McBride is a supplier of private label household cleaning and personal care products for retailers to sell under their own brands. Although McBride’s core business is private label, the company does have its own range of branded products, including Ovenpride and LimeLite.
This is not just a play on small-cap shares outperforming large-cap ones, but also a play on private label goods. Consumers, which have recently become increasingly price conscious, should become more willing to switch from the well-known brands to cheaper alternatives.
Poor UK sales
Private label cleaning products only represent about a quarter of volume sales in the UK, compared to more than 40% in both, France and Germany. So, there is much opportunity for private label goods to increase its market share in the UK.
But, so far, McBride has performed particularly poorly with the UK market, with revenues falling significantly and margins shrinking to just 1.6%. However, its market share does appear to be stabilising and the company is looking to make efficiency savings to restore profitability.
Private label sales have performed much more strongly in Spain and Poland, with volume gains in 2014 of 2.0% and 6.0%, respectively. This compares to a 3.9% decline in the UK over the same period.
A new management team has been brought in this year, with Rik De Vos and Chris Smith appointed as its CEO and CFO, respectively. Rik De Vos has substantial experience in turning around underperforming businesses, and has over 27 years experience in the chemical and manufacturing sectors.
McBride’s earnings appear to have bottomed, with adjusted operating profit in the second half of 2014 recovering 22.5% to £12.5 million. Its adjusted operating margin improved 0.7 percentage points to 3.4%, though revenues did fall by 4.1%, due to the strengthening pound. On a constant currency basis, revenue actually increased by 0.2%.
Looking forward, lower commodity prices and new product formulations should help the company offset the impact of falling unit prices. This should feed into higher margins and lead to a recovery in profitability. McBride is an attractive recovery play with a forward P/E of 12.3, and an indicative dividend yield of 5.1%.
Unilever and Reckitt Benckiser
McBride’s valuation compares favourably to Unilever (LSE: ULVR) and Reckitt Benckiser (LSE: RB), which have forward P/E ratios of 20.7 and 24.6, respectively. Historically, these shares have typically traded at less than 18 times their expected earnings. But, low interest rates and a more expensive stock market, particularly for low volatility shares, have raised their valuations.
These large-cap defensive consumer shares benefit from more stable cash flows and typically much higher profit margins, which continues to rise. Reckitt’s operating margin of nearly 25% reflects the value of strong brands, and is a stark contrast to McBride’s margin of 3.4%.
If the rise of the German discounters in the UK grocery market teaches us anything, it is not to take consumers for granted. The incumbent supermarkets failed to recognise this early enough, and increased its margins at the cost of their customers and suppliers. How much longer can consumer brands do the same, before competitors see an opportunity to enter the market?
Earnings growth is slowing for these two companies, at least in the medium term, and their premium valuations seem excessively high. The dividend yields for Unilever and Reckitt Benckiser are also very low, at 2.7% and 2.4%, respectively.
By Jack Tang