Today I’m looking at two consumer growth stocks which appear to be getting too expensive.
Reckitt is in transition
Four percent underlying earnings growth is not what many investors would expect from a stock which trades at a price-to-earnings ratio of 25.4. You’d expect much faster growth from a stock with such a high valuation multiple — but 4% is exactly what consumer goods company Reckitt Benckiser (LSE: RB) delivered last year. The company’s recent growth has been falling short of analysts’ expectations, and its more recent Q1 trading update didn’t show much signs of improvement — group like-for-like sales were flat on the same period last year.
Management hopes that the company’s acquisition of leading baby foods manufacturer Mead Johnson will revive like-for-like growth. It’s also conducting a “strategic review” of its non-core food business, which could lead to a possible sale of the business. A sale would help it to reduce debt, increase exposure to emerging markets and allow it to focus on its faster-growing brands. Reckitt’s food division, which includes French’s mustard and Frank’s Red Hot sauce, is estimated to be worth as much as £2.4bn.
However, Reckitt’s transition brings uncertainty. Its entry into the infant nutrition business adds an entirely new category to the company, and it will likely face a tough challenge to deliver on the all-important revenue and cost synergies from the merger. And even if it succeeds on the merger front, management cannot afford to ignore the poor trading momentum at its core business — it would also need sales to pick up at its existing business.
Additionally, valuations seem stretched. Even after taking into account the acquisition of Mead Johnson, shares in the company trade at 22.4 times expected earnings this year (falling to a still pricey 21.5 times by 2018). This compares unfavourably to its five-year historical average multiple of 19.6 and the sector peer average of 20.5.
Although Reckitt is a solid big brand business, its shares seem to have got ahead of themselves. Its transition carries significant risks and this could mean that there’s a lot of uncertainty surrounding the company’s earnings growth outlook.
Burberry continues to disappoint
Like many companies that are big dollar earners, shares in luxury goods firm Burberry (LSE: BRBY) rallied sharply after the UK voted to leave the European Union. However, despite the benefit of improved sterling earnings translation and an impressive performance in the UK, sales growth for the fashion group continues to disappoint investors.
Sure, it’s not all doom and gloom — Burbery has undergone some big senior management changes, with luxury retail veteran Marco Gobbetti due to take over the helm of the company. Many analysts believe his appointment would help the company to boost its retail productivity, leverage its e-commerce opportunities and improve free cash flow.
However, I reckon that Burberry’s stock is also buoyed by shorter-term factors such as sterling’s recent weakness, share buybacks and its latest dividend increase. At a current price of 1,752p, Burberry shares trade at 21.9 times the consensus analyst forecast for underlying earnings per share of 80.1p this year. That’s a big premium to the sector average of 17.5, which seems to me unwarranted given its recent disappointing sales figures and weak earnings outlook.
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Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended Burberry and Reckitt Benckiser. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.