Energizer Holdings, Inc. (ENR)

[Enterprising Investor]

Recharging the Energizer Bunny (7/18/15)

By jettisoning its consumer-products unit, Energizer Holdings should be able to focus on its core battery market, boosting margins and cutting costs.

By David Englander

When it was spun off from Ralston Purina in 2000, Energizer Holdings ’ focus was on batteries. That’s the case again. Early this month, Energizer split off its consumer products brands—Schick, Edge, and Hawaiian Tropic, to name a few—into a new company known as Edgewell Personal Care (ticker: EPC).

Energizer built up the consumer-products division over years of acquisitions, and that business gradually overtook batteries as its largest. The battery operations have long been thought of as the ugly duckling, but this column is intrigued by its stand-alone prospects.

At a recent $41.46, Energizer’s shares (ENR) have jumped 22% since the July 1 spinoff. But more gains could be ahead.

Disposable battery usage has declined, as smartphones and other electronic devices with built-in rechargeable batteries have depressed demand. Still, there are one billion devices in U.S. homes that use disposable batteries, including toys, flashlights, and remote controls. That isn’t going to change much anytime soon.

The industry has attractive attributes, especially the fact that it’s highly concentrated. Duracell, Energizer, and Spectrum Brands Holdings (SPB), the top players, have more than 80% of the market. This year, Berkshire Hathaway (BRK.A) will close on its $5 billion purchase of Duracell from Procter & Gamble (PG), and that could prompt a shift to more favorable industrywide pricing.

Energizer, whose ads long have featured a seemingly tireless bunny, has an opportunity to cut costs and boost margins. Earnings and free cash flow could grow, even if global battery demand slowly declines, as is expected.

Jefferies analyst Kevin Grundy notes that, based on free cash flow, the stock looks cheap. It trades for a 7.2% free cash flow yield, versus 5.1% for peers. He values the shares at $45, which implies a 7% free cash flow yield. His upside target is $60.

With 32% of the battery market, Energizer is No. 2, behind Duracell, which controls 41%. Spectrum Brands’ Rayovac is the smaller player.

Energizer’s alkaline- and lithium-based batteries sell under the Energizer and Eveready brands. Energizer also makes headlamps, lanterns, and flashlights. Batteries represent 83% of revenue, and the lighting segment chips in the remainder. The company sells into 140 markets around the world, with about half of sales coming from North America.

This fiscal year ending in September, Grundy expects earnings of $181 million, or $2.93 a share, on $1.65 billion in revenue. Those results don’t fully reflect changes that management has been making to the business, including exiting or paring exposure to unprofitable markets. In 2016, earnings are expected to fall to $2.65 a share, before rebounding to $3 in 2017. Annual revenue should normalize around $1.6 billion.

Historically, batteries have been a highly promoted product. That’s been especially the case in the past few years, as P&G has run Duracell with an eye toward increasing share. Since 2009, P&G has kept pricing steady, even as Energizer and Rayovac boosted prices. Energizer has lost share, while Duracell has picked it up.

Under the Berkshire umbrella, that could change. Duracell will probably refocus on improving cash flow and profitability, rather than on driving sales volume. More rational pricing could ensue, and that would boost participants’ margins. This has happened in other consolidated U.S. industries, such as beer and cigarettes.

Energizer could also cut more costs. Over the past few years, the battery business has been dramatically restructured. Since 2011, $210 million in annual costs have been taken out, and that helped boost gross margins from 41.9%, to 46.2% in 2014.

In a report, analyst Grundy observes that management could announce a program to trim an additional $50 million by targeting selling, general, and administrative cost.

He also cites the opportunity to improve profitability in Latin America and Europe, where margins are much lower than those in North America.

On Energizer’s June investor day, CEO Alan Hoskins named “driving productivity gains” a “strategic priority.” He later added, “our singular objective will be to maximize free cash flow.”

In connection with the spinoff, Energizer took on $1 billion of debt, and paid the proceeds to Edgewell. With just over $300 million in cash, that puts leverage in a comfortable place. Free cash flow could come to about $3 a share this year.

Returning some of that cash to shareholders will be key to moving the stock. In addition to paying out a $1 a share in annual dividends, Energizer has committed to buying back 7.5 million shares, or more than 10% of its shares outstanding.

Energizer’s shares rallied 12% last week. Investors accumulating a position might want to pick up the bulk of their shares on any stock price weakness.

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