Reckitt Benckiser Group PLC

LSE:RKT

Earnings Call Analysis

Strong H1 Performance and Positive Outlook

In the first half, net revenue grew by 8.1% to GBP 7.4 billion with like-for-like growth of 6.0%. Adjusted operating profit was stable at GBP 1.8 billion with margins slightly down to 23.8%. The confidence in performance led to a 5% dividend increase. Gross margin improved by 130 basis points, bolstered by pricing and productivity programs. Consistent investment in brand equity and innovation drove performance, notably in the Lysol and Health segments. A strong free cash flow of GBP 758 million was reported, with expectations to exceed GBP 2 billion for the full year. The net-debt to adjusted EBITDA ratio reduced from 2.1 to 2.0. The revenue outlook stays at 3% to 5% growth, with full-year adjusted operating margins anticipated to be slightly higher than 2022, around 23.4%.

Strong Performance Despite Headwinds, Margin Target Upward Revision

The company reported a powerful first half, delivering upper-end mid-single digit growth, despite some challenges such as tough comparisons against previous high performances in US nutrition and Lysol. This was supported by significant investments in innovation and market execution which led to gross margin expansion and operating margin leadership. Adjusted operating margins now have a revised upward target, indicating managerial confidence.

Revenue Growth and Margins: A Story of Balance and Resilience

With actual exchange rates, the company's net revenue grew by 8.1% to £7.4 billion. A particular highlight is the like-for-like net revenue growth, which stands at 6.0% for the first half of the year and is fueled by both pricing strategies, mix improvements, and a spate of innovative launches. Gross margins improved, rising to 59.4% despite inflationary cost pressures, attributed to the pricing and productivity programs. Investments in brand equity also increased to support innovation; although total fixed costs appear high, they are inflated due to one-off items from the prior year. The underlying message being a sound financial structure capable of navigating a tough economic landscape.

Segment Performance: Hygiene Growth, Health Strength, and Nutrition Leadership

The Hygiene segment returned to growth, with Lysol's revenue increasing once again and other flagship brands maintaining robust growth trajectories. Health revenues also rose notably, driven by over-the-counter (OTC) products and intimate wellness, illustrating the strength and diversity within the segment. Nutrition continued to maintain high market shares, especially in North America, with continued leadership in the US and Canada, echoing the company's competitive strength even as tougher market conditions are anticipated.

Cash Flow and Debt Management: Firm Footing for Future Investments

A key financial highlight lies in the strong free cash flow which is expected to exceed £2 billion for the full year. The company has seen a reduction in leverage, with net-debt to adjusted EBITDA declining from 2.1 times to 2 times, showing an improving balance sheet and financial prudence. Management asserts their commitment to returning excess cash to shareholders, in line with a solid capital allocation policy, viewing this as an indicator of strong underlying business health and readiness for future growth and shareholder value creation.

Looking Ahead: Revenue Growth Targets and Competitive Challenges

The outlook for the year remains positive, with management reaffirming the 3% to 5% like-for-like net revenue growth target. However, they also acknowledge the challenges ahead, such as high comparisons in the OTC market particularly in the fourth quarter and an intensifying competitive environment in US Nutrition. On margins, an augmentation slightly above 2022 levels, excluding US Nutrition impact, is expected. Nonetheless, the overall tone is one of cautious optimism as they look to balance growth with competitive pressures.

Innovation Fuels Growth and Market Positioning

The narrative strongly emphasizes the role of innovation across segments – from Lysol Air sanitizer in the hygiene category to new OTC and wellness products in health. New launches in the Nutrition segment, particularly in Latin America, are highlighted as examples of the company's proactive approach to maintaining its leadership through product development and market expansion.

Strategic and Cultural alignment as Key Competitive Strengths

The incoming CEO expresses confidence in the company's strategic direction, pointing out opportunities for growth through household penetration, premiumization, selective geographic expansion, and strengthening existing brands. Furthermore, a focus on culture, including diversity and inclusion, is considered essential for sustaining the strategic vision and preparing future leaders within the organization.

Operational Efficiency and Investment Opportunities

Management underscores the importance of strong top-line growth to drive leverage and indicates continuous efforts to improve operational efficiency. Fostering a virtuous cycle of lower fixed costs and reinvestment into growth areas is outlined as a critical focus area.

Market Dynamics: Consumer Pressure and Competitive Environment

There is a clear acknowledgment of the pressure European consumers face and the resultant competitive landscape. The performance in various markets like Malaysia, Singapore, and Vietnam was weaker, but management responds to these pressures by optimizing strategies and addressing areas within their control. The abiding sentiment is a commitment to adapt and maneuver through these challenges.

Earnings Call Transcript 2023-Q2

[Operator]

Good morning, everyone. Welcome to Reckitt's Half Year 2023 Results Presentation. Before we start, I'd just like to draw your attention to the usual disclaimer in respect of forward-looking statements.

Now, presenting our results today, we've gotten Nicandro Durante, our CEO; Kris Licht, our CEO Designate; and Jeff Carr, our CFO. Following the presentation will be the normal Q&A session. And so without further ado, I'll ask Nicandro up to kick things off.

[Nicandro Durante, CEO]

Good morning, everyone, and thank you for joining us either in-person here at Deutsche Bank or online. I'll kick-off today's presentation, some key message. Jeff will then take you through the financial review and our outlook, and then Kris will provide you with a business update as well as his initial thoughts [indiscernible] the business. We will finish with the usual Q&A session.

Well, we have delivered a strong half-one performance. The investments we have made in R&D and our innovation pipeline over the last few years are delivering. These, combined with our focus on improving our in-market execution and the relentless work by so many of our people on our productivity program have enabled us to deliver this strong first half. We delivered growth towards the upper-end of mid-single digit growth, despite some tough comps for our US nutrition business and Lysol in Q1. We delivered gross margin expansion and we delivered our market-leading operating margin. Second, when I talked to you in March, I said that we had a strong pipeline of innovations launching this year and that we're going to step-up our brand equity investment to ensure they land well in the market. Well, we have done exactly that.

Kris will walk-through some of our large innovations shortly, as well as providing you with an insight into our particularly exciting Lysol innovation that we're rolling out in half-two in the US. The early success of innovations launches this year combine a very strong half-one delivery give us confidence in our full-year targets, which we have revised up slightly in respect of our outlook on margin. And I'm delighted to welcome Kris Licht as our next CEO. I have worked with Kris over the last 11 months, and he is authentic leader, a strong operator, and the right person to lead Reckitt through the next-stage of our journey, from transformation to outperformance.

I'll now hand over to Jeff, who will take you through the financials and our outlook for the year.

[Jeff Carr, CFO]

Thank you Nicandro, and welcome ladies and gentlemen. As you can see, at actual exchange rates, net revenue grew by 8.1% in the half to GBP7.4 billion. Like-for-like net revenue growth was 4.1% in the quarter and 6.0% for the half. And the impact of price and mix was 8.4% in the quarter and 10.4% for the first-half. This was resulting from carryover pricing in the second-half of last year, innovation-led price increases, and the increase in our Nutrition business pricing deferred from last year, as well as mix improvements.

We saw sequential volume improvement in our Hygiene business with a strong performance from Lysol, which returned to revenue growth in the quarter. Overall, volume was down 4.3% in the quarter, with flat volumes in Health, and Nutrition volumes down, impacted by the market issues in the previous year.

Adjusted operating profit was strong in the half at GBP1.8 billion and margins at 23.8% was a good performance, helped by our ongoing productivity program. In absolute terms, adjusted operating profit was in-line with last year at actual rates, slightly down at constant rates, but margins, you'll see it down 180 basis points, but that is against the unusually high-margin last year which included some significant one-off items. In-line with the confidence of our outlook, we've increased our interim dividend by 5%, that's consistent with our aim to deliver sustainable dividend growth.

Moving onto the key drivers of performance. Gross margins were up 130 basis points, to 59.4%. It's pleasing to see gross margins improve following, obviously, a difficult 2022. As I mentioned, gross margin benefited from the pricing, mix benefits and the productivity programs, which continued to offset the continued inflationary pressures that we see in cost of goods.

As discussed earlier in the year, we've increased our brand equity investments, up 60 basis points or in absolute terms just over GBP100 million to support our innovation program, quite a significant increase. Other costs appear high, up 19.2% as you can see at constant exchange rates versus last year, however, the prior year first half costs at 20.8% of net revenue were unusually low, in-part due to the one-offs I mentioned earlier, such as the profit on-sale of land, which was almost GBP60 million in the first half of last year. Second half costs will be broadly in-line with the prior year, which means for the full year we expect total fixed-cost to be around just under 10% ahead of 2022.

Now moving on to our business units, let me start with Hygiene. Net revenue grew very nicely, up again into the mid-single digit growth area at 5.5% in the second quarter and while the growth was broad-based, it was particularly pleasing to see Lysol return to growth, up high-single-digits in the second quarter. As we stated earlier in the year, we saw Hygiene volume trends improve quarter-on-quarter, from a double-digit decline in Q1 to minus 7.3% in the second quarter.

Adjusted operating profit margin at 19.1% was down 250 basis points versus 2022. Now remember, Hygiene is the business unit, which was most impacted by the extraordinary COGS inflation in 2022, and additionally, this year, we significantly stepped-up our BEI investments in the Hygiene division to support the innovation program. We expect Hygiene margins to improve in the second half of the year in a more benign cost of goods inflationary environment.

So moving on to Health. We had net revenues of GBP3.1 billion in the first half. And like-for-like net revenue growth was 8.8% in the half and 4.9% in the second quarter. The growth was led by a strong performance across both our OTC business and intimate wellness portfolios, with an improving performance in China in the second-quarter.

Now Dettol was mixed across many markets with growth in South Asia and parts of Africa, but this was more than offset by a difficult market in ASEAN, where we saw declines and we faced some category weakness and some end-market challenges. This contributed to the lower volumes in our developing markets, but we expect the performance, specifically for Dettol in the second half to improve. Adjusted operating profit margin was 28.7%, an increase of 40 basis points, helped by the positive mix from a strong OTC performance in the first half.

Now let's look at Nutrition. We delivered revenue of GBP1.3 billion in the first half. Like-for-like revenue growth was 5.3% in the half and we had a small decline of 0.9% in the second quarter, as we're now fully lapping the prior year market disruptions. I'm very pleased that we've continued to maintain high market shares in the US and Canada. Enfamil remains the number-one recommended trusted infant formula brand in North America.

Of course, we do expect a tougher competitive environment in the US and Canada in the second-half and we're where we'll be lapping much higher market-share comps during the peak of the supply shortages from last year. However, Reckitt has moved into clear market leadership in the US and Canada and we're confident of maintaining that leadership through the second half of the year. In developing markets, we saw a continued strong performance in LATAM, again, offset by mixed results in Asian markets.

Adjusted operating profit margin was 23.1% in the half, helped by a positive mix from additional WIC benefits in Q1, higher market shares and pricing that was put in-place at the start of the year. The decline of 590 basis points in the half was again due to the lapping of the profit on-sale of Asian land, which I mentioned earlier. We expect margins in the second half to reflect the absence of the WIC benefits, that program was completed at the end of February and higher trade and marketing investments as we face a tougher competitive environment.

Now looking at earnings per share, it was down slightly, half from last year from 178.6 pence per share to 173 pence. As previously mentioned, adjusted operating profit was unusually high last year. So despite a good performance in the first half, AOP contributed to a 4.8 pence fall in EPS. Net financing costs were lower than expected due to foreign exchange gains on financing instruments of around GBP30 million in the first half. However, this was offset, more than offset by higher effective tax rates, with tax-rate -- effective tax-rate of 24.7% in the half. Foreign exchange translation benefited EPS by 4.9 pence, partly due to US dollar and euro strength in the first half of the year.

We generated GBP758 million of free-cash flow, a year-on-year increase of around 4%. Now, you'll see we had a rather disappointing working capital outflow of GBP451 million in the first half. And while we've made good progress in reducing inventory, we saw a larger than expected decline in payables as a result of both the inventory reduction program and lower volumes. However, we expect a working capital inflow in the second half of the year and we still expect to have a strong free cash flow above GBP2 billion for the full year and working capital remains a key focus for us throughout the Group and throughout the organization.

Now moving on to net-debt. We've continued to see a reduction in leverage. And as you can see, net-debt to adjusted EBITDA has reduced in the half from 2.1 times to 2 times at the end of the half. Our capital allocation policy has not changed. We amended our dividend policy at the end of last year. And consistent with this, we've increased our 2023 interim dividend by 5%. For the full year, we expect to have strong free cash flow, as I mentioned. And for our key ratio of net-debt to EBITDA -- adjusted EBITDA, we expect to be below two times by the end-of-the year. In-line with our capital allocation policy, we're then committed to returning excess cash to shareholders.

Now finally, let me cover the outlook for the year. Our revenue outlook remains unchanged, at 3% to 5% like-for-like net revenue growth for the year. Now, we've had a good first half and expect continued momentum in the second half. But equally, we are aware that we face tough comps in OTC, especially in the fourth quarter and an increased competitive environment in US Nutrition, while lapping the higher share gains that we had last year.

On adjusted operating margins, we now target margins slightly above 2022 levels, when excluding the US Nutrition impact of 80 basis points. And whilst this is a slight tweak up in our guidance, I don't expect consensus to move on the back of it, given that the market is already at 23.4% expectations for the full year. We've made a few other small adjustments to other more technical elements of our guidance, we've nudged our finance expense expectations down, but our effective tax-rate has gone up slightly.

Now, I'll hand over to Kris to provide you with a business update and his initial views on Reckitt. Thank you.

[Kris Licht, CEO Designate]

Thank you, Jeff. Good morning everyone. It is truly an honor to be given the opportunity to lead this great company. Today, I will take you through a business update on our three GBUs. I will then provide you with some initial thoughts on Reckitt and our future. I will come back later in the year with a more comprehensive view of how I believe this company can deliver outstanding value for shareholders in the coming years.

So, starting with the business update. In Hygiene, I'm very pleased to see the broad-based growth across our Hygiene portfolio, particularly in Q2, now that Lysol has passed Omicron LAP in Q1. We had a very strong Q2 last year for Hygiene, with the business growing at 8.9%, excluding Lysol. And therefore, to see Air Wick, Finish, Vanish and Harpic, all growing mid-single-digit or better this quarter is a rounded and well-balanced performance.

Growth was innovation-led, helping us to drive further premiumization in Finish and to deliver a strong performance in the slightly more discretionary category of Air Care. And finally, I'm very pleased to say that Lysol returned to growth in the quarter and it was strong high-single-digit growth.

Moving to our Innovations. On Finish, we launched our new Ultimate Plus all-in-one product across many countries in Europe during H1. It is our best-ever performing auto dish detergent, using our patented Cyclesync technology. This has helped drive further premiumization in the category. In 2020, less than 15% of our auto dish products were in thermoforming technology. We are now at over 50%, and this will continue to increase rapidly as we drive more superior solutions for consumers. We've launched a couple of important innovations in Air Wick this year. One of them is, Air Wick Vibrant, our most luxurious fragrance experience with twice the essential oils. These launches have helped us drive mid-single-digit growth in Air Wick in both the first half and Q2.

And in Vanish, we've launched our latest Oxi Action formula effective at 20 degrees celsius, helping to drive Vanish to high-single digit growth in the half. We've supported these launches among others, well with significant BEI and I'm pleased to say that our latest revenue forecasts for these launches this year are all in excess of our original launch plans.

Now, turning to Lysol. We are now growing from the 50% higher base that we created during the pandemic. Our Lysol brand spans a number of sub-segments within the disinfection category. And in Q2, we saw good growth across each of our segments in the US, our core Lysol disinfectant spray, our disinfectant wipes, our laundry sanitizer, and the other smaller segments in our portfolio.

Our laundry sanitizer business in particular has an exceptional runway for growth as category penetration is still very low. And I'm very excited to announce that after a number of years in development and through close cooperation with the US Environmental Protection Agency, we are now launching our new Lysol Air sanitizer, the first and only antimicrobial product to effectively kill both viruses and bacteria in the air.

Our Health business has had a strong first half, delivering 8.8% like-for-like net revenue growth and high 20s adjusted operating margins. Our OTC and intimate wellness portfolios in particular have performed very well. During the first half, we've made good progress in both broadening the shoulders of our brands and introducing several exciting innovations.

Our Dettol portfolio has delivered mixed results. Several of our largest markets delivered growth and market-share gains, underpinned by distribution improvements and innovation. However, this growth was more than offset by declines in some Asian markets due to category weakness and specific end-market challenges. We have, however, taken action, we continue to innovate, we remain agile in a very dynamic market. With these actions, we feel confident that the performance of Dettol and therefore, our total developing markets will improve in the second half.

Our OTC and intimate wellness portfolios had a very strong first half, growing by around 20% and high-single digits, respectively. Our OTC platform represent over 40% of our health GBU and is driven by our market-leading power brands, Mucinex, Nurofen, Strepsils and Gaviscon. Growth in the half came from a number of drivers, including category growth, broadening the shoulders of our brands, innovation and some retailer shelf refilling due to the fact that we struggled to keep up with demand in Q4 of last year, and the desire of retailers to hold sufficient inventory levels as they look-forward to the upcoming flu season.

It is too early to judge the upcoming season. We are well-positioned with respect to supply and customer inventory levels are in a good place. From a second half net revenue perspective, I would just caution that for OTC we're facing some very-high comparatives from a long strong season throughout 2022 with a peak in Q4 of 2022.

Our intimate wellness portfolio is almost GBP1 billion franchise today, and it has also delivered a very strong half year performance across both Europe and developing markets. And in Q2, we saw a particularly strong performance in China as it emerged from COVID related lockdowns.

We've made some good progress in broadening the shoulders of our brands in the first half. I've set-out three examples here to give you a flavor of our progress in this area. The US market was lacking a serious medicated solution for sore throats. The combination of Mucinex trusted brand promise with the science from our global Strepsils platform enabled us to successfully launch Mucinex InstaSoothe lozenges 18 months ago. We are now further strengthening this platform with our new Mucinex InstaSoothe sore throat and pain relief spray. This powerful and easy-to-use spray numbs pain, so you can get back to your day.

Since launch, we've achieved a mid-single-digit share of the store throat category in the US. And we will continue to focus on becoming a leading player in this segment, given the superiority of our products. In Germany, we entered the very large, but competitive market of adult pain relief and we're making some good progress, gaining 160 bps of share since we launched. And in France, we've introduced our Biofreeze roll-ons, sprays and gels. It's early days, but our growth potential is strong and the launch has gone well.

This year, we launched Biofreeze overnight relief patches in the US. A menthol based topical analgesic designed to stay on through the night and optimized for comfort and flexibility. You've seen over the last couple of slides that we are very active in our growth plans for Biofreeze. We've had a great first-half with Biofreeze, and I believe it will be a highly value-accretive acquisition.

In intimate wellness, we launched Durex Invisible ultra-thin condoms designed to maximize sensitivity. And we've also launched a number of innovations across our Dettol portfolio. Including two new variants of our Dettol cool bar soaps to strengthen our successful cool platform in India and the Middle-East.

Moving to Nutrition. Overall, we have had a strong first half growing 5.3%. In North America, the absolute leading market share that we've managed to maintain in the US has been excellent. We continue to improve our execution and grow Latin America, but we've seen some mixed performances in ASEAN. With respect to ASEAN, we drove good growth in the Philippines and Thailand as a result of sales force change we made last year. But we saw some weaker performances across Malaysia, Singapore and Vietnam. We've taken a number of actions to improve performance on items that are in our control, including prioritizing our supply activity, maintaining a strong marketing program and some management changes.

In the US, we've maintained an absolute non-WIC market share just below 50%. Enfamil remains the number-one recommended infant formula by pediatricians and the number-one trusted brand by consumers in the US. And Nutramigen remains the number-one allergy brand. We also have a circa 40% share of hospital contracts which we've managed to increase over the last 18 months. This is an excellent performance by our US team who did an outstanding job, along with our supply and R&D colleagues who all worked very hard to supply significantly more safe formula to mothers and babies during a national crisis.

As we look-forward, we will be lapping peak market-share from the height of the crisis last year, and in addition, we expect the competitive environment to become tougher now that full supply has been restored to the market. In Latin-America, our team is also doing a great job. We've launched some exciting innovations, including our most advanced formula yet. We've supported these launches with healthcare professional education programs and this has enabled us to gain over 50 bps of market-share across the whole of Latin America this year. In addition, the team have done a great job focusing on margin levers such as mix, channel management and promo optimization.

So that was the business update. The company has great momentum and whilst we faced some tough comps in both OTC and US Nutrition, these are built into our full year targets. And as Nicandro said earlier, the momentum we're seeing in the business gives us strong confidence in delivering these full year targets.

So, I'm now going to provide you with some of my initial thoughts, and these are initial thoughts. I will come back and provide you with a more detailed update later this year. As you may know, I started my journey at Reckitt as Chief Transformation Officer and Chief Customer Officer. I have then led our Health GBU for the past three years. Given my role in the transformation, the setting of the strategy and the progress we've made over the last four years, my first message for you today should not be a surprise. I firmly believe we have the right strategy. We operate in very attractive premiumizing categories with a long runway for sustainable profitable growth. We have strong market-leading brands and while I have no doubt that we can trim and add to this great portfolio of brands over-time, our current portfolio is excellent.

Given the categories in which we operate and the strength of our brands, I see significant opportunities for sustainable growth from household penetration, premiumization, selective geographic expansion and further broadening the shoulders of our brands into adjacent categories. All whilst delivering consistently high gross margins. Secondly, we've spent a lot of time and focus on our culture, we have reinforced and embedded what made Reckitt truly great in the past, but we've also made changes needed to be fit for the future.

Diversity and inclusion is a big area of focus for me and it is critical that this remains a focus as we develop the future leaders from within Reckitt. And finally, whilst we have the right strategy, the business is well-invested in, and we have come a long way in terms of our competitiveness and execution. I believe we still have significant opportunities for further optimization. So let's talk about those a bit more. We've made significant investments over the last few years and we're seeing the returns of these investments. But I believe there is much more to do before we can say that we are operating at our full potential and delivering the sort of value-creation that I joined Reckitt to deliver.

Firstly, we have room for further strengthening on innovation and product superiority. We have a strong pipeline of innovation, some of which you've seen today and there is much more to come. We continue to work on improving product superiority across our Hygiene power brands. A good example of that is what we've been doing with thermoforming technology in our Finish automatic dishwashing tablets. We've made good progress over the past three years, but all Finish consumers deserve high-quality thermoform tablets and we're not there yet.

Secondly, we have room to further improve our in-market executional excellence. In March, I gave you an example of the improvements we made to our sales force in India. We have more to do in other markets as we optimize both the way we operate through our organization structure and how we benefit more from digital and AI capabilities that we are embedding throughout our value chain.

Thirdly, on our cost base. We have made significant investments over the last three years in building muscle we had lost. But we also still have some dissynergies left from RB 2.0. Consequently, our cost base has increased significantly. We will take action on this, whilst remembering that driving sustainable topline growth is absolutely the first priority. And I know that through optimizing our cost base, it will provide the fuel to drive both topline and earnings growth.

And finally, as Jeff said, we expect leverage to be below two times by the end-of-the year. We have already improved our dividend policy, which is now firmly centered around sustainable growth. But we have further opportunity to improve our returns to shareholders, given the strength of our balance sheet. The Board and I have yet to conclude on the most optimal type of further returns, but share buybacks is certainly an option that we will be reviewing very closely. As I said to you earlier, I will come back and speak to you in further detail about our opportunities for optimization later this year.

I will now hand back to Nicandro to wrap-up.

[Nicandro Durante, CEO]

Thank you very much, Kris. Before we move to Q&A, I'd like to summarize the key message we want to -- you to leave with you today. First, we have had a very strong half-one. Second, our innovations are landing well, Kris has talked at length about how many of our innovations in the first half and we'll have more to come in the second half. Third, this strong half one delivery give us confidence in our full-year targets, which includes a small upgrade to our margin guidance. And finally, we welcome Kris Licht as our next CEO to lead Reckitt for the next stage of our journey from transformation to outperformance.

And with that, myself, Kris, and Jeff, we are happy to take any questions you may have. Thank you very much.

[Richard Joyce, IR]

So we'll start with taking some questions from the room and then if you still got time, we'll take some questions from the people online.

[Nicandro Durante, CEO]

Yes. [indiscernible]

[Tom Sykes, Deutsche Bank]

Thanks very much. Tom Sykes from Deutsche Bank. Just referring back to your comments on capital allocation, and that may have been sort of implicit or fairly explicit about potential for a share buyback. But when you look at it, you've obviously got potential for Consumer Health consolidation longer-term. You may or may not be exiting the pandemic and the growth rate that you hoped you were going to be exiting at, but you obviously got opportunities for M&A as well, and then you're referencing returning cash of some kinds. Now, can you do all of those and why not just allocate a bit more to M&A to increase the growth rate of the Group?

[Jeff Carr, CFO]

Look, we've set-out a very clear capital allocation policy and we've said surplus cash will be returned to shareholders, that's been our policy for some time. We've kind of define that, although there's no magic numbers below two times net-debt to EBITDA, that's where we're heading.

Having said that, yes, we are constantly looking for good quality assets to acquire such as Biofreeze. If we see other assets, we will be -- good quality assets at good value that can create shareholder value, then we'll be able to participate in that, the two aren't mutually exclusive necessarily. But as it stands at the moment, where we have surplus cash, i.e., where the balance sheet is below the leverage target that we've given, we will return cash to shareholders. Again, the two aren't mutually exclusive. The great news is, we have strong free-cash flows, we have a strong balance sheet, so we have optionality.

[Tom Sykes, Deutsche Bank]

Okay, thank you. And then in the statement you referenced the medium-term targets and still mid 20s -- by mid 20s, do you at all think there needs to be a different balance between margin accretion and top line, and is there any implication for investment at all?

[Jeff Carr, CFO]

Let me take that one as well in terms of the mid-term targets. We gave those targets in 2020, because I think it was important to let shareholders know that the margin investments that we were making in 2020 and 2021, would result in us returning to the sort of superior margins that Reckitt is known for, and we're well -- I think we're well on-track to deliver those mid-term targets, they don't come from increasing gross margins, we will get to the mid-20s simply by optimizing and getting leverage on our fixed costs and there's room to do that, there's room to do that and to increase our BEI spend that you're seeing that we're doing this year and I think it's very important that we doing, continue to invest in our brand equity investments in order to drive the top line.

So that balance is always something we look at. And quite frankly, without the strong top line growth, the leverage won't be there. So we have to do both. And the top line growth is critically important -- quality volume top line growth is critically important to the future. So that's where our focus is, that's where our emphasis is. And a consequence of that will be the mid-20s margins.

[Tom Sykes, Deutsche Bank]

Okay. Thank you.

[Richard Joyce, IR]

Just behind you [Mario] (ph). He'll come across the room.

[Unidentified Participant]

So two questions. First, Kris, you said innovation, there is much more to come. Can you give some sort of indication of the financial implications of that innovation. In the old days record, it was always be a high price point, high gross margin. Is that still the case? And secondly, I'm not sure who this is for, but Unilever on their call yesterday were talking about the possibility of a US recession. Is that something you see as a -- being worry -- to be worried of?

[Jeff Carr, CFO]

So, maybe I'll start. So our earnings model is very attractive. As I think we've covered many times, much of that rests on strong innovation, that's the only way we can sustain our premium brands and the strength of our portfolio and we have invested significantly in innovation. Today we have much stronger pipelines in all three of our GBUs, than we did four years ago. And you can see the evidence in my presentation. And as I said, there is much more to come. I would like to not disclose too much of that until we're ready to launch and talk with you about it. I hope you understand, but innovation is absolutely a core part of our algorithm going-forward and we are investing accordingly.

[Nicandro Durante, CEO]

Let me take the second one.

[Kris Licht, CEO Designate]

Okay, go ahead.

[Nicandro Durante, CEO]

It's very difficult to talk about US recession in consumers, because we haven't seen that. The consumer base and now our portfolio is performance actually well in US. In reality, we see less down trading. For example, private-label is losing share in the US. So we have performed extremely well there. Our brands are growing. We don't see the same stress on consumers in the US, as we've seen in Europe, Europe's consumers are really under stress. So things are moving well. We had a significant price increase in Nutrition in the first quarter of this year, we haven't seen the impact in terms of volume. So things are moving very well. So it's very difficult for me to predict if there is a recession out there and how this will play-out in terms of consumer demand. So, I think it's too early to discuss that.

[Kris Licht, CEO Designate]

Can I just add to that? If you look at our geographic mix, like-for-like revenue in the second-quarter in North-America was up nearly 8% and volumes were flat. So it was a good performance in North-America and that's backed by (Multiple Speakers) slowing down.

[Richard Joyce, IR]

Let's move across. Can you please introduce yourself for the people online.

[Jeremy Fialko, HSBC]

Good morning. Jeremy Fialko, HSBC. A couple of questions. So the first one is on ASEAN. And I guess it's been difficult within the quarter, so maybe you could go into the detail on the particular challenges. And I guess why you're confident in the solutions? And I guess, the second point is more generally. When I think back over previous quarters, it doesn't feel like your DVM business is necessarily generating the sort of growth that we might have expected the DVM business to generate. So perhaps you could talk about it, both on the short-term and maybe just in the slightly bigger picture on that one?

And then secondly, you kept your three to five revenue guidance intact, the consensus is at pretty much the top end of that. So, could you just clarify that you are comfortable with consensus pretty much at the top end of the range? Thanks.

[Kris Licht, CEO Designate]

So I'll start with ASEAN and I can talk DVM a bit as well. So firstly, I think it's important to know that our China business and our India business had a really good quarter, Dettol did really well from a trading standpoint, we're back to share gains in those markets, those markets are very important for us. There are a few select markets in ASEAN where we did indeed have some performance issues and we have taken action to address that. It's actually Dettol related. Many of the other parts of the health portfolio in ASEAN are doing very well. Intimate Wellness is doing well, OTC is doing well. But there is a need for us to perform better in Dettol in ASEAN and we're very focused on that. We've put actions in-place and we're confident that they're going to pay-off.

Now longer-term, DVM absolutely is an important engine of growth for us. DVM has historically also been a great engine of growth, through the pandemic Dettol performed extremely well in many of our DVM markets. So, we have a clear runway for growth in both Health and Hygiene and Nutrition in emerging markets and it remains a big priority. So some of that is more a question of some in-quarter dynamics, a very competitive marketplace and some weakening category demand in certain ASEAN markets. So I'm not concerned with our ability to grow in these markets going-forward, I think we will see strong growth across DVM.

[Jeff Carr, CFO]

I think coming back to the question on net revenue guidance, the answer is yes. I mean, obviously, I think when it comes to consensus, if we were uncomfortable, we would say something, so the answer is yes. I mean, it does imply a slightly slower second half and as I've explained, that's primarily due to Nutrition and the comps on cold and flu. The rest of the business continues with really strong momentum and we expect to deliver good numbers, but the nutrition comp is a difficult one to predict. By the way, it's a difficult forecast to predict. And one where we do expect, however, to see negative numbers in terms of the second half of the year.

[Richard Joyce, IR]

Yes. Please go ahead.

[Fulvio Cazzol, Berenberg]

Fulvio Cazzol from Berenberg. Thank you for taking my questions. I've got two. The first one is on price-mix, which was obviously strong in H1. And Jeff you highlighted three main drivers to that. One was carryover pricing from last year, one was the price increase in Nutrition, and the other one is innovation. To help us sort of understand how much of that will stick in the second-half. Could you maybe give us a bit of a guide as to the contribution of those three drivers to the first half?

And then my second question is on the OTC business, and I know that your results have been, obviously, quite good in the first half, partly because of the innovation that you've put into the market. So, I was wondering if you could perhaps give us some comments on the market performance, particularly in the southern hemisphere, perhaps Australia, which could be a good lead indicator into how the winter season might progress in the Northern hemisphere later? Thank you.

[Jeff Carr, CFO]

Well, let me let me start on the price-mix, and I do think it's worth pointing now. We report, price and mix combined and then volume separate, not everyone report it the same way. Some people mix in with the volume which favors the volume when you have a favorable mix, obviously. But again, in the first -- second half, I expect generally to see volume playing a more important part of the growth and the price-mix coming down, now that's a generalization. I think in Nutrition, we're going to see volumes also coming down because of the comps that we're up against, but generally I'd say, I'm expecting to see a stronger volume performance.

We said at the beginning of the year, we expected sequential improvement in Hygiene volumes. And therefore price where we start comping that, the bigger price increases that we took in the second half of last year, which is where we really did the heavy-lifting in terms of price increases. We'll start comping them and therefore the price will naturally come down a little bit. And volume will take a bigger impact. I think on Health, it will be a more balanced approach, but as a general sense for the Group, I'd expect to see a bigger impact from volume and a decreasing impact from price-mix in the second half of the year.

[Kris Licht, CEO Designate]

On the OTC season. Look, it's too early to predict the northern hemisphere, the Southern hemisphere, we keep an eye on it, as you say, sometimes it's an indicator of what will play-out in the Northern Hemisphere, it has been in the last couple of years. In general, without commenting too much on specifics of week-to-week, trading in Australia, in general, we're seeing an elevated level of demand, right. So, compared to pre-COVID levels, demand is significantly higher. Obviously, we've been through some very strong season as I talked about in 2022, so we're watching how we're tracking so-far, we're not seeing any major concerns, but at the same time, it is a very significant LAP, we had a spike in North America in Q4 of 2022. So it's too early to call it, but we're looking at it closely, and we'll share more as we can.

[Jeff Carr, CFO]

I would like to add. I mean just for -- put to context, cold and flu, not OTC, where cold and flu was at 7% of our net revenue. So a plus or minus 10%, which is the sort of variations, you've seen a normal flu season. It shouldn't really impact in terms of the guidance that we give or our ability to hit that guidance.

[Iain Simpson, Barclays]

Hi, there. A couple of questions from me if I could. It's in Iain Simpson with Barclays. Firstly, just thinking about the top line. Kris, you called out some stuff that you want to do to sort of help that along in terms of innovation and product superiority and end-market excellence. Are there any categories or geographies that you'd call-out where you just think Reckitt has more of a fundamental right to win and really where you'd hope to see kind of share gains, develop medium-term? I mean, I guess, at the moment your business broadly speaking is holding or gaining share in half its business. I'm assuming you'd like that number to be a little bit better than 50% in two years' time. Wondered if you had any kind of categories, which is we should keep our eye on?

And then, second question, just thinking about that margin bridge, I get -- firstly, I get that there's some LAP of the profit from property disposal, but it's still a pretty big increase in other costs in the first half year-on-year in absolute terms, GBP200 million, GBP250 million. I wondered if you could give any color on the drivers of that? Or perhaps to come at it another way, you talked about the synergies from RB 2.0 and unwinding those. Whether you give any indication of the likely scale of that and whether we'd expect to see those reinvested? Thanks very much.

[Kris Licht, CEO Designate]

So I'll start. So look I will come back later this year and talk more comprehensively about priorities going-forward. I am giving a lot of thought to the question that you're raising. They're absolutely the right questions. And I have some views, but I just want to complete my work in the analysis and then we'll come back and I'll be very clear with you in terms of what I see.

Obviously, our portfolio is full of power brands that are very strong with a great runway for growth. So we have many places where I see a runway for growth. And at the same time, I believe that we have to be choiceful about which ones we invest the most behind. So this is sort of what I'm working on right now. So it's a timely question. I'm not quite ready to give you a straight answer. Apologies for that.

[Jeff Carr, CFO]

Let me address the bridge and maybe you might want to come back in terms of the potential. Just in terms of the other cost, you're right, it's up 19% at constant currency. So it looks quite dramatic, but we had not just the one-off items in last year, if you remember what we said at the half last year is, we had a phasing in terms of some of our spends in 2022. So the fixed costs were low in the first half, higher in the second half, even absent the one-time impacts.

I think as a percent of net revenue, first half was 20.3%, second half was over 23% of net revenue. So there's quite a phasing impact. So actually when you look at it on an annualized run-rate, the first half number isn't so bad. And as I mentioned in the presentation, I think the second half actuals will be more in-line with last year.

Now having said that, salary inflation is significant. We look at significant increases -- mid to high-single-digit increases in terms of salary inflation and we have to offset that with efficiency improvements, regardless of the more significant changes that perhaps, Kris was alluding to. I think in terms of other areas, we are now traveling again. So you do see things like travel costs increase. And again, those are things we expect to offset by our general day-to-day management of our fixed costs.

But when you get to the full year number, you'll see a much more modest, I think, I've said just under 10% increase year-on-year as opposed to the 19%. And that's made-up of, once you adjust for the one-time costs, it will be an increase of around about 6% or 7%, which is basically the inflation that we're seeing in salaries. I don't know if you want to say anything else about the…

[Kris Licht, CEO Designate]

Yes, I would just say that, it's going to be a focus area. We need to lower our fixed costs to be able to invest into the growth that you were also just asking about and we need to get that virtuous cycle that's already working in our P&L, but we needed it working harder for us. So there a number of interesting areas that we're looking at. And like I alluded to, new technology is a factor as well, so I think we can become more efficient in our business and we'll share more specifics about that later this year.

[Richard Joyce, IR]

Is there any more questions in the room? Operator, could we take any -- are there any questions online? Operator?

[Operator]

Of course. We have our first question comes from Richard Cohen from Morgan Stanley. Richard, your line is now open.

[Richard Cohen, Morgan Stanley]

Thank you and good morning, gentlemen. Thanks for taking my call. A couple of questions from me. First one, as you think about your volume trajectory for the rest of the year, what gives you confidence in your ability to improve the trajectory versus the first half and how critical is it to your incremental marketing spend and innovations pipeline within that?

And then the second question. I know, Jeff, you said that you don't expect consensus margin expectations to move up for the full year, but with the gross margin beat in the first half and dynamics slightly improving, what do you think will prevent margins from getting to at least H1 levels in the second half? Thank you.

[Kris Licht, CEO Designate]

Did you get the first part? Was that volumes? Yes, volume trajectory. Okay, well, let me just, I know volumes is of interest, so let me talk just briefly about how we look at volume and volume going forward.

First of all, our Health business is showing flat volumes, which is an excellent performance. We do see some volume declines in Nutrition, but as we talked about, that's a function of the abnormal market conditions the last year and actually it is higher than we expected it to be at the start of the year. So our volume performance in these businesses are good. Hygiene is showing sequential improvement and we were for a while seeing significant volume declines in Lysol because we were lapping the effects of COVID, actually the last quarter, Lysol declined 2.2% in volume. So with this improvement that we're talking about, we can see it in the business and we believe that that will continue. So we're fairly confident that our outlook as we discussed is solid.

[Jeff Carr, CFO]

Let me take the question on margin. Look, I'm not going to go further than just repeat that we're comfortable with consensus in terms of margins. I think consensus is sitting at 23.4%, and we were slightly higher in the first half and I think that was a good performance, a bit higher than my expectations. That was a good performance and obviously, there's a lot of moving parts, but we are comfortable with consensus. If we felt there was an opportunity to upgrade, then we would, but we think this is in the right area and that's a good performance relative to 2022, ex the effect of Nutrition, that would be a 40 basis points increase year-on-year at a time where we were still seeing significant impacts not just from commodity inflation, but also from high CPI and salary inflation and energy costs. So I think that's a good performance, it was a good performance on gross margins in the first half. And if we see opportunities to upgrade that, we'll talk to you in due course. But at the moment, I'd say we're comfortable with where consensus is.

[Richard Joyce, IR]

Can we take another question if there's another question online?

[Operator]

Thank you. We have our next question comes from Alicia Forry from Investec. Alicia, your line is now open.

[Alicia Forry, Investec]

Hi, thanks everyone. I just wondered if you could comment on deterioration in volumes in Europe and Australia-New Zealand sequentially in Q2, it looks like it's quite a bit worse than the rate in Q1. Your comment on what's driving that, please? Thank you.

[Kris Licht, CEO Designate]

Yes, I spoke a bit to volumes now, actually what we are seeing is sequential improvement in the Hygiene business. Now the European marketplace is very competitive, the consumer in Europe is under pressure, there's no doubt about that, but we are seeing sequential improvement. We're confident in the plans that we have in-place and as I look at the volume numbers. I mean, we've had a specific poor performance in terms of volume in Mortein, which is making our total Hygiene volume number look softer than really most of the brands are, most of the brands are actually improving very well and trading well, Finish is an example, is gaining share in Europe at the moment and we're very pleased with that. So -- but there's no doubt that the consumer is under pressure, it's a very competitive marketplace and we continue to optimize our competitive strategies in Europe.

[Richard Joyce, IR]

Okay, let's take another question if there is another question online.

[Operator]

Our next question comes from Karel Zoete from Kepler Cheuvreux. Karel, your line is now open.

[Karel Zoete, Kepler Cheuvreux]

Yes, good morning. Thanks for taking the question. I have two questions. The first one is for Kris, if you can reflect a bit on the Health business, today you are fairly focused on Health business, particularly in OTC on a few areas. If you look forward, is then really the ambition to potentially add more categories and adjacent categories to become less and focus on the flu season or really more less friction in the current strongholds? And then a more near-term question is, how do you look on the promotional intensity in some of your categories and with input costs coming down, are there already signs that this is normalizing? Thank you.

[Kris Licht, CEO Designate]

Okay, so starting with Health and OTC, as I discussed and as you've seen in prior quarters, our OTC portfolio has performed extremely well. And our brands are very strong and that allows us to expand the shoulders of our brands into adjacent categories and I talked about InstaSoothe, but there's multiple other examples. We've added Biofreeze, which means that we now have a topical analgesics platform and we intend to expand that and drive good growth behind that. As Jeff said, cold and flu is far from the thing, the only thing that we're focused on. Actually we have market-leading pain franchises that are unrelated to the cold and flu season, sore throat occasions happen all throughout the year, as I'm sure you all know.

And so there's Gaviscon is another platform where we see strong growth and a great runway for growth, that is also unrelated related. So OTC is a fantastic market for us to compete in, we already have a strong portfolio, our brands can certainly stretch and solve more problems for consumers. I don't think we would say we're explicitly interested in not playing big in cold and flu, because that's also a very attractive market. It's just a seasonal business and you have to know how to navigate seasons, but it's a feature of the category and we can be -- we can perform with those characteristics.

[Jeff Carr, CFO]

I think on promotional intensity, look, my -- I'd say, yes, as you go through the second half and we see more people competing for volume, you're going to see a little bit of an increase in promotional intensity. I don't think it's significant, but I do expect there is going to be more promotional intensity in the second-half, in such that the growth that's going to come is going to come more from volume growth and people are going to be fighting for market share in that area. So I do see a little bit of an increase in promotional intensity, but that's baked into our guidance baked into our plans.

[Richard Joyce, IR]

I'm going to take one final question, again from the telephone, if there's another question on the telephone.

[Operator]

We have no further question from the line.

[Richard Joyce, IR]

Okay. In that case.

[Nicandro Durante, CEO]

Thank you very much. Thank you for coming.

[Jeff Carr, CFO]

Excellent, thank you.

[Kris Licht, CEO Designate]

Thank you.