Description

We recommend a short position in Reynolds Consumer Products (NASDAQ: REYN). Covid’s well-publicized impact on at-home consumption and a commodity tailwind have boosted numbers, but 2020 should represent peak earnings.

REYN went public in January 2020 at $26 per share, pricing slightly below the midpoint of the initial range of $25-$28.  Capital allocation messaging has been to pay down debt (IPO went to market at 3.7x Net Debt / EBITDA) and to pay out 50% of net income in the form of a dividend.  The Rank Group, controlled by Graeme Hart, owns ~75%. They did not sell any shares at IPO and their lockup expires 7/29/2020.

The business is separated into four categories and we will focus on the two largest:

• Reynolds Cooking & Baking – traditional aluminum foil and baking related essentials.  Dominant market share with full distribution and revenue driven by commodity pricing. We see this as a solid cash flow business that is defensible.  Reynolds manufactures the aluminum and is the only player in the space that is vertically integrated.  Market share is ~70% (~60% of the share is branded) and Reynolds is the only major brand name in the space with limited private label exposure relative to the balance of the portfolio.
  
• Hefty Waste and Storage - food storage bags and the branded Hefty Trash bags. The key competitors in the space include Glad (CLX) and Private Label. The primary channel for REYN is Walmart (WMT). While the company only discloses consolidated exposure to WMT (43% in 2019), we believe WMT represents a greater proportion of this business. From a pricing perspective, the Hefty brand sits between private label and Glad.

Source: REYN 4Q20 Earnings Presentation

Our diligence suggests some clear areas of deficiency for REYN, as well as a lack of leadership. We cannot remember an instance of such high turnover at the executive level.  The only executives with significant tenure are CEO Lance Mitchell and CFO Michael Graham, who have been in their respective roles since 2011 and 2016. 

Key division presidents have significantly less tenure.  We see this as odd timing for the former presidents to leave ahead of an IPO.

• Francis Arseneault - Hefty Waste & Storage, President since 2019
• Craig Cappel – Reynolds Cooking & Baking, President since 2018
• Rachel Bishop – Hefty Tableware, President since 2019

Our key diligence conclusions:

• Innovation is lacking, management is not willing to invest in the business and has been unwilling to pursue M&A to drive growth.  Leverage likely prevents material M&A at current levels
• Categories are mature and innovation is not driving growth.
• Distribution gains are largely not available; the bigger risk is decreasing brand selection from the shelf.
• Foam plates and the disposable portfolio are out of favor with enviornmentally conscious consumers and retailers.

We see the Cooking & Baking category as a clear winner from COVID, similar to many CPGs.  Our primary concern is related to the commodity backdrop as we exit 2020.  Our calls suggest that it takes roughly 6 months for declines in aluminum to flow through to the bottom line. As a result we expect 2H20 to be strong as COVID strength is amplified by a deflationary commodity backdrop.  Expectations are for roughly flat Y/Y EBITDA growth in 2021 off a very difficult 2020 comp, which we see as unrealistic even without aluminum inflation.

Moving to the highest margin segment, Hefty Waste and Storage.  Our primary concern is related to the shift to private label.  Retailers are putting a greater emphasis on private label and we see significant margin risk to REYN.  Given the large exposure to WMT mentioned above, we expect volume to shift from Hefty Branded to WMT’s Great Value.  We do not expect to see expanded shelf space and expect Hefty to lose share.  Our diligence suggests that Hefty trash bags have significantly higher margins than REYN’s private label bags.  We see serious ramifications of lower margin mix in the trash bag business, potentially impairing REYN’s ability to market the Hefty brand (with lots of John Cena commercials), in order to preserve margin. 

If we think about the innovation that has been introduced, it was led by Glad and CLX with Force Flex.  For both CLX and the consumer, Force Flex was a game changer and justified a premium price.  In 2016, CLX lost its patent on Force Flex and trash bags are now a commodity product as Force Flex has made its way to private label and put downward pressure on brand pricing.  We are unlikely to see anyone develop another Force Flex technology that is both value-add to the consumer from a usability perspective and economic to the manufacturer as resin was actually removed from the bag which drove margin. 

WMT’s private label with CLX’s Force Flex technology:

Source: Walmart.com

We find it interesting that AMZN’s Solimo branded trash bags already occupy two of the top five best sellers in the trash bag category on Amazon.  To us, this emphasizes private label’s traction with the consumer in the category.  While REYN does manufacturer Solimo, we see this as a slippery slope in a zero growth category as private label gains share and REYN loses Hefty margins.  This also has potential to accelerate WMT’s shift to private label, particularly with the latest Walmart+ initiative.  But the biggest risk is losing shelf space at WMT.  We do not see the value of multiple branded trash bags (Glad & Hefty) at WMT when the technology is no different than WMT’s Great Value brand.  Glad’s premium price point offers WMT a better value proposition at the high end, while private label is clearly a more economic option at the low end.

Source: Amazon.com

Similar to most CPGs, we do not think 2Q20 estimates are high enough but believe buyside estimates are significantly higher than 2020 EBITDA guidance of $695-$715 and current consensus of $715m.  While guidance appears to be achievable based on current scanner data, we see risk to buyside expectations and EBITDA growth into 2021. 

We would also highlight the potential conflict of interest for the Rank Group. Currently Rank, through its portfolio company Pactive, has arm’s length agreements with REYN.  While we do not know the terms or the timeline, we find it hard to believe that the supply chain efficiencies will persist in the long term.

Source: REYN 2019 Form 10-K

We believe REYN should trade like a slower-than-GDP grower with significant headwinds from private label pressures.  REYN is currently trading at ~13x EBITDA.  We think REYN should trade at a discount to KMB’s ~12x multiple given: (i) private label exposure and trade down risk out of branded; (ii) concentration with WMT; and (iii) a balance sheet that limits capital allocation. In a more dire scenario, THS could represent the best private label comp, and it is currently trading at

Catalyst

• Loss of shelf space at WMT
• Mix shift to private label, negative to both market share and margins
• Inflationary commodity costs and difficult COVID comps moving into 2021
• Secondary from The Rank Group
• Elimination of arm’s length agreement with Pactive
• Valuation reset closer to THS & KMB given private label exposure

Risks

• Commodity prices remain depressed
• Category leadership prevents loss of shelf space
• Refinancing of debt
• At-home consumption remains elevated

Disclaimer:

The views and opinions stated are the personal views of the author. Do not rely on the information set forth in this write-up as the basis upon which you make an investment decision – please do your own work. The author and funds in which the author manages hold positions in and trade, from time to time, securities issued by REYN and options on such securities.  This write-up does not purport to be complete on the topics addressed, and the author takes no responsibility to update this write-up in the future.  This is not a recommendation to buy or sell any securities.

Catalyst

• Loss of shelf space at WMT
• Mix shift to private label, negative to both market share and margins
• Inflationary commodity costs and difficult COVID comps moving into 2021
• Secondary from The Rank Group
• Elimination of arm’s length agreement with Pactive
• Valuation reset closer to THS & KMB given private label exposure