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

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Ivelin Radkov

Introduction

If we look at a technical chart from Reynolds Consumer Products Inc. (NASDAQ:REYN), we can see that stocks, for the most part, have traded in a range (except for the June lows of this year) between around $26 per share and $31 sharing. Dividend growth stocks that trade in a narrow range appeal to income-oriented investors because of the possibility of accumulating their gains at a much faster rate. In addition, range-linked stocks also provide the income-oriented investor with the opportunity to write covered call options against their long stock positions to earn more income on top of the dividend. Liquidity, however, in REYN options, or better the lack thereof, can present a problem with this strategy.

REYN striker dividend the yield is currently 3.2%. The company’s performance is well above the average for this sector (2.69%). Additionally, the recorded payout rate of 67.6% demonstrates at least on the surface that the payout is sustainable for now. However, given the current inflation situation in the United States and the fact that 10-year US Treasuries (which are virtually a risk-free investment compared to stocks) are now yielding well over 4%, the REYN’s 3.2%+ return means investors are well 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 is now ALL about checking out the total return potential of the particular stock. In the case of Reynolds Consumer, its total return potential (given its narrow multi-year trading range resulting in significant overhead resistance) must be compelling to ensure that a potential breakout higher is in sight. Therefore, let’s review the key areas and metrics that make up the Reynolds Consumer Dividend to determine what the true potential is here. A strong, growing and sustainable dividend generally indicates high stock prices over the long term.

REYN Technical Sheet

REYN trading range (Stockcharts.com)

Profitability

REYN’s gross margin over the last twelve months stands at 20.68%, which is worrying compared to the company’s 5-year average (27.53%). In addition, the recent printing of the second quarter gross margin, which was (20.07%) below the tracking average, further demonstrated that profitability remains under pressure. Although lower income statementwe find that while the company has done well in maintaining high net profit margins (7.43%), the decline in gross margin is concerning for the following reason.

That 7% drop in gross margin, for example, over the past five years, all things remaining equal, could have meant that net profit would now hover around 1% at this point if costs were standardized across the income statement. Thanks to strong financial engineering, however, REYN remains profitable due to lower costs relative to overall gross profit. This bought REYN some time, but you can bet the market will stay on this gross margin metric like a hawk.

The reason for this is that inflation has the potential to affect a company with a 20% gross margin much more severely than a company with a 35% gross margin, for example. REYN, in essence, has less breathing room compared to its peers, which is why we need to see a recovery in this key metric before long.

Assess

Given the company’s profitability, REYN must have a stellar valuation in order to have a chance of removing this overhead resistance in the near term. Followers of our work will know that we favor companies with low earnings, cash, books and sales multiples, and we also like to see a growing interest coverage ratio overall. As we can see below, although the company’s assets and sales multiples are lower than their 5-year counterparts, the company’s earnings (evoked earlier by those falling margins) are actually more expensive today on a non-GAAP basis.

Metric 12 rolling months 5-year average
Non-GAAP earnings quotes 20.61 17.18
Price to book 3.32 3.90
Sales price 1.60 1.75
Price to cash flow 15.01 18.62
Interest coverage ratio 8.49 4.89

The much higher interest coverage ratio today is a huge blessing considering the gross margin contraction in recent years. However, is there enough firepower here to drive stocks forward, especially given how future earnings revisions have contracted? I’m not so sure.

Chart: Reynolds Consumer Products Earnings Revisions

REYN Earnings Revisions (Quarterly) (Looking for Alpha)

Conclusion

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

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