

20%); and 2) KVUE retaining potential outside–North America liabilities tied to talc litigation. We also believe JNJ wanted to set KVUE up for a successful offering given it would still own such a meaningful stake in the business (i.e., price the ~10.4% well so it would have better monetization on remaining ownership).

De-Consolidation Process on a Tax-Free Spin-Off or Split

On the potential overhang from additional liquidity coming to the market, we highlight a few items to consider: 1) there are a number of ways ways JNJ could effect reducing its

stake – a spin-off (i.e., pro-rata distribution of KVUE shares to current JNJ shareholder)

or a split-off (i.e., exchange of JNJ shares for KVUE shares often at a discount), with a split-off more of an 􀋘active􀋙 decision to hold KVUE shares and thus may limit selling

pressure; 2) JNJ could decide to delay and/or not pursue a distribution of shares pending

market conditions; and 3) while there is a 180-day lock-up on selling/disposing of

shares post-IPO, our understanding is that the provision can be waived by the underwriters. There are a number of precedent transactions including recently the split-

off of Elanco (ELAN) from Lilly (LLY) in 2019 whereby LLY offered exchange for

ELAN shares at a 7% discount and in 2013 the split-off of Zoetis (ZTS) from Pfizer

(PFE) whereby PFE offered exchange for ZTS shares at a 7% discount.

Talc Liability Outside the US & Canada

On the potential talc liability, JNJ management on April 27 stated, 􀋘As unequivocally and unambiguously stated, Johnson & Johnson has agreed to retain all the talc-related

liabilities – and indemnify Kenvue for any and all costs – arising from litigation in the United States and Canada.􀋙 KVUE will retain potential liabilities relating to talc litigation outside of North America, but our understanding is that as of now there are only a handful of active claims outside of the U.S. and Canada, but to date KVUE management has not recorded any reserve liabilities relating to these claims, and the tort laws and consumer protections outside of the U.S. and Canada are not as robust. KVUE plans to discontinue the sale of talc-based Baby Powder globally this year (already