Description

Overview / Background

(NOTE: Multiples above adjusted for pending Harry’s acquisition)

Edgewell Personal Care (“EPC” or the “Company”) is one of the world’s largest pure play manufacturers and marketers of personal care products in the wet shave, sun and skin care, feminine care, and infant care industries. The company has a portfolio of over 25 brands, including Schick, Edge, Banana Boat, Hawaiian Tropic, Wet Ones, and Playtex, and conducts business in over 50 countries. The company was formerly the Personal Care division of Energizer Holdings (ENR) and split off from Energizer in July 2015.

Since its separation from Energizer, EPC’s stock has been down 66%. This is due to many factors, including 1) competitive pricing pressures, especially in Wet Shave, 2) steep share loss in Feminine Care, 3) misses to financial estimates resulting from these factors, and 4) the company’s recently announced acquisition of Harry’s, which was perceived to be too expensive and in a category that has seen little success from M&A (i.e. Unilever’s acquisition of Dollar Shave Club).

The wet shave industry has traditionally had very favorable business characteristics, including high barriers to entry (IP portfolio, manufacturing and distribution infrastructure), loyal and sticky customers, and benefits of scale. For many years, P&G’s Gillette and Edgewell had held almost 80% of the global wet shave market, which Edgewell’s brands representing a clear #2, if not #1, in most markets. However, in recent years, the increased prominence of direct-to-consumer (DTC) subscription businesses, such as Dollar Shave Club and Harry’s, has chipped away at the pricing power of the incumbents, especially among the more cost-conscious millennial segment.

Sun Care in the U.S. is highly consolidated with top three branded players comprising ~70% of sales. This segment can be seasonal but has generally benefited from a secular tailwind of increased sun protection awareness. Feminine care is a mature business in the U.S., but Edgewell’s products have lost share against bigger competitors such as Kimberly-Clark and P&G. Edgewell’s management has started a process to evaluate a potential sale or other strategic alternatives for the Feminine Care and Infant Care businesses.

We believe investors have a unique opportunity to buy a good business at an extremely attractive valuation. Sentiment on the name has turned overly bearish, and fears of competitive pressures are overblown, especially as the industry continues to consolidate. Although the Harry’s acquisition was expensive on a headline basis (particularly given Harry’s lack of current earnings, likely due to investments generating 30% topline growth), the acquisition is actually a strong strategic fit with EPC that will significantly improve the business profile and growth outlook of the combined company.

Overview of Harry’s Acquisition

On May 9, 2019, EPC announced that it has entered into a definitive agreement to acquire Harry’s, Inc. for a total consideration of $1.37bn, consisting of $1.085bn in cash and $285mm in EPC stock. The company revealed that Harry’s expects to generate 2019 revenue of $325mm, which has been growing at 30% annually since 2016. To finance the cash portion, EPC has secured $1.2bn of debt financing, consisting of a $400mm TLA and $800mm TLB. EPC will also be refinancing its current revolver with a new revolver, which will be undrawn at close.

Investment Thesis

Fears of competitive pressures in the wet shave industry are overblown, and pricing pressure will likely abate going forward. The wet shave industry has been affected by the ascent of startups, most notably Dollar Shave Club and Harry’s, with a DTC business model, low-priced razors, and renegade marketing tactics. Incumbents such as Gillette have cut prices, most notably in 2017, to respond to these pressures. The sector is also impacted by other trends, including but not limited to, longer shave intervals and higher usage of blades, which have resulted in volume declines. However, we believe such competitive pressures are now either overblown or temporary. From a pure industry competition perspective, Dollar Shave Club and Harry’s have now both been acquired by large incumbents, who are incentivized to act rationally as they search for profitability in a more consolidated industry. Over the past two years, Nielsen pricing data has shown some stabilization. Per an analyst report, Harry’s co-founder Jeff Raider has stated that he believes the “dust has settled” with regards to competitive pricing, and promotional levels have moderated. Mr. Raider has committed to doing his part to price rationally going forward.

Strong player of scale competing in several attractive industries benefiting from secular tailwinds. EPC competes as the #1 or #2 player in most of the segments it participates in, and benefits from scale in its advertising, manufacturing, and distribution. Over the long run, we believe the wet shave industry is structurally attractive, with increasing consolidation, high barriers to entry, a loyal customer base, and scale benefits, ultimately leading to high margins supported by a consolidated manufacturer base. The sun & skin care segment should continue to benefit from an increased awareness on health in general and skin protection in particular, especially in the international markets. Finally, the U.S. online wet shave market is expected to grow at 15% over the next five years, doubling penetration to 20% of the U.S. wet shave market, providing a long runway for EPC to grow.

Harry’s acquisition combines a highly complementary set of capabilities to better serve the modern customer. On May 9, 2019, EPC announced that it was acquiring Harry’s for $1.37bn, consisting of cash and stock. To finance the cash portion of the acquisition, the company was raising $1bn of net debt, bringing its total PF leverage to 5.2x. Although this announcement was not well received by the market (for reasons discussed later), we believe the strategic rationale for the acquisition is sound, in both an offensive and defensive manner.

·         Complementary capabilities – Harry’s has operated a disruptive DTC model with fast growth and strong brand building, but management admits that the quality of their product hasn’t always lived up to the quality of their brand. EPC’s brands are not as well regarded, but they have a world-class product and product development technology, as well as a global scale and infrastructure. Combining the two companies can produce the “best of both worlds”, including a strong product backed by a strong brand and effective, modern brand marketing, with global manufacturing and distribution capabilities. EPC will be able to leverage its product technology and IP to improve the Harry’s product, and apply Harry’s brand-building and digital capabilities to EPC’s products.

·         Synergy opportunities – The company has guided to $20mm of annual revenue synergies and $20mm of annual cost synergies, which we believe is very achievable, and likely conservative, for the company’s revenue and earnings base. Revenue synergies come primarily from leveraging EPC’s international footprint to accelerate Harry’s expansion, while cost synergies come from optimizing manufacturing, distribution, procurement, and leveraging the combined company’s scale.

·         Talent improvement – Harry’s two founders, Andy Katz-Mayfield and Jeff Raider, will become head of Edgewell’s US business. Per sell side analysts, half of their economics of the sale will come from future performance, so they should be motivated.

·         Improved corporate profile – By purchasing Harry’s, EPC will immediately have a much stronger CPG business profile, with MSD topline growth and strong margins. Hence, there is an opportunity for the story to change from cost-rationalization and cash flow optimization to real growth via an omnichannel business model. This transformation may allow the combined EPC business to earn a higher multiple in the marketplace.

·         Industry consolidation – This is one more step in the consolidation of the space, and along with the Dollar Shave Club acquisition, may result in stronger pricing power for all industry participants, as discussed above.

Management focus on cost discipline, cash flow generation, and deleveraging will result in earnings growth and value accretion to EPC’s equity. Management has been aggressively buying back shares, but with the acquisition, will likely also focus on deleveraging. Although the Harry’s transaction has increased gross leverage to 5.2x, the overall entity remains a highly cash-generative business, and management expects to reduce leverage by 1x each year, both from debt paydown and EBITDA growth. Regardless, we believe the company’s double digit FCF yield will benefit shareholders, whether it is from debt reduction or share buybacks.

Margin of safety from strategic value of the company’s assets and brand value. EPC is one of the only public companies with wet shave and sun care assets, and though it has international scale, it could be a strong complement to a larger multi-national CPG company. Unilever was seen as a potential acquirer before it acquired Dollar Shave Club. EPC has historically attracted activist investors, and in a formal sale process, a sale of individual segments to separate buyers could also maximize proceeds and value on a sum of the parts basis.

Attractive valuation. At a price of $33.50, the company is trading at less than 10x our estimated FY2019 earnings, a valuation we believe to be very attractive. Adjusted for the Harry’s acquisition, the company is trading at ~10x current EBITDA and ~9x combined EBITDA (PF for Harry’s acquisition and synergies), which is very cheap for the strong combined business profile detailed above. This is also assuming very little profit contribution from Harry’s, which is currently break-even EBITDA, so there is upside if Harry’s can reach profitability.

Key Risks & Mitigants

Significant execution risk due to a new, unproven management team having multiple tasks on its plate. Due to activist pressure, EPC has recently switched its management team, appointing Rod Little, its former CFO, as CEO, and hiring Daniel Sullivan, formerly CFO of Party City, as CFO. Last year, EPC appointed several new members to its board as well. As part of the Harry’s acquisition, Harry’s co-founders, Andy Katz-Mayfield and Jeff Raider, will also join EPC as co-Presidents of U.S. operations. The new management team will have its plate full, with running the business, integrating Harry’s, selling its Fem Care and Infant Care divisions, and Project Fuel, the cost savings initiative that the company has been undertaking. There is significant execution risk in all of these tasks. Mitigants: The management and board changes were prompted by activist shareholders reacting to the company’s underperformance, so the bar has not been set very high. Project fuel has been going well, and the company actually raised its cost-savings targets. Per EPC’s CEO, they’re on year two of the initiative, everyone knows what they need to do, and at this point it’s just “execution mode”. There will certainly be integration risk with Harry’s, but much of the assets are complimentary.

Competitive environment around the company’s product worsens. Over the past few years, EPC’s sales have suffered from competitive pricing pressures and share losses to new DTC companies, as well as the pricing response by P&G. If P&G maintains promotional pricing levels, EPC’s margins will be squeezed in order to defend share. Mitigants: Industry consolidation will likely lead to less pricing pressure; Harry’s founders believe the worst is over and have committed to price rationally going forward.

Concerns around Harry’s acquisition prove legitimate. EPC’s stock price dropped 16% on the day it announced the Harry’s acquisition. Investor concerns with the acquisition include: 1) near term earnings dilution given that Harry’s is currently break-even in profitability, 2) purchase price of $1.37bn was too high, 3) this was a desperate move by EPC in the face of a declining core business, and 4) previous acquisitions in this space (i.e. Unilever’s acquisition of Dollar Shave Club) have not worked out. Mitigants: We’ve detailed the positives of the transaction above. In terms of price, the company lost $350mm of market cap after announcing the Harry’s deal, so at current prices, investors are effectively buying Harry’s at 25% cheaper than what EPC paid, assuming the valuation of EPC remained constant. Finally, Edgewell CEO Rod Little argued that the Unilever / Dollar Shave Club deal is not a good comparison to this one, because Harry’s is a better company with product diversity, technology, and scale, and EPC is a smaller, more nimble company than P&G.

Out-of-favor stock that will not easily regain the market’s trust, with a multiple that will not easily rerate. A company with a low multiple is not inherently a good investment, because oftentimes there’s a reason the multiple is low and will stay low. If EPC’s multiple doesn’t expand, shareholders may not earn as strong of a return. Mitigants: Even without multiple expansion, at these valuations, EPC has a strong, double digit FCF yield, which will likely accrue to the equity in the form of deleveraging and share buybacks. We have argued that the combined EPC/Harry’s company will have a very strong business profile and has a chance to be a top quartile CPG company in terms of topline growth and margins.

Valuation & Estimates

We believe that as the company executes on Project Fuel, competitive pressures moderate, and the Harry’s integration drives growth and incremental profitability, EPC’s earnings will increase and its multiples will rerate. Our current 2022 base case price target is $55, representing a 13x P/E multiple, an 8.5x EBITDA multiple, and an IRR of 16.5%.

Catalyst

Succesful integration of Harry's

Rerating of multiple based on execution

Signs of progress on operational turnaround