Consumer goods producer Reckitt Benckiser (OTCPK:RBGLY) has had a very bumpy few months.

I last covered the name in November, with my hold-rated piece Reckitt Benckiser: Not A Bargain Despite Its Potential. Since then, the London shares have tumbled 17%. That is even after a 10% bounce over the past couple of months.

At this point, I change my rating from “hold” to “buy” and indeed bought some of the shares for my portfolio over the past couple of months.

The Key Investor Worry

The main reason the shares have tumbled this year is, surprise surprise, concerns stemming from the company’s Lernaean hydra of a nutrition business. As many pieces have attested in recent years, this has been a source of large problems and massive losses for the company since it acquired it in 2017 from Mead Johnson.

In March came news of an adverse judgment in an Illinois court, with lots of other cases pending. An announcement in March addressing an Illinois court awarding $60m in damages to a plaintiff concerning necrotising enterocolotis. Reckitt’s statement emphasised that this was a single judgment, and the company said it would “pursue all options to have it overturned.”

Compare that to the statement in its final results published a fortnight before (emphasis mine):

Product liability actions relating to NEC have been filed against the Group, or against the Group and Abbott Laboratories, in state and federal courts in the United States. The actions allege injuries relating to NEC in preterm infants. Plaintiffs contend that human milk fortifiers (HMF) and preterm formulas containing bovine-derived ingredients cause NEC, and that preterm infants should receive a diet of exclusive breast milk. The Company has denied the material allegations of the claims. It contends that its products provide critical tools to expert neonatologists for the nutritional management of preterm infants for whom human milk, by itself, is not nutritionally sufficient. The products are used under the supervision of medical doctors. Any potential costs relating to these actions are not considered probable and cannot be reliably estimated at the current time.

The share price fall we have seen in reaction to the Illinois judgment reflects the potential cost of wider such litigation and, I suggest, investor concerns that management may not have fully appreciated the risks.

The shares nosedived but for now the ultimate cost of the cases remains to be seen and investors have been throwing around ballpark figures that vary wildly. Barclays analysts opine that £2bn would be an “extreme worst case” and £100m-£400m is more likely.

While Reckitt has pledged to fight the cases, it is hard to imagine a scenario where there is not some ultimate cost to the company, even if just to settle the litigation without admitting liability.

But in the long run, I think even a £2bn hit (basically a year’s free cash flow for the firm) is manageable and does not merit the sort of markdown in share price we saw after the judgment.

Business Performance is Alright, Not Stellar

In April the company released a first quarter trading update. The headline “good q1 performance, on track for full year delivery” did not seem accurate to me, or at least if declines in both volume and net revenue are seen as “good” then I would not like to witness what management would regard as a bad performance. Part of the blame was put on foreign exchange movements.

The health division is not performing very well in my view, unlike the hygiene division, but the big challenge remains the long problematic nutrition arm of the business. I have covered in previous analyses why this is problematic, and it continues to be so.

Overall the quarter’s results felt underwhelming to me, with both the health and nutrition businesses showing declining volumes, though in the case of the health division at least, that was offset by price and mix changes.

The company pinned the nutrition performance on strong comparatives from the prior year, due to competitor supply issues at that point.

The company is in the third tranche of its £1bn share buyback programme and expects to complete it in July.

Reckitt affirmed its full-year outlook, of 2-4% like for like net revenue growth and adjusted operating profit growing ahead of net revenue growth, with the year’s performance weighted to the second half.

Taken overall, I think the update affirms what we’ve been seeing at Reckitt in the past couple of years: a former growth machine has turned into a company that needs to work hard to stand still. By and large, though, it has managed to do that. It still has a strong stable of brands and is more strategically focussed than it has been for almost a decade, in my opinion, so the basics remain there for future success.

That came on top of a performance at the full year level last year that can be described as workmanlike rather than strong given the ongoing inflationary environment (though the free cash flow performance was strong).

But it is important to recall that Reckitt’s hygiene brands boomed during the pandemic, and it continues to show growth in two of its three divisions despite that elevated base. Revenues last year were 14% higher than they had been in 2019, for example.

So while the business does not have a very exciting feel about it at the moment, I think the stage is set for solid performance in coming years. I thin Reckitt’s forecast 2-4% net revenue growth for the current year is not to be sniffed at, especially given its ongoing problems with the nutrition business (in which it foresees a mid- to high single digit decline in net revenues this year) and weak economies in many markets squeezing demand for premium priced branded consumer products.

Negative Scuttlebutt

I am not a regular user of Reckitt product but recently bought a tub of its “Vanish” detergent in a Spanish supermarket. I was disappointed to discover that the sizeable container was barely half full. Some settlement can occur in transport and there is typically a finite range of container sizes in use to reduce complexity, but the low fill level really soured my view of Vanish and indeed Reckitt as a consumer.

Whether this is an unusual case or symptomatic of a wider approach to shelf impact by the company I do not know. I dare say, though, that it has negatively coloured my view of the company and in the long term leaving shoppers feeling short changed is rarely a way to thrive.

I’ve Bought at What I see as an Attractive Valuation

But while recent business performance has been mixed and the potential for nutrition liabilities is indeed a risk, I feel the share price has been overly punished. I bought into the company over the past several months and am upgrading my rating to a “buy”.

At the moment, the P/E ratio is 14. Compare that to 20 for U.K. peer Unilever (UL) and 25 for U.S. peer Procter & Gamble (PG). I think there is still some discount for the uncertainty surrounding Reckitt following the U.S. verdict (though this has reduced in recent months) as well as the lacklustre performance of the business more generally of late.

But let’s not overdo it. The company owns a host of very well-known brands with considerable pricing power, such as “Lysol” and “Durex”. Revenues last year were its highest ever. The company made £1.6bn in profits after tax. Adjusted free cash flows last year were £2.3bn. Net debt remains higher than I would like but fell last year, to £7.3bn. That means Reckitt has an enterprise value of under £40bn. I think that looks like good value for a company with its brand assets and proven profitability over the long run, even allowing for its legal uncertainties.

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