Household products company Reynolds (NASDAQ:REYN) reported results in line with analysts' expectations in Q3 FY2023, with revenue down 3.3% year on year to $935 million. Turning to EPS, Reynolds made a GAAP profit of $0.37 per share, improving from its profit of $0.23 per share in the same quarter last year.
Reynolds (REYN) Q3 FY2023 Highlights:
- Revenue: $935 million vs analyst estimates of $932.4 million (small beat)
- EPS: $0.37 vs analyst estimates of $0.36 (2.7% beat)
- Free Cash Flow of $190 million, up 111% from the previous quarter
- Gross Margin (GAAP): 26.6%, up from 18.4% in the same quarter last year
- Organic Revenue was down 3% year on year
- Sales Volumes were down 4% year on year
Best known for its aluminum foil, Reynolds (NASDAQ:REYN) is a household products company whose products focus on food storage, cooking, and waste.
The company and its famous foil trace their roots back to 1947 when a nephew of the Reynolds Tobacco Company founder established Reynolds Metals Company. From there, the company expanded its line of kitchen and cooking products to include parchment paper, wax paper, containers for food storage, and others. In 2010, Reynolds further expanded its portfolio with a strategic acquisition that added the Hefty brand of trash bags.
Reynolds targets middle-income consumers, especially those who cook at home for themselves or their family members. These customers are looking for proven brands that are competitive in price versus alternatives. Given Reynolds’ brand awareness, though, the company’s products don’t need to be the absolute cheapest. Many consumers are willing to pay a reasonable premium to buy established brands rather than lesser-known or private-label brands.
It’s quite easy to find Reynolds’ products for sale, and the company tends to dominate the section or aisle for food storage. Traditional brick-and-mortar retailers such as supermarkets, mass merchants, drug stores, and specialty stores are the most common sellers of the company’s products. Given Reynolds’ scale and traffic-driving brands, the company often has prominent placement on retailer shelves.
Household Products
Household products companies engage in the manufacturing, distribution, and sale of goods that maintain and enhance the home environment. This includes cleaning supplies, home improvement tools, kitchenware, small appliances, and home decor items. Companies within this sector must focus on product quality, innovation, and cost efficiency to remain competitive. Household products stocks are generally stable investments, as many of the industry's products are essential for a comfortable and functional living space. Recently, there's been a growing emphasis on eco-friendly and sustainable offerings, reflecting the evolving consumer preferences for environmentally conscious options.
Competitors that offer household products, especially in the areas of food preparation and storage, include Proctor & Gamble (NYSE:PG), Clorox (NYSE:CLX), and Kimberly-Clark (NYSE:KMB).Sales Growth
Reynolds is larger than most consumer staples companies and benefits from economies of scale, giving it an edge over its smaller competitors.
As you can see below, the company's annualized revenue growth rate of 6.1% over the last three years was mediocre as consumers bought less of its products. We'll explore what this means in the "Volume Growth" section.
This quarter, Reynolds reported a rather uninspiring 3.3% year-on-year revenue decline, in line with Wall Street's estimates. Looking ahead, analysts expect sales to grow 1.1% over the next 12 months.
Volume Growth
Revenue growth can be broken down into changes in price and volume (the number of units sold). While both are important, volume is the lifeblood of a successful staples business as there’s a ceiling to what consumers will pay for everyday goods; they can always trade down to non-branded products if the branded versions are too expensive.
To analyze whether Reynolds generated its growth from changes in price or volume, we can compare its volume growth to its organic revenue growth, which excludes non-fundamental impacts on company financials like mergers and currency fluctuations.
Over the last two years, Reynolds's average quarterly sales volumes have shrunk by 3.3%. This decrease isn't ideal as the quantity demanded for consumer staples products is typically stable. Luckily, Reynolds was able to offset fewer customers purchasing its products by charging higher prices, enabling it to generate 6.1% average organic revenue growth. We hope the company can grow its volumes soon, however, as consistent price increases (on top of inflation) aren't sustainable over the long term unless the business is really really special. 
In Reynolds's Q3 2023, sales volumes dropped 4% year on year. This result was a further deceleration from the 7% year-on-year decline it posted 12 months ago, showing the business is struggling to push its products.
Gross Margin & Pricing Power
All else equal, we prefer higher gross margins. They make it easier to generate more operating profits and indicate that a company commands pricing power by offering more differentiated products.
This quarter, Reynolds's gross profit margin was 26.6%. up 8.2 percentage points year on year. That means for every $1 in revenue, a chunky $0.73 went towards paying for raw materials, production of goods, and distribution expenses. 
Reynolds has poor unit economics for a consumer staples company, leaving it with little room for error if things go awry. As you can see above, it's averaged a paltry 21.5% gross margin over the last two years. Its margin, however, has been trending up over the last 12 months, averaging 13.9% year-on-year increases each quarter. If this trend continues, it could suggest a less competitive environment.
Operating Margin
Operating margin is an important measure of profitability accounting for key expenses such as marketing and advertising, IT systems, wages, and other administrative costs.
This quarter, Reynolds generated an operating profit margin of 14.3%, up 5.7 percentage points year on year. This increase was encouraging, and we can infer Reynolds had stronger pricing power and lower raw materials/transportation costs because its gross margin expanded more than its operating margin.
Zooming out, Reynolds has managed its expenses well over the last two years. It's demonstrated solid profitability for a consumer staples business, producing an average operating margin of 11.3%. On top of that, its margin has risen by 1.5 percentage points on average each year, showing the company is improving its fundamentals. The company's operating profitability was particularly impressive because of its low gross margin, which is mostly a factor of what it sells and takes tectonic shifts to move meaningfully. Companies have more control over their operating margins, and it signals strength if they're high when gross margins are low (like for Reynolds).EPS
Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.
In Q3, Reynolds reported EPS at $0.37, up from $0.23 in the same quarter a year ago. This print beat Wall Street's estimates by 2.7%.
Between FY2020 and FY2023, Reynolds's adjusted diluted EPS dropped 43%, translating into 10.7% average annual declines. We tend to steer our readers away from companies with multiple years of falling EPS, especially in the consumer staples sector, where consistently negative earnings could imply changing secular trends or consumer preferences. If there's no earnings growth, it's difficult to build confidence in a business's underlying fundamentals, leaving a low margin of safety around the company's valuation (making the stock susceptible to large downward swings).
On the bright side, Wall Street expects the company's earnings to grow over the next 12 months, with analysts projecting an average 33.7% year-on-year increase in EPS.
Cash Is King
If you've followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills.
Reynolds's free cash flow came in at $190 million in Q3, representing a 20.3% margin. This result was great for the business as it flipped from cash flow negative in the same quarter last year to positive this quarter.
Over the last two years, Reynolds has shown strong cash profitability, giving it an edge over its competitors and the option to reinvest or return capital to investors while keeping cash on hand for emergencies. The company's free cash flow margin has averaged 7.6%, quite impressive for a consumer staples business. Furthermore, its margin has averaged year-on-year increases of 6.2 percentage points. This likely pleases the company's investors.
Return on Invested Capital (ROIC)
We like to track a company's long-term return on invested capital (ROIC) in addition to its recent results because it gives a big-picture view of a business's past performance. It also sheds light on its management team's decision-making prowess and is a helpful tool for benchmarking against peers.
Reynolds's decent track record of profitable investments over the last five years gives it the flexibility to engage with financiers if it wants to raise or borrow capital. Its five-year average ROIC was 11.5%, slightly better than the broader consumer staples sector.
Key Takeaways from Reynolds's Q3 Results
Sporting a market capitalization of $5.60 billion, Reynolds is among smaller companies, but its more than $124 million in cash on hand and positive free cash flow over the last 12 months puts it in an attractive position to invest in growth.
We enjoyed seeing Reynolds exceed analysts' gross margin expectations this quarter. We were also glad next quarter's earnings guidance exceeded Wall Street's estimates. On the other hand, its EPS missed analysts' expectations and its operating margin missed Wall Street's estimates. Zooming out, we think this was still a decent, albeit mixed, quarter, showing that the company is staying on track. The stock is up 1.4% after reporting and currently trades at $27 per share.
Is Now The Time?
Reynolds may have had a favorable quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.
We cheer for all companies serving consumers, but in the case of Reynolds, we'll be cheering from the sidelines. Although its strong free cash flow generation allows it to invest in growth initiatives while maintaining an ample cash cushion, the downside is that its estimated revenue for the next 12 months is weak. On top of that, its mediocre sales volumes have been a headwind.
Reynolds's price-to-earnings ratio based on the next 12 months is 17.2x. While we think the price is reasonable and there are some things to like about Reynolds, we think there are better opportunities elsewhere in the market right now.
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