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.

Church & Dwight Demonstrates That Managements Matter

Investors in household-goods company Church & Dwight (NYSE: CHD  ) have watched the stock almost double over the last five years. It's tempting for them to think that the outperformance of the stock is solely due to the nature of the company's products. Indeed, 40% of its sales come from the kind of value brands that the consumer has been trading down toward. However, events over the last year have demonstrated that the company's excellent management team is an even larger part of its success.

When the going gets tough...

The recent second-quarter results saw the company delivering good numbers in spite of an ongoing tough consumer market. Indeed, there are three reasons to suggest that conditions are going to remain difficult.

 

Firstly, full-year organic sales growth is now forecast to be just 2% from an earlier estimate of 3%-4%. One-third of the shortfall is due to weaker-than-expected sales within specialty products. The remaining two-thirds is due to plans to increase discounting in the face of price competition. When pressed on the categories facing pricing pressures, the management replied that cat litter and laundry were the main culprits.

Secondly, plans are being made to increase marketing spending in the third quarter in order to support some of its key brands. Again, this is a sign of a more difficult marketplace. Indeed, management outlined that in the conference call:

"In fact, of the 14 categories that Church & Dwight operates in, five incurred lower category dollar sales in the second quarter versus the prior year and five more had category growth of less than 2% versus the prior year."

Thirdly, key rival Procter & Gamble (NYSE: PG  )  recently discussed plans to release a cheaper version of its Tide laundry detergent in 2014. Although the launch is set for next year, Church & Dwight is likely to act in advance to try to protect market share for its XTRA brand. In addition, Germany's Henkel will also be pressured into protecting its Purex detergent brand.

 

....the tough get going

The good news is that its management team has long been acquainted with dealing with difficult conditions, and its excellent execution is a key reason why the company continues to do well. There are three near-term pathways to growth, and all of them are thanks to management's actions.

 

Firstly, full-year gross margins are now expected to increase by 50 basis points to 75 basis points instead of the 25-to-50 basis-point increase previously forecast. The key to this upgrade was better-than-expected cost savings with the integration of its gummy-vitamin manufacturer Avid.

Secondly, sales growth at Avid is "tracking ahead of expectations," and is expected to be a significant contributor to sales growth in the second half. Thirdly, on the conference call, Church & Dwight argued that it had a "great pipeline" of new products to be released next year.

 

What about its peer group?

Essentially, the mass-consumer market remains difficult, but Church & Dwight has already demonstrated that it can outperform the market and its peer group in such an environment.  

 

Procter & Gamble data by YCharts

 

Moreover, the company has a good opportunity to continue its outperformance. Its relatively small size gives it a significant amount of flexibility in responding to changing market conditions. Furthermore, unlike much larger peers Procter & Gamble or Kimberly-Clark (NYSE: KMB  ) , it does not rely on premium brands for its profitability.

 

In previous economic cycles, such companies would have preferred to retain pricing during the downturn in order to benefit when the recovery came. However, this recovery has been so tepid (particularly for the mass market) that many large consumer goods companies are forced into discounting to retain market share.

 

A good example of this is with Procter & Gamble with the previously mentioned plans to release a cheaper version of Tide (rather than just cutting Tide prices), but also with its plans to downsize its Pampers diapers. Similarly, its key rival Kimberly-Clark is also used downsizing with its Kleenex brand. While such measures are innovative ways to try to keep pricing for premium brands, they are also emblematic of a weak consumer market.

Church & Dwight set to carry on outperforming

This sort of macro environment favors Church & Dwight's mix of value and power brands. In addition, its management has demonstrated that it can make earnings-enhancing acquisitions, and generate productivity improvements, even in a weak economy. Furthermore, at some point, a much larger rival may look to buy the company in order to generate some much-needed growth.

 

On a less positive note, Procter & Gamble appears to be stepping up the competitive pressure, and Church & Dwight's valuation of over 23 times current earnings suggests the stock is close to fair value. Consequently, long-term investors can look for the stock to 'do its earnings growth' in future years. Given that this implies double-digit returns, the stock remains attractive, particularly if its management can continue to wring every bit of growth it can from unhelpful market conditions

Church & Dwight a Recession Proof Small Cap

Church & Dwight Co $CHD is a great stock to do some equity research analysis on because the co is largely recession resistant, trades on a good evaluation and offers the prospect of some upside from a fall in commodity input costs.

Church & Dwight are in the personal and homecare space and, are a small cap  company which is comparable to the like is Reckitt Benckiser, Colgate, Clorox, Unilever etc.  The company is little discussed but has an excellent track record of generating earnings through the cycle. This analysis seems them being able to generate at least double digit returns for a stock investor from here.

Church & Dwight Brands

The brands can be categorized as a diversified collection of personal and homecare goods. Much of their brands are value propositions which offer upside in a stagnant economy as consumers trade down to cheaper brands. In terms of profits and sales, 80% of them come from their eight leading ‘power’ brands…

• Arm & Hammer (toothpaste, baking soda, detergent, cat litter)
• Trojan Condoms and Vibrators
• OxiClean Laundry Additive
• Spinbrush Battery Powered Toothbrush
• First Response Pregnancy Kit
• Nair Hair Removal
• Orajel Pain Relief
• Xtra Extreme Value Laundry Detergent

…which reads like a roll call of US value brands found in the home. However, Church & Dwight is far smaller than its major competitors and its business model is tailored towards grabbing leadership in niche markets.  What makes this company special is its execution.

Church & Dwight Earnings

The management has demonstrated a tremendous ability to grow earnings and revenues over the years and this can easily be summarized below…

(m)	2006	2007	2008	2009	2010	2011E
Revenue	1,955	2,221	2,422	2,520	2,589	2,710
Gross Profit	761	877	972	1,101	1,157	1,205
EPS	1.04	1.23	1.43	1.74	1.98	2.18
EPS Growth		18.3%	16.3%	21.6%	13.8%	10.1%

Analyst estimates for 2012 are for a further 4% revenue growth and 10% EPS growth.  

All of which paints a picture of a recession proof company but 2011 has proved challenging as end demand was lower than initially expected and rising commodity costs put pressure on margin expansion. No matter, the outlook for 2012 presents upside potential as the US economy generates employment gains and commodity costs abate with slowing emerging market growth.

 It is also worth noting that gross margins jumped in 2009 with the fall in commodity prices and, Church & Dwight has managed to hold onto them despite rising costs in 10-11. Similarly, with such a well run business, working capital management is excellent and the co generated large amounts of free cash flow. 

Church & Dwight Evaluation

The stock trades at a price of $44.51 with a market cap of $6.37bn. There is $275m in cash on the balance sheet with $250m in outstanding debt. FCF has grown from $200m to $364m from 2007-2010 at a CAGR of 22% with trailing FCF currently running at $391m.

Obviously, a PE ratio of 20.4x for 2011  makes little sense and even in further ahead where analysts see EPS of $2.19, the PE ratio only drops to 18.5x in 2012. However, the true value in an investment lies in its ability to generate cash and on a current FCF/EV of 391/6350= 6.2% the stock is attractive.

For a relatively secure double digit growth over the next couple of years, this stock could trade on an evaluation closer to $50 with upside potential from reducing commodity costs.  A decent 12% upside.