Reynolds Consumer Products Stock: Assessing Total Return Potential (NASDAQ:REYN)

Intro

If we look at a technical chart of Reynolds Consumer Products Inc. (NASDAQ:REYN), we can see that shares, for the most part, have traded in a range (with the exception of this year’s June lows) between approximately $26 a share and $31 a share. Dividend growth stocks that trade within a narrow range attract income-oriented investors because of the potential of compounding one’s gains at a much faster clip. Furthermore, rangebound stocks also offer the income-orientated investor the opportunity to sell covered calls against their long stock positions in order to earn more income on top of the dividend. Liquidity, though, in REYN’s options, or better the lack thereof, may present a problem with this strategy.

REYN’s forward dividend yield presently comes in at 3.2%. The company’s yield is well above the average in this sector (2.69%). Furthermore, the registered pay-out ratio of 67.6% demonstrates at least on the surface that the payout is sustainable for now. However, given where inflation is currently in the U.S. and also the fact that the 10-year U.S. treasury bond (which is practically a risk-free investment compared to stocks) now yields well over 4%, REYN’s 3.2%+ yield means that investors are way behind the eight ball, especially if we see minimal stock-price appreciation over the next 12 months.

Suffice it to say, investing in dividend stocks now is ALL about vetting the total return potential of the stock involved. In Reynolds Consumer’s case, its total return potential (given its multi-year narrow trading range resulting in significant overhead resistance) needs to be compelling to ensure a potential upside breakout may be on the cards. Therefore, let’s go through the key areas and metrics which make up Reynolds Consumer’s dividend to ascertain what is the real potential here. A strong, growing, viable dividend usually points to high stock prices in the long run.

Profitability

REYN’s trailing twelve-month gross margin comes in at 20.68%, which is worrying when compared to the company’s 5-year average (27.53%). Furthermore, the recent second-quarter gross margin print which was (20.07%) lower than the trailing average further demonstrated that profitability remains under pressure. Although further down the income statement, we see that while the company has been doing well with respect to keeping net income margins elevated (7.43%), the declining gross margin metric is worrying for the following reason.

That 7% drop for example in gross margin over the past five years, all things remaining equal, could have meant that net profit would now be hovering around 1% at this point if costs were standardized across the income statement. Through some solid financial engineering, however, REYN remains profitable due to decreasing its costs when compared to gross profit in general. This has bought REYN time, but you can bet the market will remain clued into that gross margin metric like a hawk.

The reason being is that inflation has the potential to affect a company with a gross margin of 20% much more cruelly compared to a 35% gross margin company, for example. REYN, in essence, has less leeway compared to its peers, which is why we need to see an upturn in this key metric before long.

Value

Taking into account the company’s profitability, REYN needs to have a stellar valuation in order to have any chance of taking out that overhead resistance over the near term. Followers of our work will be aware that we favor companies with low earnings, cash, book, and sales multiples, plus we also like to see a growing interest coverage ratio overall. As we can see below, although the company’s assets and sales multiples come in lower than their 5-year counterparts, the company’s earnings (alluded to earlier by those declining margins) are actually more expensive today from a non-GAAP basis.

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The much higher interest coverage ratio today is a huge blessing given how gross margin has contracted in recent years. However, is there enough firepower here to drive shares forward, especially considering how forward earnings revisions have been contracting? I am not so sure.

Conclusion

Although the dividend yield may attract some investors here, we believe the company’s declining gross margin metric & strong overhead resistance on the technical chart will limit strong upside potential in Reynolds Consumer Products, at least for the time being. We look forward to continued coverage.