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.

Nice Systems Offers Recession Resistant Growth?

Nice Systems $NICE is a stock that benefits from increasing security and regularity compliance within financial services. They make the kind of surveillance and monitoring systems that the likes of UBS would have needed to make sure that a rogue trader like Kewku Adoboli might have been picked up early on in his activities. As such, Nice Systems primary profit driver is increasing regulation and awareness of ever complex needs to gather information from multiple sources, both internally and externally.

Nice Systems Equity Research

There is a detailed write up on Nice Systems in a previous post on Earnings View. The post is intended to analyze Nice Systems as a possible stock to buy in the light of recent results and guidance.

Turning back to the original post-referred to above- it’s clear that Nice Systems has done quite well this year.

	Feb Guidance	Current Guidance	Mid-Point Change
Full Year Revenue	$775-800m	$792-806m	+1.5%
Full Year EPS	196-202c	205-209c	+4%

The numbers are nothing stellar but it is solid performance and the stock price has moved in a highly correlated manner to the S & P 500. In other words, the stock is flat. The recent earnings were quite good and the company raised guidance but analysts were left enquiring over the book to bill ratio for the third quarter and why it was below one. A number of reasons were given for this on the conference call, which are summarized below

• Slower customer bookings in the third quarter, some of which were closed in the ongoing fourth quarter
• Book to bill forecast to be much higher in the fourth quarter
• Weakness in Q3 not seen in any product line or geography
• Management explained that the book to bill was also had a pattern of being weaker in the third quarter in previous years, and that this was partly due to the increase in maintenance revenues and the way that business was conducted

All of which, is perfectly feasible but cannot allay particular fears about the macro economic uncertainty creeping into their order book. Moreover, as the share price is tracking the S & P 500, it is perhaps prudent to wait until they confirm a return to a string book to bill ratio in Q4.  That said, Nice Systems rival Verint $VRNT Inc raised full year revenue guidance growth to 9% from 8% in September.

Nice Systems and Verint Systems Recession Proof?

The odd thing about these two stocks, Nice Systems and Verint Systems is that they both increased net income and cash flow through the recession. This is to be understood, as their revenue drivers are relatively secular. However, with Nice Systems, there was a drop in revenues of 6.5% from 08-09 and gross profit fell by 10% However, Nice managed to only lose 7% in EBIT due to reduced SG & A expenses.

This suggests that Nice Systems is relatively recession proof but the problem is that a large amount of the company’s revenue comes from the financial services vertical. Unfortunately, if there is a Sovereign Debt Crisis induced slowdown then it is this sector and its suppliers that will get hit the hardest and, Nice Systems will not be immune from negative sentiment.

Nice Systems Stock Evaluation

No matter, even though the outlook does look uncertain and, investors will want to see the book to bill ratio improve in the next quarter, this stock is an intriguing one to follow for the potential to outperform when/if the Sovereign Debt fears subside. It is certainly not cheap on a PE basis but Nice Systems do generate consistently good free cash flow and as of September had nearly $600m in cash and equivalents on the balance sheet. Its an attractive stock to buy but, for now, its on monitor.