Description

At a 5.4x Enterprise Value/EBITDA multiple, Edgewell (EPC) is currently the cheapest public consumer staple equity by a wide margin, appealing during a moment of extreme market volatility.  Work from home practices aside, we all still need to shave, apply sunscreen, use tampons and now more than ever, utilize antibacterial wipes. Brands under EPC’s umbrella include Schick, Intuition, HydroSilk, Skintimates, Edge, Hawaiian Tropic, Banana Boat, Bulldog, Jack Black, Playtex, o.b, Wet Ones and others.  The Company is inexpensive on both a historical and a relative basis. EPC has traded at 9.5x EV/EBITDA since its spin from Energizer in July 2015. Meanwhile, consumer staple comps trade at 13.3x EV/EBITDA. Today, EPC is trading at 5.4x.

Applying a conservative 7.5x multiple to a coronavirus adjusted 2021 EBITDA implies a $39 price target which is 70% higher than today’s $23 price.  Note that at the end of February, Goldman re-initiated on EPC with a 10x EV/EBITDA multiple and a $56 price target. Certainly the end of February was a lifetime ago, but the long-term (and private market) value of this Company has not changed over the last few weeks.

Business Description

The Company segments its business into three categories:

1) Wet Shave (60% of revenue, 65% of EBIT);

2) Sun and Skincare (25% of revenue, 22% of EBIT); and

3) Fem Care (15% of revenue, 13% of EBIT). 

Wet Shave is $1.3B of revenue, $250M of EBIT, and declining at a low single digit rate.  However, several of the major overhangs have abated, explained in more detail below.  Brands include Schick, Wilkinson Sword, Edge, Skintimate, Skin Guard, and Personna. Major competitors are Gillette, Harry’s, BIC, and, to some extent, Dollar Shave Club (DSC). 

Sun and Skincare is $460M of revenue, $80M of EBIT, and growing mid-single digits, but sales are dependent on weather as suncare is the main product category.  Wet Ones, an antibacterial wipe, is also in this segment and is ~$60M in sales and typically grows at a low-single digit rate. Major brands include Banana Boat, Hawaiian Tropic, Bulldog, Jack Black.  Competitors include Coppertone, Neutrogena, and an array of microbrands.

Fem Care is $310M of revenue, $50M of EBIT, and declining at a mid-single digit rate.  This business could stabilize in the next year or so but the declines have been persistent over the past few years, driven by customers aging out of the particular products that EPC specializes in.  Brands in this segment include Playtex, Stayfree, Carefree, and o.b. Major competitors are Kimberly-Clark and P&G.   

Why it is Mispriced

Strength in a recession and limited coronavirus exposure

Shaving habits and sun care usage rates are likely lower with work-from-home practices and spring break cancellations.  Furthermore, a recession seems probable going-forward, prompting an analysis of 2009 performance by EPC. At that time, Edgewell was a segment within Energizer but the brands were more or less the same as today, outside of some small acquisitions/divestitures. 

Organic revenue grew 3% in 2009 and profit grew by 10%.  The Company drastically reduced marketing spend which is a lever available to Edgewell today, according to contacts. 

2010 profit declined but largely due to marketing expense to support the launch of a new Hydro product in shave and the Edge and Skintimate brands, which had just been acquired.  The conclusion is that during a recession, topline performance is relatively unaffected, with the Company able to flex costs to preserve the bottomline. A coronavirus stay-at-home scenario is more challenging given possible lower shaving habits and vacation/outdoor time.

In Suncare, the category most impacted by coronavirus, 2Q shipments are likely to decrease as usage drops in March and April.  ~60% of Suncare sales occur during the four months between May-August with the other ~40% spread relatively equally throughout the remaining months of the year.  Suncare is a $300-$350M business, implying $16M/month in March and April and $50M/month from May through August is at risk. Roughly 1/3rd of March and April sales are tied to travel/spring break compared to May-August, which are more tied to weather.  We’ve assumed a $10M coronavirus sales impact in Q2 with additional risk the longer quarantines and social distancing are in place.    

Wet Ones, which is part of Suncare, was about $60M of revenue last year.  Demand is currently at extreme levels, and there may be a structural change underway in this business going-forward, even post-coronavirus.  Production has switched from 5 days to 7 days per week implying a 40% or $24M increase in sales if this persists. Our contacts have suggested this business ran at a 50% utilization rate, so it could potentially be up by as much as $60M (we are not underwriting this upside).

In Shaving, it is less clear whether work-from-home will impact demand for shaving products but we have modeled a small decline.  Fem Care will not be impacted at all.      

Confusing thesis changes

In March 2019, the new CFO (Rod Little) was promoted to be the CEO after a year on the job.  Two months later, Little announced a big acquisition of Harry's for $1.4B, with $1.1B in cash and $300M in shares.  Harry's generated $250M in sales and was burning $3-$4M of cash a month. The market hated the deal - it was expensive, dilutive, substantially increased the Edgewell debt load (5x gross debt post-close), had a lot of execution risk, and smacked of desperation to a lot of shareholders.  The stock traded from $42 the day before the deal was announced to $30 a month later. After a long FTC review, the FTC unanimously blocked the acquisition for anticompetitive reasons. In reaction, the stock traded up, hitting $39 on the day the deal was terminated (February 10). 

There is an investor base rotation happening right now, in addition to general market turmoil.  Value investors who initially owned the stock sold the Harry’s acquisition. Then buyers of the Harry's acquisition sold the FTC ruling.  Edgewell's internal IR has indicated they are fielding several new investor calls a day from value firms that appear to be kicking the tires again. 

There is also confusion over whether this Company is in long-term decline.  Certainly Wet Shave will continue to be pressured as Harry’s rolls out to retail in the near-term, grabbing market share and deterring price increases.  The Harry’s brand has resonated with consumers, with a “good enough” shave product at a low price point, and sales/marketing that has cost hundreds of millions of VC dollars.  Originally, the belief was that the direct-to-consumer (DTC) model would turn profitable at scale but this has not panned out as the customer acquisition costs have skyrocketed over time.  Harry’s has never been profitable, their direct-to-consumer business has burned through cash spectacularly and their retail business is not making money. We do not believe this path is sustainable for Harry’s and that longer-term, this historically oligopolistic industry should return to rational pricing (and price increases) typical in the industry prior to Harry’s emergence.        

Easier comps in the Wet Shave segment

EPC comps ease in the Wet Shave business as price cuts and market share losses at their #1 and #2 customers (Walmart and Target, respectively), in the Men and Women’s categories are mostly behind them.  The timeline and our estimate of the impact is as follows:

August 2016: Harry’s launches in Target (men’s business)

September 2016: Edgewell’s fiscal year ends.  Only 1-2 months of Target disruption captured in 2016 numbers.  Wet Shave down $16M or -1.1% yoy 

September 2017: Edgewell’s fiscal year ends impacted by a full year of Target disruption.  Wet Shave down $50M or -3.5% yoy

May 2018: Harry’s launches in selected Walmart stores (men’s business)

September 2018: Edgewell cuts price by $1/unit (13%) in the Men’s and Women’s businesses

September 2018: Edgewell’s fiscal year ends, impacted by 4 months of selected Walmart store disruption and one month of pricing cuts.  Wet Shave down $45M or -3.3% yoy

November 2018: Harry’s launches in all Walmart stores with an expanded assortment (men’s business)

February 2019: Harry’s launches Flamingo at Target (women’s business)

April 2019: P&G launches Joy at Walmart (women’s business)

September 2019: Edgewell’s fiscal year ends impacted by 8 months of selected Walmart store disruption, 11 months of remaining Walmart store disruption, 11 months of price cuts, 7 months of Flamingo disruption, 5 months of Joy disruption.  Wet Shave down $80M or -6% yoy

Total lost sales, 2016-2019: $176M versus a category decline of $25m (2.5% annually)

Our estimate for revenue impact is based on the customer split in 2016 below:

Nearly all the above is behind the company.  Harry’s now has more market share than Edgewell in Walmart and Target.  While Harry’s recently launched in Walgreens in March 2020 (and launches at CVS or Rite-Aid likely only a matter of time), share losses at these accounts should be meaningfully less painful than losing share at Target and Walmart given the absolute dollars at risk.  For our modelling purposes, we’ve assumed continuing declines in the segment despite low-single-digit category growth projections. 

Harry’s is likely to remain the only major new entrant in retail.  Dollar Shave Club (DSC) has made a conscious decision to focus on owning the customer relationship and therefore is strictly DTC.  In addition, DSC has already raised its prices – the 4-blade flagship box is $10 vs. Harry’s $9 – making it a more challenging fit for retail placement. 

As we mentioned above, Harry’s has spent hundreds of millions of VC dollars to gain entrance to this category.  The DTC model in shave is not profitable, and Harry’s is also losing money on the Target and Walmart deals to gain market share.  In fact, Target and Walmart, even with a higher sales take-rate from Harry’s, make less per Harry’s unit sold than on Edgewell or Gillette products since the price point is lower (after the initial razor buying/interest surge).  Once the dust settles, there’s good reason to believe that price increases will resume in the industry – incentives are strongly aligned for both manufacturers and retailers to do so. 

And lastly and further supportive of a resumption in growth, it appears that the beard/facial hair fad is stabilizing per Google Trends and based on conversations with industry folks that conduct customer surveys.  The average customer shaved 4.5x/week in 2013, which declined until 2018 and has since stabilized at around 4x/week.   

Underappreciated growth in Suncare segment

In Suncare, two tough years have obscured bright and sunny prospects for a segment that has grown 2% in both of the last two years despite category growth of mid-single digits.

Unfavorable weather explains weak results in 2017.  Then, in September of 2018, Edgewell voluntarily reformulated all Suncare products to exclude a chemical that European regulators banned.  This led to supply chain disruptions, and an inability to meet demand and some market share losses. The company lapped this dynamic and in Q1 the segment grew 13% yoy.  Furthermore, the Company is entering the Asia market this year where sunscreen is widely used and is growing as a category. These positive forces will of course be offset by the impact of coronavirus on seasonal travel and outdoor recreational activity but should be helpful overall.

Project Fuel restructuring charges temporarily obscuring true FCF generation abilities

The Company is in the middle of a three-year restructuring project related to supply chain and operations improvement that is expected to continue through 2021.  This obscures the true FCF generation potential of the Company, particularly in 2019 and 2020: 

*Note that the chart above excludes additional infant care sale proceeds of $12M in 2020 and 2021 

As you can see, Project Fuel should be done at the end of 2021 and the Company will generate $210M+ of FCF in 2022.    

Meanwhile, note that EPC is trading at 14.4% NTM FCF yield versus comps at 7.3% FCF yield. 

Valuation

Our forecast results in a $39 price using a 7.5x 2021 EBITDA multiple:

Risks

1. The coronavirus quarantine period lasts well beyond April, increasing headwinds (particularly in Suncare) the longer it lasts.

2. Unilever acquires Harry’s which is unlikely given the poor performance of their DSC acquisition and lack of profitability at Harry’s.   

3. Wet Shave is in long-term decline as competitive brands continue to take market share, leading to multiple contraction.

4. A transformative acquisition although the Company has expressed no appetite for anything larger than a tuck-in at this point ($200m or less).

5. Restructuring costs continue, post-Fuel.

6. Fem care revenue declines continue and cost cuts in this business do not keep pace, leading to margin degradation.      

Catalyst

1. Flight to quality: finding stable, predictable businesses during coronavirus volatility

2. Better performance in Wet Shave

3. Wet Ones outperformance

4. Successful end to Project Fuel in 2021, which will reduce restructuring charges and improve FCF

5. Share repurchases planned

6. Take-out potential