Kenvue (KVUE) – Price Recovery – 10%+ Upside

Current Price: $22.78

Target Price: $25-$26.5

Upside: 10%+

Expiration Date: 2 weeks

 

Johnson & Johnson is about to divest 80.1% (out of the 89.6% stake) in Kenvue, its recently IPO’ed consumer healthcare division. Besides the split-off arbitrage (which I have already covered last month), I think a similar quick 10%+ return could be generated by simply going long KVUE. The stock price appears to be temporarily oversold due to the pending split-off. The exchange offer expires today and new KVUE shares will be distributed in about a week. My bet is that once the split-off is completed, KVUE will recover to the previous $25-$26.5/share levels. The upside is not particularly wild at 10%, however, the timeline is just 1-2 weeks and the risk of losing money seems to be very limited.

Here are the key points why I believe KVUE is oversold:

  • At the current levels, KVUE appears to be a bit too cheap on a relative valuation basis. The company trades at 14.0x TTM adj. EBITDA, while other prominent consumer brand powerhouses like PG and CL are valued at higher multiples of 18.5x and 16.0x, despite having similar margin profiles. KVUE operates at 24% adj. EBITDA margin vs 25% for PG and 23% for CL. Before the split-off announcement, KVUE was trading much more in line with peers – at $26.5/share the company was valued at 16x TTM adj. EBITDA. The dividend yield at KVUE is also higher at 3.5% vs 2.5% at PG and CL. These are businesses of similar quality and prospects and therefore should be trading at similar multiples and dividend yields.
  • KVUE is a fresh IPO that was trading within the $25-$27/share range since the market debut in May. Currently, the company trades at its lowest point since listing and this recent sell-off stands out from peers and personal care-focused ETFs.kvue graph
  • It is likely that the pressure on KVUE share price was primarily caused by arbitrageurs hedging the to-be-received spit-off shares. Short interest is now at 15% of KVUE’s current float, whereas the borrow fee has already skyrocketed to 50% and IB no longer shows any availability. This selling pressure will abate once the split-off is completed.
  • The pending 9x increase in free float (from 10% to 90% of outstanding shares) likely weakens the share price support as the market is afraid of the potential short-term price turbulence. The completion of the split-off should alleviate this concern as well, catalyzing KVUE share price rebound.
  • KVUE is set to be added to the S&P500 index promptly after the completion of the split-off. While I am not sure what are the rules for index funds and if they are already building up positions in KVUE or will start doing that once the company is added to the index (the former is more likely), at the very least this should provide additional share price support for KVUE. There were 3 other previous split-offs (PFE/ZTS, GE/SYF, and BMY/MEAD), which also caused the split-off entity to be added to the S&P500 index following completion of the transaction. Neither of them has experienced any sell-off after the tender expiration.
  • KVUE is a very stable and high-quality business with the leading consumer health and personal care brands. In turn, the share price should remain stable in the short term and any sudden downward spikes due to increased float are unlikely.

Aside from a simple long KVUE, the same share price recovery bet could be played in two other ways:

  • For those that have not participated in the split-off yet, there is a possibility to acquire KVUE at a 5% discount by buying JNJ shares and submitting those for the exchange offer. This is limited to 99 JNJ shares only to ensure priority acceptance, so c. $17k in total (for large positions only a portion of JNJ shares submitted for the exchange will be accepted). This would give you exposure to KVUE at around $21.66/share. On Interactive Brokers it is still possible to buy JNJ shares today and participate in the exchange (the deadline is at 13:00 EST). The deadlines for other brokers might have already passed.
  • Another way to play this is by selling the August 25th put options. Puts with a $22 strike trade at $0.60 with high liquidity. This would either result in a $21.4/share KVUE cost basis, or a collected option premium (2.6% in a week).

 

Kenvue

KVUE is a consumer health brands powerhouse, with multiple brands which hold the #1 position in their respective markets across different regions.

kvue 20230803 g12

KVUE generates its sales primarily in the US (45%), followed by EMEA (21%), APAC (21%), and the rest of the Americas (13%). The company has a leading market share presence across all regions.

Historically, KVUE has been a very stable business, growing consistently at a 2-4% rate and operating at 54-56% gross and 24-26% EBITDA margins. The company is aiming to ramp up its growth by refocusing its portfolio on faster-growing premium brands.

Margins have been somewhat weaker recently, driven by industry-wide cost pressures (applies to most other consumer brand businesses too), however, the management expects the margins to normalize as costs revert to lower levels.

Historical financials are provided in the table below:

kvue historical 1

36 Comments

36 thoughts on “Kenvue (KVUE) – Price Recovery – 10%+ Upside”

  1. Is the split-off an automatic process on IBKR where you click a button? Or do you have to call them.

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    • Button t+1 under Corporate actions in acct mgmt, but if u buy today prob have to call.

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      • Isn’t there a settlement date as well? Where it takes 2 or 3 days for the trade to be settled.

      • There is a guaranteed delivery clause (as was the case with all split-offs) so a settlement period is not necessarily required to participate in the exchange. However, your broker might have different rules.

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  2. “…the risk of losing money seems to be very limited.” The downside risk in my mind is that everyone participating in the exchange offer sells their KVUE shares soon after receiving them, putting downward pressure on KVUE’s price. This could create a buying opportunity for long-term holders but is worth calling out.

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  3. I definitely see this trade as an opportunity as well, but like Ex Dividend, I’m wondering if it will play out a bit later. There were significant amount of people who did the JNJ/KVUE trade unhedged, so they will receive their KVUE shares from what I”m hearing in 5-10 days from now. Many of those unhedged arbs will sell their shares promptly. Also, some other participants in the exchange offer whose exchange will be prorated, but nevertheless did it for what they hoped to capture some percentage of the 7.53% exchange premium – some of them may sell their KVUE shares when they receive them. Coupled with that, from the press release announcing KVUE’s inclusion in the S&P 500, there was language in it that said, “Upon successful completion of the exchange” – or something to that effect. Its possible that literally means the day it is announced that its been completed – so like next Tuesday, but at that point the exchange will still be ongoing in some sense, so its possible that inclusion will come after the exchange fully shakes out (meaning all JNJ exchangers receive their KVUE shares).

    My overall point is – this KVUE price recovery could happen on a bit later timeframe than next week. I’m not at all sure but wanted to post these thoughts to see if anyone has insights on any of what I’ve mentioned above.

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    • My gut feeling as well.
      Imo one of the few situations/scenarios where applying some TA could be useful for timing entries..

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      • TA just tells you what people did, doesn’t tell you what they’ll do.

    • There will be a fair bit of short covering though, which partially makes up for it.

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  4. Based on the way the S&P 500 has previously handled adding a split-off, do we have an educated guess on when this date is likely to be?

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    • S&P said the exact date will be determined after the expiration, but I think it shouldn’t take long. In the previous instances, the companies were added to the index 1-4 days after the tender expiration.

      ZTS was added 2 days after the tender expiration. SYF – 1 day after expiration. MEAD – 4 days after the expiration.

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      • Barron’s date is just a safe guess exactly one week after the expiration. Judging by a very high trading volume yesterday (almost 10% of all shares outstanding) I would think some investors got their new shares earlier than those holding in a street name.

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  5. Sure seems like the timing of this was very accurate in terms of hitting a turning point. Thanks!

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  6. KVUE is set to join S&P500 index on the 25th of August. As per write-up, ‘I am not sure what are the rules for index funds and if they are already building up positions in KVUE or will start doing that once the company is added to the index’, but probably there is likely to be more incremental buying by index funds this week, which might offset pressure (if any) from the sellers of newly received KVUE shares.

    https://www.prnewswire.com/news-releases/kenvue-set-to-join-sp-500-advance-auto-parts-to-join-sp-smallcap-600-301906061.html

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  7. Volume yesterday was way above average. I’m assuming that is also index funds buying.

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    • Usually it’s 1-2 weeks after the expiration. So in the next couple of days I guess.

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  8. Shares hit my fidelity account this morning. That may explain some of the weakness in the stock today. It looks like it was upgraded by GS sell side research this morning for similar reasons outlined in this idea as well.

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  9. Am long KVUE for this trade as makes sense. I spent a lot of time studying KVUE peer PRGO and its worth a look and has a lot more upside than KVUE (more levers including margin expansion, deleveraging) but not an event driven story and its more of a 6-12 month story that requires execution. PRGO trades at 10.7x 24′ EBITDA and 12.3x 24′ EPS so has more multiple re-rate potential than KVUE if investors begin to look at it more as a self-care company and give it more of a CPG multiple (which I think they will over time). PRGO new CEO from Bayer and P&G seems like the right person and he felt comfortable with plan by old CEO from February for a 2023-2025 low-mid single digit revenue CAGR mid teens AOI growth and mid to high teens EPS CAGR through 25′ (Adj. GM expansion from 36.2% in 22′ to 40% in 25′, AOI margin from 11% in 22′ to 14-16% in 25′, net leverage from 5.5x in 22′ to 4.5x in 23′ to <3x in 25') which is above the LT algorithm of 3/5/7% CAGR for revenue/AOI/EPS.

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  10. Original timeline has expired – still believe in this one, or closing position?

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    • While I expected this to play out a faster, I don’t believe the split related sell-off has already ended. JNJ divested a huge 80% stake and KVUE’s volumes are still very elevated (but gradually dropping). The stock seems inexpensive so I’m quite comfortable with giving it a bit more time to rebound.

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  11. Has the index fund buying ended by now? If it did, the catalyst that was supposed to drive the price up wasn’t enough to offset the sell-off from either arb selloff or whatever that was.

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  12. KVUE dropped by 6% on Thursday on significantly increased trading volumes. There were no news or updates from the company itself. The only explanation I’ve found is Barron’s article saying the move might’ve been related to investors’ worries around Tylenol-related lawsuits. This is puzzling, as Tylenol lawsuits are nothing new and have been known to the public for at least half a year already (they were also mentioned in JNJ’s 10-K in February). These lawsuits are still early-stage and KVUE itself says the potential outcome is impossible to assess yet. To my uneducated eye, KVUE’s case doesn’t look weak. Meanwhile, Tylenol accounts for only about 10%+ of KVUE revenues. The massive drop yesterday seems simply out of touch with the company’s fundamentals and looks more like a technical sell-off, which might’ve also been impacted by the split-off related volatility. KVUE now trades at 13.2x TTM adj. EBITDA vs 18.6x for PG and 15.8x for CL. For now, my thoughts remain in line with this Goldman Sach’s comment on KVUE’s valuation gap:

    “On a consensus NTM P/E basis KVUE is now trading 5X turns cheap to PG and 3.1X turns cheap to CL. As we detailed within our initiation and again within this report, there is no basis for a discount based on asset quality; KVUE has top-tier brands in a category/country footprint that should afford it growth and returns in line with these peers. Skeptics argue that the company’s track record of share losses provide justification for the discount and, while we see some truth to the argument, we also see this as the catalyst for a treating.”

    The lawsuits claim that Tylenol “caused neurological disorders in children whose mothers took the medicine while pregnant” and that KVUE is responsible for not including a warning. The effect is allegedly caused by acetaminophen, which is one of the ingredients of Tylenol. The same plaintiffs have also made similar claims against retailer chains with similar allegations around generic acetaminophen products. However, KVUE argues that:

    “The active ingredient in Tylenol, is one of the most studied medications in history, and that U.S. health regulators and medical organizations agree it is safe. The American College of Obstetricians and Gynecologists calls acetaminophen “one of the only safe pain relievers for pregnant individuals during pregnancy.”

    A bit more color on the situation from Barron’s article:

    “The lawsuits are at an early stage, but the plaintiffs have won a series of procedural victories in recent months, Barron’s reported. This fall, the lawsuits will enter a decisive phase, as the sides argue over which experts will be allowed to testify at trial. If the judge approves the plaintiffs’ experts, investors will need to start paying more attention.”

    Barron’s article: https://www.barrons.com/articles/kenvue-stock-price-today-lawsuits-f05f04da
    SA on Goldman Sach’s rating upgrade for KVUE: https://seekingalpha.com/news/4006043-kenvue-is-called-cheap-by-goldman-sachs-on-a-valuation-basis

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  13. There’s no threat to tylenol sales – this is purely about whether there should be a label warning pregnant women against use. The real financial concern is the size of any potential fine.

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  14. Partial rebound pre-market today on positive court filing in Friday and buy rating from Deutsche Bank.

    “While the Food and Drug Administration denied the judge’s invitation to comment on the proposed label or issue a statement of interest, the regulator did attach a March 2023 epidemiology report that stated that recent studies don’t change its conclusions, UBS analyst Peter Grom wrote in a note on Sunday.

    The FDA’s response suggests Kenvue is unlikely to see material damages as there is no determination of causality between in utero exposure of acetaminophen and ASD/ADHD,” Lizzul, who has a buy rating and a $30 price target, wrote in a note on Monday.

    The next catalyst in multi-district litigation is the Daubert motions on Sept. 19 in front of Judge Denise Cote, JPMorgan analyst Andrea Teixeira wrote in a note on Monday. At the hearing the judge will consider which experts can testify regarding the science of causation.”

    https://seekingalpha.com/news/4010574-kenvue-gains-after-upgrade-bullish-notes-on-tylenol-autism-warning-label-suit

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  15. Initially this was supposed to be a short-term trade to profit from possible inefficiencies around the split-off. That thesis didn’t work out and now we’re suddenly trying to handicap a gigantic class-action lawsuit. This was a mediocre idea in the first place (not saying the write-up was bad, but it wasn’t exactly a high conviction no-brainer idea), it didn’t work out, I’d say just move on.

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    • It is still a short term trade related to the split-off and KVUE trading significantly below peers. I am not trying to handicap or argue for/against the class-action lawsuit. I have shared the information above only for information purposes in order to shed some light on what might have caused higher volatility in the stock price.

      But you are correct – I have over-stretched the initially expected timeline for this case, and now any remaining split-off dynamics (if there are still any left) are mixed up with other news. So the initially contemplated trade has ended and it failed.

      6.5% loss in a month (including dividend received in August).

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  16. Think this sell off is because the phenylephrine Sudafed more easily available was ruled ineffective by FDA.

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