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Does a 43% price drop make this undervalued UK stalwart one of the best cheap shares to buy now?

Photo of a man going through financial problems
Image source: Getty Images

When looking for cheap FTSE shares to buy for potential long-term returns, I look at price action over various periods. This helps me get an idea of what is causing the dip, whether it be problems at the company or broader macroeconomic factors.

Reckitt (LSE: RKT) is down badly over the past four years. Since its highest price of £77.50 on 17 July 2020, the shares have lost 43.3% of their value. That’s an annualised loss of 13% per year.

Not exactly promising, is it?

However, in the 20 years before the high, the shares rose 903%, providing annualised returns of over 12% per year. So why is the company struggling now and will the profitable days return? Figuring that out could give investors a better idea of whether now is a good time to buy — or just another value trap.

A dominant, diversified business

Using a discounted cash flow model, independent analysts have calculated that Reckitt shares may be undervalued by as much as 43%. Yes — the same amount it’s down by since its peak! This model uses estimates of future cash flows to better evaluate the fair price of a stock. It’s not necessarily accurate but in the case of Reckitt, other factors support the thesis.

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The company is very well established, with a £30.8bn market cap built up over several decades of selling top-branded products. Some of its better-known top sellers include Strepsils, Gaviscon, and Clearasil. It employs 40,000 people worldwide and was the leading acne cream and condom manufacturer in the US in 2023 and 2022 respectively.

The above tells me two things. First, Reckitt’s revenue derives from a diversified mix of products and regions, making it highly resistant to localised economic problems or single-product failures. Second, it tells me that the company has been a dominant market force in the past, increasing the likelihood that it can re-establish that performance.

So why the price decline?

The Reckitt price fell by over 20% earlier this year after news emerged that one of its products, Enfamil, had been blamed for the death of a premature baby in the US. A court ruled the firm should pay a $60m fine to the mother of the victim. However, the company launched an appeal to the verdict, stating that it stood by the safety of all its products.

Ultimately, the full effects of the case remain unclear, leaving the share price in limbo. If the verdict is upheld, Reckitt could face further losses due to fines from additional cases brought forward. However, if the appeal is successful, the share price could make an impressive recovery.

But it’s not the only risk. Before the Enfamil ruling, revenue was already suffering, possibly due to inflation with supply chain disruptions. The combined factors mean Reckitt has run up £8.2bn in debt, leaving it with a debt-to-equity ratio of 96.6%. That’s a little too close to 100% for comfort. If earnings don’t improve, it could have trouble managing the debt load.

My verdict

Currently, the future for Reckitt is uncertain. My shares are already down this year, but I’m holding because I believe the company will recover eventually. The share price could still fall further this year but in the long term, it seems likely to me it will regain past highs.

If it does, the current price could make a good entry point for new investors.

The post Does a 43% price drop make this undervalued UK stalwart one of the best cheap shares to buy now? appeared first on The Motley Fool UK.

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Mark Hartley has positions in Reckitt Benckiser Group Plc. The Motley Fool UK has recommended Reckitt Benckiser Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2024