Tuesday, November 12, 2013

Church & Dwight Still Has Upside Potential

f you have any doubt about how difficult the US mass consumer market is right now, you need only look at the third quarter results from Church & Dwight (NYSE: CHD  ) . Its organic sales growth was only up 1.6% amid increasing pricing competition. However, its management team continues to deliver in challenging times. The full-year earnings per share target of $2.79 was reaffirmed. Can it continue to outperform despite a difficult environment?

Church & Dwight's management delivers mixed results
The bad news in Church & Dwight's latest results was the reduction in its full-year organic sales growth estimate to 1.5%-2%. Church & Dwight started the year by forecasting 3%-4% sales growth, and just last quarter the forecast was at 2%. Furthermore, six of the 14 categories that the company sells into experienced lower category sales in the quarter.  In addition, rival household goods company Clorox (NYSE: CLX  ) only delivered 2% sales growth in its first quarter and predicted 2%-3% sales growth for its full year.

Meanwhile, industry end markets remain tough. Church & Dwight may already be feeling the early effects of Procter & Gamble's (NYSE: PG  ) decision to launch a cheaper version of its market leading Tide laundry detergent in 2014.

Indeed, when questioned about the reduction of organic sales growth on the conference call, management cited laundry detergent as being "the key call."  Procter and Gamble's move is intended to take aim at Church & Dwight's value-based Arm & Hammer and XTRA laundry detergents. Consequently, it's understandable if Church & Dwight took pre-emptive measures to strengthen market share before Procter & Gamble launches in 2014.

And now the good news
First, Church & Dwight's Avid (gummy vitamins) acquisition continues to outperform expectations with 20%-plus growth generated in the quarter. Management forecasts "double-digit growth for the foreseeable future." 

Second, Church & Dwight's specialty products saw a return to form with an organic sales increase of 3.7%. Going back to the previous quarter, there had been some weakness attributed to cold weather reducing demand for electrolyte replacement products for cows. However, with a more normal weather pattern in the third quarter this product's sales rebounded.

Third, thanks to ongoing productivity improvement,s Church & Dwight's gross margin continues to grow. In fact, the company's gross margin is now forecast to grow by around 75 basis points for the full year. This is an increase on last quarter's forecast of a 50 to 75 basis point improvement, which in turn was an improvement on the 25 to 50 basis point increase forecast two quarters back. Essentially, Church & Dwight has been progressively generating better margins as the year has gone by. An impressive performance when you consider that the company has been increasing its discounting in response to pricing competition.

What will 2014 look like?
A pessimist will look at the company and argue that the contributions from Avid's gummy vitamins mask weakness in organic sales growth. Moreover, increasing competition from Procter & Gamble in the value end of laundry detergents will pressure Church & Dwight further in 2014. Furthermore, when Clorox came out and announced that its first-half sales will be at the "lower end of our full year range due to competitive activity,"  the conclusion he would draw is that Church & Dwight faces significant headwinds going forward.

On a brighter note, there are plenty of reasons for optimism. The company is promising its "biggest amount of new product launches we've ever had," and the idea is that 2014 will turn into a year where the industry focuses on product innovation rather than pricing competition.

Much of this will depend on overall US GDP growth in 2014 because it's fair to say that US growth was expected to be higher than it turned out in 2013. The upshot of this is that many household products companies were forced into discounting in order to retain market share in 2013. With growth expectations somewhat more muted going into 2014, there may well be some easing of pricing pressures if growth turns out better than expected during the year.

Furthermore, the increased competition from a value version of Tide may spur more interest in the value category and paradoxically lead to increased sales for Church & Dwight's value brands.

Where next for Church & Dwight?
All told, your decision to purchase or hold the stock will partly depend on your level of confidence in Church & Dwight's management continuing to execute well in 2014. Fortunately, history would be on your side should you decide to do this. The company's management has an excellent record of generating market share growth with its leading brands. Moreover, the stock is attractive on a relative value basis.


CHD EV to EBITDA (TTM) data by YCharts

Analysts only expect Church & Dwight's rivals to achieve single-digit earnings growth, while it has analysts penciling in double-digit EPS growth for 2014. Overall, the stock looks slightly undervalued.

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