Company name: Church & Dwight Company Inc.
Ticker: CHD
Market cap: $11.3 billion
GuruFocus Business Predictability Rating: 4 stars
Morningstar Purchase Rating: 2 stars
Industry: Consumer Packaged Goods and Household and Personal Products
Church & Dwight Company Inc. (CHD, Financial) develops, manufactures and markets a broad range of household, personal care and specialty products. The company sells its products under a variety of brands, including Arm & Hammer (used in multiple product categories such as baking soda, cat litter, carpet deodorization and laundry detergent); Trojan condoms, lubricants and vibrators; OxiClean stain removers, cleaning solutions, laundry detergents, dishwashing detergent and bleach alternatives; Spinbrush battery-operated and manual toothbrushes; First Response home pregnancy and ovulation test kits; Nair depilatories; Orajel oral analgesics and Xtra laundry detergent.
Other core brands include L'il Critters and Vitafusion. The company sells its products through a broad distribution network that includes supermarkets, mass merchandisers, wholesale clubs, drugstores, convenience stores, home stores, dollar, pet and other specialty stores and websites, all of which sell the products to consumers. The company also sells specialty products to industrial customers and distributors.
The company’s business is divided into three primary segments: consumer domestic, consumer international and specialty products division. The consumer domestic segment includes the brands noted previously as well as other household and personal care products such as Scrub Free, Kaboom and Orange Glo cleaning products, Arrid antiperspirant and Close-Up and Aim toothpastes and Simply Saline nasal saline moisturizer.
The consumer international segment sells most of the same products as the domestic segment but in international markets, including Canada, France, Australia, the United Kingdom, Mexico and Brazil. The special products division is the largest U.S. producer of sodium bicarbonate, which it sells together with other specialty inorganic chemicals for a variety of industrial, institutional, medical and food applications. This segment also sells a range of animal nutrition and specialty cleaning products. The consumer domestic, consumer international and special products division account for about 75%, 16% and 9% of company revenues respectively.
Analysis
We are always on the lookout for quiet, boring, low profile companies that have discovered a formula for success. This is certainly the case with regards to Church & Dwight’s household and personal care products –Â products it has been able to sell at lucrative margins for many years. Key success drivers in its markets include maintaining strong brand appeal, customer loyalty, achieving economies of scale in production, and achieving distributional advantages either by selling through more venues or through greater shelf space.
Church & Dwight is poised for success as it is a leader in most of its respective markets, has won consumers’ minds as a “best choice,” has achieved scale and has a well-established distribution network. The company’s future growth will depend to a large extent on international population growth. New product innovations and a greater presence in emerging markets will also prove critical. Slow wage growth, increased penetration by lower cost generics, and near market saturation in the U.S. will work against the firm’s sales growth moving forward.
The average return on investment for Church & Dwight during the last 10 years was approximately 13.5%, with returns on reinvested capital averaging 14%. The company is required to make moderate capital expenditures on plant and equipment to maintain and grow company operations (averaging 27% of net earnings). Church & Dwight has generated strong cash margins, with free cash-flows to sales averaging 13%. Church & Dwight also has minimal leverage, with an adjusted debt-load that would take about four years of annual earnings to pay off.
Given the stable nature of its business, expanding brand value, low debt levels and strong cash generating power, the company should have sufficient resources to support growth through additional acquisitions and will be capable of continuing to increase dividends, hopefully supporting strong shareholder returns.
Valuation –Â Multipliers
Discounted cash-flow analysis
Free cash-flow-to-equity projections
Assessment
Church & Dwight’s per share earnings in 2014 were $3.01. Historical earnings per share grew at an annual rate of approximately 14% per year since 2005. Church & Dwight’s sales per share in 2014 were $23.98. We project that sales will grow at a steady rate of about 4% per year between 2015 and 2024. We expect slight operating and net margin compression. Interest expenses will remain minor. Capital expenditures will remain at recent historical levels in the amount of approximately 3% of sales. Our fair value estimate of Church & Dwight equals $93.66. At a current price of $87.49, this suggest that Church & Dwight is underpriced by about 7.1%.
Pure Monte Carlo Simulation
Based on a pure Monte Carlo Simulation, there is a 48% probability that the company's true underlying fair value exceeds the current market price.
Recent developments
2015 third-quarter results
- Organic sales growth of 3.2%, reported growth 2.4%
- Gross margin expansion of 110 basis points
- Operating margin expansion of 100 basis points
- Currency neutral EPS up 10.6%, reported up 5.9%
2015 full-year outlook
- Organic sales growth of approximately 3%
- Gross margin expansion of 35-45 basis points
- Adjusted EPS growth of 7-8%, reported 1-2%
- Cash from operations in excess of $585 million
Management discussion
CEO James Craigie said, “2015 has been another excellent year so far in terms of overall business results. We believe that we are positioned to continue to deliver strong sales and earnings growth with our balanced portfolio of value and premium products, the launch of innovative new products, aggressive productivity programs and tight management of overhead costs.”
With regard to the full year outlook for 2015, Craigie said, “We continue to expect organic sales growth of approximately 3% in 2015 driven by new product introductions on our core business. We expect gross margin to expand by approximately 35 to 45 basis points. Marketing spending is expected to be approximately 12.3% of sales or down 30 basis points, which is largely driven by shifting some marketing funds to trade and couponing to continue to support proven consumer trial generating activities for the OxiClean megabrand. We now expect to achieve approximately 65 to 75 basis points of operating margin expansion, excluding the previously reported second-quarter pension termination charge, which equates to 35 to 45 basis points of expansion on a reported basis.”
In conclusion, Craigie said, “The midpoint of our currency neutral adjusted EPS 2015 outlook remains 11.5%. This excludes an estimated 4.0% EPS negative impact from foreign exchange. The year-over-year negative impact of currency has grown in the second half. As a result of these incremental F/X headwinds, we now expect to achieve 7% to 8% adjusted EPS growth in 2015 or $3.22 to $3.24. This excludes both the pension termination charge (5 cents) and the Natronx impairment charge (13 cents) recorded in the second quarter. This EPS growth is top tier within the consumer packaged goods industry. This earnings forecast does not include any impact from potential acquisitions, which we continue to aggressively pursue.”
“For the fourth quarter, we expect organic sales growth of approximately 1% on top of the 5.2% organic growth achieved in the fourth quarter of 2014. Gross margin is expected to expand versus the prior year despite continuing to invest behind the growth of the OxiClean megabrand, unfavorable currency impacts and incremental costs for our new gummy vitamin manufacturing facility. We expect marketing as percentage of sales to be flat. Finally, we expect fourth quarter earnings per share of 79 cents to 81 cents. Currency neutral EPS growth is expected to be 3.5% to 6.5% in the fourth quarter.”
Potential catalysts
- New product launches
- Increased brand recognition — further strengthening margins
- Acquisitions
- Capturing additional market share as a result of greater brand penetration
- Increasing market share in emerging markets
Risks
- Rising and volatile input prices
- Intensified price competition
- Excessive premiums paid for acquisitions
- Brands falling out of favor with consumers
Conclusion
Given its strong competitive position, we think that Church & Dwight trades at a reasonable multiple – 24x forward earnings. The stock has grown considerably over the last year (+14%) — growing even more successfully over the last 10 years. While I wouldn’t expect an enormous return on the position given its current price, it remains modestly undervalued considering its free cash-generating power and should continue to post moderate returns for shareholders including dividends.
