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I would now like to turn the call over to your J.P. Morgan host.
Thank you. Good afternoon, good morning. I'm Celine Pannuti, and I head the Consumer Research at J.P. Morgan. I am very pleased today to be joined by Kris Licht, CEO of Reckitt. Kris, good afternoon.
Good afternoon, Celine.
I'm very pleased to have you today, Kris. I think it's the first time you are joining our Fireside Chat series.
Yes.
It's all the more important as you have laid out last year's strategy. Over the past 12 months, we have seen some changes, but there have been two announcements that have just popped up in the past week. You sold the portfolio, and you also announced good results yesterday on the call that allowed you to raise the guide. I think it's a good starting point maybe to focus on the strategy or on the go-forward for Reckitt. Maybe as we start, if you could maybe give your perspective on what you think have been the milestones achieved and how you see the priorities for the next 12 months.
Yeah, thank you, Celine. So as you say, we set out a new strategy for the company about a year ago, this week, a year ago. We have been busy executing the strategy since then. The strategy has a couple of different elements to it. First and foremost, it's about returning Reckitt to sustained high performance, leveraging the Power brand portfolio we have, 11 leading Power brands with number one positions across health and hygiene, and harnessing the power that that gives us. That's really the biggest thing we are setting out to achieve. In order to do that, we've simplified our organization, and I can speak more about what that means, but really creating a more effective and more accountable organization. And then we have also declared that some of our businesses are no longer core and that we would seek to exit them.
As you mentioned, Essential Home is one of those non-core businesses, and we did reach a sale agreement just announced last week. And then on top of that, what we're really doing is investing heavily in innovation, in brand building so that we can bring these Power brands to life and drive accelerated growth. And we're seeing really good forward momentum in that respect. And our emerging markets portfolio in particular is very strong, so I'm pleased with that. As part of these announcements, we also said that we would reduce our fixed costs, and we have made very good progress on that, a little bit ahead of maybe what we expected or what we signaled. That's pleasing to me that we can demonstrate that, and that allows us to invest back in our brands.
So what we were able to share earlier this week was a very significant reduction in our fixed cost year on year and a significant investment behind our brands, as well as EPS growth, which ultimately is extremely important for us to demonstrate. So sitting here a year later, I'm happy with the progress. We are making good progress. I appreciate all the efforts of our associates and what they've been able to do so far. But I would also tell you we have a lot more to do. We are by no means done. We are not delivering at our full potential yet, and we have a lot more to do.
Right. We're good to that, and I would like to talk about the targets. But before we do this, can we talk about Reckitt culture? Because that's always been quite typical, and there's been a few changes in leadership over the past five years. There's been as well changing in strategy. And I think your associates, as you mentioned them, have gone through a lot. So can you talk about what is changing in culture at Reckitt and how maybe some of the good part of the Reckitt culture is as well enabling those changes?
Yeah. Culture is more important than pretty much anything. It's more important than strategy. I don't know if it's more important than the brand portfolio, but it's right up there, in my view, as an absolutely essential part of any successful company. Reckitt has a distinct culture. We have a very strong performance culture. It's been around for a long time. It's anchored in the idea that you own your business, you drive your business, that you want to drive performance and ideally outperformance. So it comes with a high degree of accountability. There's a lot of action orientation in our culture. Our people really want to get on with the program and do stuff in the marketplace and be successful. I think this is a major asset. In my career, I've been fortunate to work in some cultures that are positive and performance-oriented.
Probably the strongest performance orientation I've seen in my career is the Reckitt culture. I think we are known for that, and we're known for that for a long time. So this is something that we're definitely seeing as an asset. It's positive. We celebrate it. At the same time, like any company, we're going through evolution too. And I think we have done a few things with our culture. The first thing we've said is, for the avoidance of doubt, we do the right thing always. And when you work in any industry, but certainly in health and hygiene, and you make medicines and you sell products that need to be high quality, they need to be efficacious, they need to be safe and effective every time. Doing the right thing always is just a foundation.
It just says that we are aware of our responsibility and we will always do the right thing in terms of serving our consumer the right way and also taking care of our employees in the right way. And I think that's something that maybe we have enhanced in the culture. We're saying that very clearly, and we're seeing our employees really embrace that and live it every day. Other than that, I would say culture is a benefit for us. We just have to harness it, and we have to celebrate it, and we have to do things that reinforce it so we keep it alive.
But I think if you step back and look at what our organization was able to do for the last 12 months. I think the only reason why we could do a restructuring of the company, a carve-out of a business, a strategic pivot, and really accelerate our execution in the market to do all those things at the same time, you have to have a workforce that's fired up. You have to have an organization that's really passionate about winning in the marketplace, and we're lucky to have that at Reckitt.
Right. So coming back to read more quantitative numbers. So early this year, you mentioned that your midterm target for Reckitt Core to be 4%-5%. And for this year, you say above 4% as the new target.
That's our new guide, yeah.
Yeah. Can we just try to, first of all, understand your market growth exposure? Where do you think the market opportunity is? And maybe if you could differentiate by EM versus DM or by category as you wish. And then I presume for Reckitt to be firing on a four to five on an ongoing basis, there are probably you have to beat these markets. So where are the opportunities from either market share gain or opening new avenues of growth where you see that you cannot perform?
Yeah. Look, I think it's important that we set a guide that we think is something we can deliver and we feel confident about. That's what that medium-term guide is. 4%-5% growth, I think, is a good medium-term guide. It implies a little bit of outperformance, but it's quite achievable at the same time. So our categories will probably grow right around or slightly below 4%. And so with a bit of outperformance, we comfortably get into that range. We also know that we're exposed to some high-growth categories. We are fortunate that we have a really big footprint in emerging markets. We just spoke a bit about that. It's 40% of our portfolio in Core Reckitt, and that's a fairly big exposure. And inside that, we have some really large businesses in places like China and India that are growing very fast.
They have grown very fast, and they have the potential to continue to grow very well. So that emerging markets portfolio, we think, is a mid-single digit or high, sorry, high single-digit growth portfolio. We also know that when everything comes together and our teams are really executing at a high level, we can do better than that. And you've seen in the last three quarters, we've grown double digits in emerging markets. And we saw an acceleration in that through the first half. And I'm really impressed with what our teams are delivering at the moment in emerging markets. I think maybe they're delivering ahead of even the medium-term expectation, but that's a good thing. And I think we'll have periods of time when we do that, and then we'll have periods of time when we're doing sort of high single digit. And I think that all is fine.
That works with our growth algorithm. Obviously, Europe is a very big business for us, and so it's important that we see growth in Europe. At the moment, things are a bit slower category-wise. It's been slow. Our start to the year was not fast in Europe. The good thing is the portfolio can balance that out. So we're still delivering above expectations in the first half, but I think we'll see Europe sequentially improving as it has been through the first half, and we should get back to growth in the back half. North America is probably the toughest part of the landscape for us at the moment. I don't think that that necessarily will be that way for the medium term.
North America actually is a place where I think we can grow, and we have really nice opportunities where, irrespective of the consumer backdrop, we can just do better. We have executional opportunities there that I think can accelerate our growth. We posted a slight negative in the first half for North America. Some of that is the category dynamic. Some of it is things that happened in the retail environment, some destocking. And a portion of it is also that we're resetting our Mucinex business at the moment. We're removing phenylephrine from our sinus range, and then we are now, in this month, refilling the shelf with new products. So that causes a quarter-to-quarter shift of phasing impact. But when you adjust for that, our North America performance was fairly resilient in the first half, and I think will be quite a bit stronger in the second half.
I would like to understand how you see the volume versus price mix equation. I think volume has been pedestrian over the past two years. Even in the first half, volume was up 1%. When you think about the 4%-5%, what do you think is a healthy level of volume? And does it mean that going from 4% plus this year to 4%-5% on a sustainable basis, that's good volume? That's going to be the delta in that case. What kind of investment or what needs to happen really for us to see that?
Yeah. I mean, I think the way to gauge the health of the business is to focus on volume growth. We went through a historic pricing cycle, right, with the cost of goods inflation and all the pricing that the whole industry had to take. So now we're coming out of that. What we're looking for this year is a balanced algorithm, just as we would usually be in before the spike we were delivering that. We have seen really strong sequential volume improvement in all our segments. So every segment you look at from Q1 to Q2, we saw volume acceleration. And Q2 volumes were actually pretty healthy, but a lot of that had to do with the 7% volume growth we delivered in emerging markets, which is a really strong number. What we're looking for in the back half, again, is a balanced algorithm.
The volume growth comes from innovation. Innovation is the lifeblood of our business. We have a lot of good innovation landing in the marketplace behind Durex, behind Lysol, Finish, Dettol. So a lot of our biggest brands are benefiting from really strong innovation landing this year, and we also have some really good innovation for next year. And that's a big driver of the volume growth. So what I'd like to see is a continued sequential improvement in volume, maybe something like two points from volume in a normal environment, two points from price, and then some mix on top, and that puts us in that 4 to 5 range.
Good. In fact, yeah, I have a question on innovation, so let's go there.
Let's go there.
So it's always been, I think, a key feature of Reckitt that you come with products that provide a solution for consumers. And it feels that maybe at some point, the organization kind of lost a bit that traction to come with superior products. So I know since a few years ago now there's been a renovation. I don't know if that's the word for your innovation R&D organization.
Absolutely.
So can you talk about how you feel about now in terms of the ability to really come with superior products? How do you measure that? Is there more CapEx investment that's unneeded or higher R&D spend? And how do you feel about the phenomenon of innovation coming forward?
Sure. Innovation is the lifeblood of what we do, and innovation starts in R&D. So you have to invest in R&D if you're in a business like ours with a portfolio like ours. You have to have a disciplined approach where you invest well ahead of the growth. You have to invest five years out. Sometimes it's a shorter cycle, but a lot of our innovation, the best innovation that's really breakthrough, that's really adding something new to the market that grows the category, takes quite a while to deliver and develop, in part because we have to go through clinicals, registration. There's a lot that goes into breakthrough innovation in our industry. I joined the company six years ago. Our pipelines were not very robust at that time. I think there had been a time when maybe we didn't invest enough in R&D.
You can do that for a while. You can do it for a year. You can do it for two years, but it catches up. I think it caught up to us. We set about investing in R&D. As you said, there's been an ongoing investment program. Angela, who is our Chief R&D Officer, has led this reinvigoration of R&D as a function at Reckitt. We now spend about 3% of revenues on R&D. I think that's a really good spend level. I think it has to stay there. I don't ever want to be in a situation where our pipelines are not robust enough. I'm very happy that we've gone through this process, and it's been a lot of work. The innovation platforms that are landing now are a function of the direct effect of those investments and a sustained investment.
It's not just R&D. It's other related functions, regulatory, where we have a very strong team now, medical affairs, which really does a lot of the foundational clinical work. When I joined the company, we weren't running a lot of clinicals, and now we are. That's the machine that produces great claims, great consumer-relevant benefits, and ultimately new products. Today we have a good pipeline. That work is never done. You always have to see if you can make it stronger and better. We measure that, to your question. We measure something we call innovation sufficiency. We measure superiority vis-à-vis our competitors. Historically, we were very focused on technical superiority. We've made a shift where we're much more focused on consumer-perceived superiority, which really, at the end of the day, yes, we want technical superiority, but only if the consumer values it.
So it's been quite a journey. You don't really necessarily get credit for those kinds of improvements in the early stages because you have to do so much foundational work. But I'm happy that now it's becoming clearer that we have great innovation. And I think we are at Reckitt getting back to what was an absolute strength of the company, that we were category creators and we create great innovation. And so Lysol Air is a great example of that first-to-market product and platform. Durex Intensity is a great example of that. And those are things that are driving growth right now.
You mentioned you have 11 brands, which I think represent 80% of the source, and you have four categories. Can we just spend a bit of time to understand from a category standpoint, high level, where you see the growth? I think intimate wellness is probably the category where we see the highest growth. But if we could maybe go through each of them on a high-level basis.
Absolutely. In fact, maybe I'll start with what is the unifying principles for our portfolio and how we decided what's core to Reckitt and what's non-core. The first thing is a brand has to have a long-term runway for growth that's really credible to belong in our portfolio. And so all our 11 Power brands have a clear runway for growth. It's concrete, and it's demonstrated in past performance, and we can see what the opportunities are. And much of that has to do with household penetration and premiumizing the categories that we're in. And so they have to have a runway for growth. All our 11 Power brands have a clear runway for growth. The second is we have to have a leadership position. We have to have a source of competitive advantage, some reason why we're more likely to win than lose every day.
Typically, that has to do with the strength of the equity in the marketplace. All of our brands, all of our 11 power brands have a number one position with one exception, which technically is a number two position in Mucinex, although if you look at where Mucinex competes, it's actually also a number one. It's an absolute privilege to have brands that are that strong, that are leaders in their categories, and have number one position. That's the competitive advantage. Then thirdly, we look for an attractive earnings model. Our portfolio is a premium portfolio with very high gross margins, which give us good structural economics that allows us to reinvest in equity and reinvest in innovation and still have great operating margins left over. That's always been a hallmark of Reckitt's, and we're getting back to that. Those are the three principles.
All the brands that are in those 11 and even some smaller brands that could be Power brands when they satisfy those criteria. And so that means that there's really nothing in our portfolio that can't grow. Our Core Reckitt portfolio is quite special. So we have our self-care portfolio where we have leading brands like Strepsils, Nurofen, Mucinex, Gaviscon. These are brands that have a clear runway for growth, that we have a success model that we roll out behind those brands, and they're growing very nicely. Obviously, some of them are a bit exposed to seasonal fluctuations, but if you look through the season, they have all demonstrated a strong trajectory of growth, and we are absolutely sure that that can continue long into the future as long as we innovate and support them.
We have our disinfection franchise, Lysol and Dettol, which taken together is the leading global franchise for disinfection. Both brands are absolute Power brands. Lysol, one of the most trusted brands in America overall of all brands. Dettol, an absolute powerhouse brand in emerging markets around the world. There's a clear runway for growth there. Obviously, we had explosive growth in COVID, and then we had a normalization post-COVID, and now we're back to really good steady growth behind those brands. Intimate wellness, where we're global leaders with Durex. We also have some other important brands like Intima, which is growing very fast in female intimate wellness in China. Then really auto dish, which is a core category for us, where Finish is a global leader. The runway for growth in auto dish is also significant. In Europe and North America, it's about premiumizing.
We're trading people up in our franchise up the premiumization ladder with our premium innovation and superior thermoforming products that are very successful now. In emerging markets with auto dish, it's all about household penetration. There's a decade-long runway for household penetration. In many emerging markets, just a small portion of the population have a dishwashing machine and use it. We see that in more markets are moving up the curve and that penetration grows. That's a nice decade-long runway for Finish.
Another part of the equation from renewing the growth is execution.
Yes.
So I would like to understand. I think you've changed the way you go to market from category to region.
Yeah.
And I think you have as well focused a lot on customer servicing. So could you maybe give us a bit more color of what's happening on the ground in terms of execution? I think supply chain financing was as well part of that.
Yeah.
How you have evolved maybe the organization to cater to as well a changing landscape in terms of your distribution, especially even in emerging markets where we see new models of distribution?
Sure. I mean, innovation is our lifeblood, but execution has to happen at a very high level with excellence. Otherwise, we don't deliver the kind of performance that we aspire to do. I think we have a history of strong execution, commercial execution in Reckitt. I think one of the things I said when I set out the plan last year is we have an opportunity to be more consistent in our execution. And then we have some really special capabilities in some markets that we should roll out, and we should scale them across our markets so that we can accelerate our performance. I did change the organization. And a big part of why I did that was to make sure that we had a simpler organization that could focus more on the day-to-day execution in our markets. We still have a global category organization, actually.
It's not like we don't have global categories and global innovation and global brand management. We do have that, but it's unified in one organization. One of the idiosyncrasies of our structure before was that Dettol and Lysol, for instance, weren't actually living in the same category organization. And so we brought them together as an example. So we have a unified global category organization that manages the brands and drives the innovation pipeline. But then the business is delivered through three geographies: the emerging markets portfolio that we talked about, Europe, and North America. And each of those has a president that reports to me, and then we have our leadership teams there. That means that we've gotten a lot closer to the markets in the organization. So now there's three layers versus five before. So we have a much more direct management of the markets.
We have very clear accountability of who's responsible for execution. And that makes my job easier so that I can drive the appropriate level of accountability, and our presidents can drive very strong and more consistent execution. I did appoint three presidents who have been at Reckitt for a very long time. They're very capable leaders. They are of our culture. They really understand our business deeply. They all grew up in our business. And so that trio of presidents is making a big difference as it pertains to execution.
Okay, so let's talk about each of them. If I start with North America, you mentioned earlier how the year has unfolded and the reacceleration that we expect in the third quarter, but maybe stepping back, I think this is a region where it's really focused around Lysol, Mucinex, and Finish. If I look at the last two, three years, performance has been rather lukewarm. Market share has not been great. Again and I take Mead Johnson out of this equation, so what do you think? I mean, in a normalized environment, whatever that is in the U.S. right now, but what do you think? What does it take for Reckitt to be a more consistent grower and with single-digit performance that you aspire to in this market?
You said it. We have the brands to do it. I mean, Lysol is one of the most trusted brands in North America. Great innovation behind it. Mucinex is actually a very strong brand. The only brand in OTC that I think has a memorable character associated with the brand in Mr. Mucus. So it's a special business. And Mucinex actually has done pretty well over the years, and we've had very good innovation. Obviously, it moves with the season. Mucinex is a high-priced product. It's the most efficacious in the marketplace. So it has a tendency to do well when the season is strong. And when we're out of the season, fewer people buy Mucinex just because they don't need that efficacy. But we've stretched that brand. We actually play in more categories now, sore throat, where we've been very successful extending the brand in there.
Mucinex, Lysol, and Finish all have a reason to win in the marketplace. I think in North America, we've had good years. We've had less great years. Consistency is the key, as you rightly said, and consistent, strong execution. We have made some investments, and we're still making investments to try to strengthen that. A lot of that has to do with our supply chain. So actually, if you look at our supply chain around the world, the opportunity that we see the clearest is our supply chain for North America. So we have invested in a large anchor facility in Wilson, North Carolina, which will be the home of our health business from a production standpoint going forward. Actually, our health business was predominantly relying on European or Mexican facilities, and that was just not an agile supply chain, not resilient enough.
So we're really investing in the supply chain for North America. That's one element. The second one is we're investing in frontline execution, so in-store sales and merchandising. And I think that's an opportunity for us. One of our principal competitors, in fact, several of our principal competitors are really good at sales execution in North America, and we admire that. And so we have an opportunity to catch up to them, and we're investing in that both from a technology standpoint, from a people standpoint. I myself came from PepsiCo, leading frontline organizations in North America. And so I know what that looks like when it's great and when it's a pretty intense effort that you have to have. And so we want to instill that kind of intensity in our frontline in North America from a sales execution standpoint.
So I think those are two elements that will make a big difference. We'll continue to be investing in innovation, and we actually have been very successful with category creation in North America. So I mentioned Lysol before. I mean, we've created two whole new categories that are going to be multi-hundred million dollar categories in laundry sanitizer and air sanitizer. So we can do it. We just have to do it a bit more consistently.
Now, same question I want to say for Europe. I think it has been, of course, the whole market, usually a more challenging market. You have a much more diverse exposure in terms of your different categories and brands.
Yes.
I think recently you mentioned that Finish is back to being a leader through innovation. You improved there.
Great improvement.
But so what does it take for Europe as well to elevate the performance on a sustainable basis?
In Europe, we have a very strong portfolio, as you say, broad-based. We also have a lot of strength in our execution. We have an excellent pharmacy channel, sales force, and we have a lot of know-how in terms of how to execute with healthcare professionals and the pharma channel. And we've seen a lot of growth, especially in the health business. In Europe, we've been quite successful over the past years. But Europe has gone through some ups and downs. It is a bit sluggish right now from a demand standpoint. We are upping our execution. You mentioned the Finish share gains, which are significant and something that I'm really pleased to see because we are market leaders in Europe, and we should be operating at that level. But I would say executionally, again, there's a step up there.
There's more that can be done, and I'm looking for more from our teams in terms of execution. Innovation is good, and you can see when we launch innovation like we're doing with Durex Intensity, we immediately capture share momentum. It's incremental to the category. It's what we should be doing. And I'm pleased to see that that's unfolding right now, but we're not done. As I said at the beginning, we have more work to do.
So you mentioned earlier emerging markets, and it has been clearly the stellar performer when we looked at numbers in H1.
Yes.
I think part of that probably reflects the new organization.
Yes.
I mean, I have to say it's quite surprising how well you grew in an environment where some of your peers are talking about slowdown in Latin America, unclear performance in China, and you guys grew double digits.
Yes.
So maybe, I mean, what do you think? Is category, I mean, right here, right now, growing that fast? Do you think it's really the benefit of new category, new launches? Are your categories a bit better than others in emerging markets? And then maybe if we can just spend a bit of time to look at three biggest markets: China, India, Brazil, their relative size, and maybe the differentiated strategy that you have there.
Yeah, sure. Look, emerging markets are definitely doing very well. And like I said, performing ahead of our medium-term algorithm and expectation. That doesn't happen overnight. It's a function of a lot of good work by a lot of people for a long time. It's a function of investment. Maybe if we start with China, which is our largest emerging market, and it's growing extremely fast at the moment, double-digit. We've invested a lot in China. We've invested in manufacturing. We've built a state-of-the-art plant there with a mindset of China production for China. We're building a big R&D center and have invested a lot in innovation and R&D over the past years, again, with a mindset of China for China because the speed of innovation in China is extremely high.
And we have invested in specialized go-to-market capabilities, in particular focused on winning online, and that's paying off in a major way. We have good innovation, and we're executing at a very high level. So to your question about is it category exposure, or is it our brands, or is it execution, I think it's actually all three. We operate in health and wellness and hygiene, right? And those categories seem to benefit from more of a tailwind than I think the broader consumer goods space. It's clear that the macro is tough in China, and it's clear that some categories are seeing real headwinds, but we are not. The consumer engagement in our categories and the consumer engagement we see with our brands is extremely high. I would go so far as to say that the most sophisticated consumer that we find anywhere in the world is in China.
The curiosity about the product, the ingredients, claims, benefits, the desire to try new products. The Chinese consumer is very knowledgeable and very curious and will certainly try new things, but it's also discerning. If it doesn't work, if it's not an enjoyable experience, there won't be a repeat. So no place is better to harness your innovation muscle and even your go-to-market muscle in terms of online business, certainly, than China. In fact, I think we are guilty of a misclassification. We have put China in our emerging markets portfolio. China is no longer an emerging market. China is perhaps the most sophisticated consumer market in the world. So I think we have the right category exposure. We have the right brands. We have number one brands that are really compelling, premium brands with highly efficacious products to back up the promise of the brand. That helps.
In China, we're just very good at executing online, and I think if you look at what's happened in China, I've been going there frequently over the past five years. We have seen a dramatic shift of business and consumer behavior from offline retail being the majority to online retail. Our business today is overwhelmingly online. The last couple of times I've been to China this year and late last year, we do market tours like we normally do. When I go to the market, we go into stores, look at execution. There's almost no one shopping. The shopper is online, and it's a dramatic shift. I have not seen this kind of shift at this speed anywhere else in the world in my career in the industry, so it's a special thing.
And that means if you're ready for that, if you're ready to meet the consumer there and you engage in the right way, that gives you a big benefit. If you're somehow caught a little off guard, then there's a penalty for that. So anyway, I'm really pleased with how our team is executing there. India is actually a very different story. So India is our second largest emerging market, but India is very much an offline country still. I mean, there's a lot happening in e-commerce in India, but the vast majority of the population is still shopping in stores, a lot of them very small. So in India, this is very much a game of reach, and you have to have scale. We have been growing our sales footprint very well and very consistently through the years.
So we now cover over a million outlets in India, which is a staggering number to think about, but that's just how big the retail landscape is there. And really, the investments we're making there and the difference maker, I think, is all about precise execution. So we have built some tools that guide our sales force. We're using very sophisticated technology there to drive assortment, drive coverage decisions, pricing decisions. And that means that we get to more stores and we sell more lines in more stores, and that's making a big difference. And by the way, that capability in India, we're moving to other markets because there's distributed fragments of trade like in India, in many other markets in this portfolio. And so we're going to roll those capabilities across. In Latin America, we have historically done well.
And some markets, of course, have been through some turbulence that happens and seems to happen quite a bit in Latin America. But through that, we have built some nice businesses. We have a very nice health business in Brazil, in Mexico. We have a good hygiene business as well with a particular strength in Brazil as well. We have some nice opportunities. One of the countries that we don't talk that much about that grew very fast in the first half and contributed to this performance is a country like Colombia, where we're actually still fairly small, but we see an opportunity to triple our presence. There's other markets like that, Malaysia, Indonesia grew very fast. And again, we are not so big yet. We have a nice runway for growth.
So I would say overall emerging markets, it's the right categories, it's the right brands, and then it's advantaged commercial capabilities. I think that's what's making the difference.
Shifting gear now, looking into the organic, well, the operational performance from an operating standpoint. So you have mentioned 300 basis points of savings that you want to achieve on the fixed cost, and you are making some good progress on that already. I mean, one thing that surprises me is that you expect gross margin to be flat. So how does that work if you think about volume benefits, if you think about mixed benefits? I know you already have very elevated gross margin, but you could explain that. And then as we look into the P&L reinvestment between the A&P investment and what you see as sustainable margin, how do you going to pilot that going forward?
Yeah. Yeah. So these are very important elements of the strategy. One of the things that is a help for us is that our fixed costs were a bit too high. So even though we generate very high gross margins and we have historically generated very high operating margins, it was clear to me that our fixed costs were actually not in line and a bit excessive. And we could see why. We could see some inefficiencies in the organization. We could see an opportunity to scale our global business services footprint. And now we're also working with generative AI to reduce our overhead costs. And that's going well. So what we're setting out to do is, as you say, 300 basis points. We made a very fast start on that. That's pleasing, but we're keeping this target for the time being.
And what that does is creates a lot of oxygen to invest in the P&L, in advertising, in innovation, and it gives us the ability to enhance EPS performance as well, right? So our guidance framework we've set out says that we will grow to 4%-5%, and we will commit to growing our operating margins ahead of that. We haven't said exactly how much because we know we have the fixed cost reduction coming through the P&L. We know we want to reinvest in brands, and then we know we also want some of that to flow through and deliver margin growth and EPS growth. But we like the freedom to make the choices around investing. When we see opportunities, we'd like to have the freedom to invest in them. And if we don't see any, then we'll let it fall through.
That's how we're thinking about it. The fixed cost opportunity is significant, and we've made this good start. And we have a lot more work to do still. But what I would say is the benefit of taking out the fixed cost is our organization is also becoming simpler. So it's actually also making us more effective at the same time. Sometimes you worry that if you're taking costs out, are you slowing down growth? Is that somehow going to hurt your top-line growth? For us, I think it's actually a little bit of the opposite. As we simplify the organization, I think we can be more successful in terms of growth, and we're getting a cost benefit. On the gross margins, look, they're high. Our gross margins are high. Competitively speaking, they're high. They will remain high.
What we have said is we are not explicitly looking to expand them. As you rightly point out, if our mix improves, if we have volume leverage in the business as we grow, could they increase? Yes, they could. It's possible. We're simply saying we're not chasing that as an objective because they are so high already, and also because we know that in our organization, high gross margins has become a mantra, and it's been a mantra for many years, so our people are very focused on it, and that's good. That's partly why they're so high in the first place, but if you only focus on enhancing your gross margin, you can't really constrain your growth, and so we have seen examples of that in the past where that became the overriding objective almost.
Then you don't build the manufacturing lines that you need to grow, and you don't necessarily invest in the things you need to invest in for new technology or new product lines. So I think it actually constrained our growth at times that we were overly focused on gross margin. So the reason why we're saying we're happy, they're high, we like them there, is just to make sure that no one gets in their mind that that's the primary objective. But could they go up? They could.
Maybe looking at now the unlocking value and the different parts still in the portfolio. So first of all, in terms of the portfolio itself, so you make a choice. You made a choice to concentrate on these 11 brands plus, I don't know how many smaller brands. And a lot of the other brands have gone into the portfolio. So I presume, I mean, how do you feel you've done now in terms of selecting brands? And you have had a good, and we'll talk about that in a minute, but cash return policy. Do you think that's the right balance between looking at maybe bolt-on M&A versus cash return? And maybe more broadly, do you think that I would like to hear your view, but we think about potential bigger merger or M&A activity consolidation within the industry?
Okay. So starting on the portfolio and the choices that we've made, I talked to you before about the principles for our portfolio, why things belong, why they don't. I think it's really important for a business like ours to have very clear thinking, very clear choices about capital allocation and why things belong and why they don't. And so that's what informed the Essential Home carve-out, and I'm pleased that we have done that. Mead Johnson is also a non-core asset, right, that we still have that doesn't fit those criteria and isn't very synergistic with Core Reckitt. I'm also happy with that choice. I don't think that we have a lot more businesses now that don't fit. I mean, it's a very concentrated portfolio now.
The benefit of doing this relatively quickly like we have is we're not getting caught in a very extended process of exiting one smaller brand after another, smaller brand after another. It can be quite distracting for an organization, and so the idea of selling it in a bundle as a platform was so that we don't get caught up in years and years of portfolio work that sometimes feels never-ending. And honestly, it's operationally quite distracting because every time you're separating something out of a sales force or the manufacturing footprint or every part of them, even though they're small, you still have to do it well. Things can still slip if you don't do it well, so we judged that it was important to get on with this, and it's an efficient way to do that, but no, I like everything that's in the portfolio now.
I mean, and it's not really about whether I like it. The key is they fit the criteria. It's a credible choice, and it's a consistent principled choice that we've made. So now it's more about how do we maximize the potential of this portfolio? And then, yeah, we're always open-minded. If there's assets that fit, again, we would hold any asset that we look at up against those three principles. And we don't want to buy something if it satisfies one of them. It really must be all three. And what that means is there are not so many things that are for sale that are as good as what we have in our core. So if one comes, we'll certainly look at it, and it would be exciting if we found one and if the value was right and all that. But I would temper expectations.
It's not easy to find something as good as Nurofen, Finish, Mucinex, or Durex.
All right. Any view on the broader industry consolidation? Or you think that's?
What I can say to you today is we have a lot going on at Reckitt. We are doing a lot of work, and we still have a lot of work to do. I'm pleased with the progress 12 months into executing our plan. I judge that we have another 12 months of hard work, but I note that we have momentum, and it's nice to be able to share the results that we shared this week. And we want to keep doing that, right? That's the most value-creating thing we can do. We're always paying attention to our industry. We have to. And it is an exciting industry. There's a lot of tailwinds in our industry from a macro standpoint. I think that'll be the case for a very long time.
So we'll pay attention to the industry, and if and when something evolves, we'll, of course, look at that, but it's not our focus today.
So you mentioned that Mead Johnson was non- core. I have two points here on Mead Johnson. So first of all, obviously, we still have the ongoing litigations that are happening. At the same time, it's uncertain outcome. So what can be done if you're thinking about a settlement? I mean, is it anything you can tell us in terms of what is the I mean, there is a way, and that may help you kind of reduce the window of waiting for an outcome to happen. Then we saw as well on it was quite a specific disposal because you kept a percentage in the business. So, how sellable do you think that Mead Johnson asset would be if when you have settled or litigation is out of the way?
Yeah. Well, I mean, you're right. We continue to defend ourselves in the next litigation. It's kind of a unique litigation in the sense that we are making, as well as our competitor, we're making lifesaving products that are absolutely critical to the health of premature infants in the U.S. So they must be available because no one wants a public health crisis. So it's an unusual case in that the allegations that we're defending ourselves around are not backed by science or the medical community. So we will continue to defend ourselves based on the science and based on the expertise from neonatologists and that profession. We would like to one day resolve this litigation. That would be good, and we think we will prevail.
When that happens, I think Mead Johnson will be recognized as what it already is, a great business with a great market position, makes great products. There's a clear runway for premiumization and infant formula. There's a lot of great science and new science that will allow that industry to do well, I think. And it's quite a cash-generative business, and it's just a good business all around, really. And so I suspect that there will be people out in the world that agree with that and find it an attractive business. I feel fairly certain about that. But we haven't set a timetable for this because, as you say, the uncertainty around the timeframe for the litigation, ultimately, I'm sure we will resolve this and prevail. And I am not worried about our ability to eventually exit and find a good home for Mead Johnson.
I'm feeling quite confident about that. But we didn't want to box ourselves in for obvious reasons in terms of timing. And just in terms of the structure on Essential Home, Mead Johnson and Essential Home are different. They're the same in the sense that they're actually fundamentally pretty good businesses, and they're both not synergistic with Core Reckitt. But in the case of Essential Home, it's a full carve-out, whereas Mead Johnson, we run it fairly standalone today or very standalone, I should say. So Essential Home, because it's a carve-out, it's a large business, and it involves separating supply chains and separating IT systems, which we have a great plan for that, that we know how to do it. We've done it before with other disposals that we've done. We can do it well. But it's a lot of work, and it requires partnership.
You have to do it together, buyer and seller. If you don't have aligned incentives, it can be messy. And so for that reason, I actually always was keen on having a minority stake in the business. And then on top of that, I think it's fair to say Essential Home is not exactly at peak performance at the moment. It hasn't had a great first half, although it's a very mature and stable business with good margins. It needs some work. Part of why we're carving it out is it needs work. I think when that work happens, and especially with a partner like Advent that's going to be the majority owner that we're selling to, I think this business will actually do well and will be worth more in time. And so for us to participate in the upside of that, I think, is a very nice thing.
So it's both to make sure that we have a great experience carving out and working together as partners to do that, and also to participate in what I believe to be significant upside.
Just to finish on Mead Johnson, in terms of the book value over time, that's been reduced. And I think we have seen the impact of higher costs to regulatory requirements in the US. So as you know, we have been as well near the tornado. So maybe if you look at it on a midterm basis, what kind of growth rate do you think that Mead Johnson can deliver and the margin profile, and how good you feel that now the book value is reflective of that opportunity?
Yeah, I think it's a 3% to maybe 4% growth business. I think the margins are good. I think the margins can actually go up a bit. That's our plans at the moment. Like I said, there's a good runway for premiumization. We're investing a lot in the manufacturing footprint at the moment. That'll both necessitate some CapEx spending, but it yields benefits, operating benefits, and efficiencies. I think this is going to be a 3%-4% grower. And in terms of value, look, it's too early to speculate about a transaction and so forth, but I think if we do the things that I just spoke about, we'll realize a full and fair valuation for Mead Johnson. And I certainly think that that could be higher than the book value is today.
Okay. Right. We're almost at the end. So I would like to finish with the carve-out you mentioned. So just to the point is that there is this deferred payment as well. So you mentioned yesterday that the GBP 400 million that are linked to 2025 performance is escrowed.
Sliding scale.
Sliding scale. I presume that that will be 2026, and you would return extra cash. If you could talk about that. What is the timeline for the remaining GBP 900 million on that transaction? As we look into 2026, where we have the full year excluding, if you could talk about how the KPI in terms of willing to grow EPS, your leverage, your dividend policy, your cash return, share buyback, all of that, how does that change?
Celine, I think that was six or seven questions on a Friday afternoon. So let me see if I can remember them all. In terms of the contingent consideration, the first portion is a sliding scale based on 25 performance. Look, in general, we're committed to return excess cash to shareholders, and we take that commitment very seriously. And so that will not change. And that's enduring. That's not just now. It's not just for this contingent consideration. It is a principle in our capital allocation framework, and that's not going to change. As you know, we've been buying back shares again at a significant clip, but we just announced a new tranche of our share buyback. And then when we have events, disposals, we'll do the same. When we have considerations, if they result in excess cash, we'll do the same.
I think one thing to note is that the bigger contingency is a longer-term contingency based on the performance of Essential Home and the performance of the investment overall. I feel quite good about that. Like I said, I think there'll be high returns associated with this business and the carve-out. And so we will realize those returns over time. That's a longer-term thing, and it's also a sliding scale. Other than that, our capital allocation framework is consistent. We're buying back shares. Our dividend policy is clear and progressive. We will return excess cash to shareholders. In terms of our debt levels, we're at a 2x. That's really our rule of thumb. It's not some hard target per se, but it gives us a very strong balance sheet, which we have today. We would like to maintain that. We think that's appropriate.
Could it drift up a little bit or down from the 2? Sure, but we wouldn't look for any major deviation, and we're very committed to that. If there's one thing that I believe in, it's that this framework stays stable. I think it's very important that we're not changing our minds about these things. So that's what I can tell you. That's going to remain that way.
Okay. With a commitment to keep growing EPS?
That's absolutely our ambition. So I was so pleased that we grew EPS at a healthy clip last year. That was a big thing for me. In my first year as CEO, I wanted to be sure that we could really demonstrate our commitment to that. You saw we grew EPS at the half year, and we aim to keep doing that full year 2025, full year 2026, full year 2027. I mean, this is what we want to do. This is what we should be doing. Now, I know that there's a lot of questions still about when you do big disposals like this, inherently, that puts a drag on EPS, and it can be diluted. Well, mechanically, yes, but we have our Fuel for Growth program. And so what we're committing to is offsetting stranded cost, offsetting the dilution.
That doesn't mean that we will grow high EPS, have high EPS growth every year as we go through the disposals that may vary a bit, but we want EPS growth. That's what we're looking for.
Excellent. Good way to end. Thank you so much, Kris. It was a pleasure. Thank you, everyone, for joining us. And, well, have a good Friday.
Thank you.