Current Price: $22.78
Target Price: $25-$26.5
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.
- 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).
KVUE is a consumer health brands powerhouse, with multiple brands which hold the #1 position in their respective markets across different regions.
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: