Previous Acquisitions Still Worry Energizer (NYSE:ENR)

Energizer Holdings, Inc. (NYSE:ENR) manufactures and sells batteries and portable lighting products under the Energizer, Eveready, Rayovac and Varta brands. Additionally, the company has a portfolio of car fragrance and appearance brands, including A/C Pro, Armor All, Bahama & Co. and many others.

The stock’s history on the stock market hasn’t been particularly exciting – the stock lost 16% of its value after the company was spun off in June 2015, and the current dividend yield of 4.06% doesn’t make the total return over that period acceptable. The most notable decline has come since 2018, after Energizer announced extensive acquisitions from Spectrum Brands Holdings (SPB) that didn’t turn out well for shareholders.

Spectrum’s Acquisitions That Changed Energizer

Energizer made transformational acquisitions from Spectrum, announced in fiscal 2018 and completed in fiscal 2019. Initially, the acquisition Spectrum battery business, including the Varta and Rayovac brands, was announced in January 2018 for $2.0 billion in cash, representing an EBITDA multiple of 7.5x based on 2017 EBITDA of $169 million for the battery brands, expected synergies of $80-100 million and a tax benefit from the acquisition. Due to resistance from the European Commission, Energizer had to sell the European operations of Varta consumer batteries for $401 million for the acquisition to be completed, which will reduce the total consideration but will also negatively impact synergies, causing the estimated EBITDA multiple to be between 9 and 9.5.

Then, in November 2018, Energizer and Spectrum announced an additional transaction for Spectrum’s global Auto Care business, in which Energizer acquired the Car Fragrances and Appearance brands for $1.25 billion in combined cash and equity, at an estimated EBITDA multiple of 10.5x, with EBITDA of $117 million for the acquired brands, and expected synergies of $15 million. Given Energizer’s battery brand portfolio, the addition of Car Fragrances and other similar products is an odd acquisition.

Ultimately, the acquisition of Battery and Auto Parts closed in January 2019, increasing Energizer’s long-term debt by more than $2 billion to $3.42 billion by the end of fiscal 2019, which was used to fund the transaction.

Acquisitions continue to erode shareholder value

Several years after the acquisition and realization of synergies, analysis of the acquisition and financial results reveals the reasons for the stock’s poor performance.

The Auto Care acquisition contributed approximately $79.3 million to Energizer segment revenue in fiscal 2020, while the second quarter of fiscal 2024 generated approximately $82.4 million in segment revenue after synergies—given the high inflation since fiscal 2019, earnings growth was minimal to negative if not including the announced synergies.

Battery category sales remained nominally stable during the same period, with total operating income increasing just 4.8% compared to fiscal 2024 to now stand at $454.1 million, despite highly communicated synergies and high inflation during the period.

Given the excessive debt that Energizer had to take on to fund the acquisitions, the acquisitions worsened shareholder value, with $3.18 billion of long-term debt still sitting on the balance sheet, putting pressure on earnings and exposing shareholders to interest expense of $163.2 million. Energizer has also been in a steady state of restructuring since the acquisitions, spending a total of $399.6 million since fiscal 2019. Restructuring charges of $75 million to $85 million are expected in fiscal 2024, according to a Q2 press release.

Where are profits heading?

After integrating the Energizer acquisitions, sales began to underperform, with several quarters of very slow growth in a high-inflation environment, and five of the last six quarters had negative growth. The latest revenue growth in Q2 was -3.0% – sales continue to decline as Energizer struggles to attract sales volumes.

The company’s gross and operating margins continue to be fairly stable, aided by ongoing restructuring – in November 2022, Energizer announced its Momentum restructuring plan, which aims to recover profits with $80-100 million in annual savings, which will start to take effect in fiscal 2023. In fiscal 2023, gross margin increased by 1.7 percentage points and continued to have positive momentum in fiscal 2024. However, due to the continued decline in sales volumes, the positive impact on operating income was mostly mitigated.

Macroeconomic pressures appear to have moderated global battery volumes, as market sales growth has been minimal. Volumes have recently started to recover, driven by lower prices. Global battery volumes have fared better in terms of value change than Energizer revenues – Energizer’s sales weakness cannot be entirely attributed to weak industry trends, which makes future revenue prospects weak in real terms. Well-known Energizer brands appear unable to sustain their position in global competition with generic alternatives.

For fiscal 2024, Energizer is forecasting adjusted EBITDA of $600 million to $620 million, compared to $597.3 million in fiscal 2023. Revenue is supported by ongoing Momentum plan cost reductions. I believe that after a modest industry sales recovery and full implementation of the Momentum plan, Energizer’s earnings growth prospects are incredibly weak as sales are likely to remain weak.

Energizer’s Valuation Still Unattractive

Energizer shares are currently trading at an adjusted EV/EBITDA multiple of 8.4, which is slightly lower than the all-time average of 9.8 and lower than the EBITDA multiple from prior acquisitions.

However, given the results, I think the valuation is unattractive. To estimate a fair value for the stock, I have constructed a discounted cash flow (DCF) model. The model estimates weak growth of -2.5% in FY24, a 1% rebound in FY25 supported by the industry, but small declines thereafter to a stable revenue level – Energizer’s recent results do not show signs of improved growth.

For EBIT margin, I estimate modest leverage in FY2024 and FY2025 from the Momentum plan, but it declines to 15.0% thereafter as weak real sales growth slightly reduces margins. Energizer should have relatively low growth in capex and working capital, which will make cash flow conversion quite good.

Estimates suggest that Energizer has a fair value of $23.30, 21% below its share price at the time of writing. The stock has lost about half of its value from its peaks, prior to the Spectrum acquisitions, but the stock is still on a downward trend as earnings appear weak – the acquisitions are likely to further erode shareholder value unless organic sales improvement is achieved.

The DCF model uses a weighted average cost of capital of 6.76%. The WACC used comes from the capital asset pricing model:

In Q2, Energizer had $38.7 million in interest expense, which gave the company a yield of 4.85% on the current amount of interest-bearing debt. The continued high debt keeps my long-term debt-to-equity estimate high at 80%, despite the company’s plans to reduce balance sheet leverage.

To estimate the cost of equity capital, I use the 10-year Treasury yield of 4.41% as the risk-free rate. The equity risk premium of 4.60% is Professor Aswath Damodaran’s estimate for the US, updated to 5^t January. Yahoo Finance estimates Energizer’s beta at 1.00. At a liquidity premium of 0.25%, the cost of equity is 9.26% and the WACC is 6.76%.

While I believe this activity is defensive in nature, a heavily leveraged balance sheet and currently relatively low interest rates could lead to higher WACC in the future.

To go

Looking back, Energizer’s acquisitions from Spectrum in fiscal 2019 significantly undermined shareholder value and will likely continue to do so as acquisition financing debt remains high and organic sales are weak. The company likely has weak earnings growth ahead of it, following a modest industry recovery and the implementation of its Momentum plan, and the stock remains unattractive at its current valuation. As such, I’m starting to sell Energizer. With an organic turnaround, the highly leveraged stock could become attractive at the current price—but that’s looking increasingly unlikely in my opinion.