Description

Description:  Edgewell was spun off from Energizer in July, 2015. It is one of the world's largest manufacturers and marketers of personal care products in the wet shave (60% of sales), sun and skin care (17% of sales), feminine care (16%) and infant care categories (7%). Edgewell's brands include Schick, Edge, Skintimate, Banana Boat, Hawaiian Tropic and Playtex.

Thesis: The proliferation of online shave clubs (Dollar Shave Club, Harry's) has led to market share losses by the incumbents (Gillette and Edgewell). The acquisition of Dollar Shave Club by Unilever brings a consumer staple powerhouse into the category which should lead to additional competitive pressures. Despite weak fundamentals YTD, Edgewell is guiding for a significant ramp in sales and margins in Q4 despite record levels of promotional activity by Gillette. Bulls hope for a takeout but the arrival of Unilever coupled with the departure of Edgewell's Chairman (who left a significant amount of unvested options on the table) decreases the likelihood of such an event.

Secular Challenges from Online Subscription Clubs: In the past five years, online shaving clubs went from 0%-10% market share in the U.S. mens shaving market. Dollar Shave Club has about 3M members in the U.S. and Harry's reportedly has 2M. Online shave clubs offer convenience and cost less. Harry’s sells five-blade cartridges for $2 apiece, while five-blade cartridges by Gillette sell in stores for $5 each. An August 3rd blog post at Target.com announced a partnership between Harry's and Target to bring Harry's products to the mass retailer. According to Target’s senior vice president of Beauty and Personal Care, John Butcher: "With companies like Harry’s, the men’s grooming industry is changing quickly. This evolution is largely driven by the way men are shopping these days. They’re extremely selective, buying online more than ever before, and also care more about expressing their personal style than past generations." Gillette recently launched its own online club where it is discounting its own cartridges in order to stave competition. Gillette offer a Mach 3 razor along with 5 blades and one 7 oz. shaving gel for $16.99 per month. This is a significant discount to retail price. For example, Amazon sells Gillette blades with shaving gel (excludes the razor itself) for $19.99. It isn't surprising that Gillette has been growing faster than Edgewell in three of the past four quarters as Gillette is well ahead of Edgewell with its online strategy. According to data from Euromonitor, Edgewell's share peaked in 2011 at 19.1% in the U.S. and fell to 15.5% in 2015.

Unilever Entering the Men's Grooming Market: Unilever recently acquired Dollar Shave Club for $1B dollars. Unilever is the #1 company for mens growing ex-shaving with brands like Axe and Dove. According to Unilever, "we're buying an innovative and disruptive brand with a cult-like following." The emergence of a major player like Unilever to the shaving market is a significant development and a negative one for Edgewell who is much smaller with less scale and resources at its disposal. Unilever hinted that it will deploy the subscription model internationally and will leverage its strength in mens grooming to support share growth in razors.

Chairman Retirement a Negative for Takeout Bulls: Ward Klein, Chairman of EPC, retired at the end of April. Interestingly, Klein walked away from over $20M of options that would vest under a change of control scenario. Bulls on EPC have argued that Edgewell is an obvious take-out candidate and the expiration of a poison pill was supportive of this notion. However, Klein's willingness to leave a significant amount of unvested options on the table calls pours cold water on the M&A thesis. Additionally, Unilever's purchase of Dollar Shave Club arguably makes the likelihood of a EPC take-out less probable as a would be acquirer would need to get comfortable with the idea of competing against P&G AND Unilever.

Guidance/Consensus Too High: EPC's full year guidance appears to be exceedingly aggressive. The company expects full year revenue declines of 4% for the full year which implies over 2% growth in Q4 (YTD revenues are down nearly 6%). Guidance also implies nearly 50% EBITDA growth in Q4 and margins of nearly 22% (vs. 15% in Q4 2015). It seems highly implausible that Edgewell will be able to both accelerate the revenue growth and expand margins. The environment has become hyper-competitive with the proliferation of online clubs and Gillette has become increasingly promotional. During their earnings call on August 2nd, P&G discussed the shaving market dynamics as follows: "we're facing more aggressive competition at lower price points, and we will respond to ensure our brands remain a superior consumer value:" Furthermore, "we have already this year increased our support for our U.S. shave care business, and we'll continue to make sure we support it at a level required to get back to growing." On EPC's earnings call they explicitly stated that "we are seeing P&G ramping up their spend....we were surprised that their promotional level in Men's systems in the U.S. hit 40%, the most ever since we've kept records." Given the heightened competitive environment, how will Edgewell grow margins and accelerate revenue growth? Consensus EBITDA is in-line with guidance and consensus expectations are for steady 2% growth over the next couple of years as well.

Valuation: Using 20x my 2017 estimates, I derive a fair value target of  about $60, or 25% downside in the stock.

Risks: Takeout, accretive M&A using expensive stock as a currency, trend away from facial hair.

Catalyst

I expect the company to miss earnings in Q4 due to large scale roll-out of Harry's at Target, aggressive guidance assumptions and heavy promotional activity from Gillette. The company will also issue full year fiscal 2017 guidance on the call and I expect that to come below the Street due to the aforementioned factors.