Church & Dwight (CHD)
Church & Dwight CHD 0.00%↑ sells household and personal care products. The company was founded in 1846 and is best known for its Arm & Hammer brand.
Quality (4/5)
Church has very consistent mid-single digits (MSD) sales growth, coming from a combination of low-single digits (LSD) organic and acquisition-driven growth. Around 83% of sales take place in the United States. A quarter of total sales are to Walmart, and 43% of sales are to a group of four customers.
Church has no revenue declines (on a trailing twelve month basis) over the last twenty years, as seen in the Koyfin chart above. The company is on 122 consecutive years of paying a dividend and 19 straight years of dividend increases. However, the dividend growth rate is slowing: 7% on a 10-YR annualized basis, 5% on 5-YR, and 4% most recently. Leverage, as measured as total assets over total equity, is not excessive, especially for a consumer staples company, at 2.1X. Asset turnover is steadily declining (from 1X to 0.7X), which is concerning given Church’s acquisitive nature.
Visibility (3/5)
While one would think visibility is high since Church is a consumer staple, it has actually been low, especially in recent years. Management noted that it had low visibility beyond a quarter or two due to commodity inflation (oil and oil-based derivatives), rising labor costs, and higher freight and manufacturing costs. Church suffered from $290M of additional costs in 2021, $250M in 2022, and expectations are for another $120M in 2023. In turn, gross margin dropped from 45% to 42%.
Church generally sells “fast-moving” consumables, however, it has gotten itself into more one-time device sales recently with its acquisitions, leading to less reliable repeat sales. Management notes that 80% of the business is currently doing well, while 20% (Waterpik, Flawless, and gummies) is going backwards. Overall, the products that Church sells are rather boring: baking soda, laundry detergent, cat litter, and condoms. The company’s financial statements use some non-GAAP adjustments, more-so in recent years to try to adjust out poor acquisitions. It is worth noting that Church does not adjust out amortization of acquired intangibles, so earnings will seem lower than peers that do adjust it out, and Church’s P/E ratio will seem higher. Finally, there is $6B (70% of total assets) of goodwill and intangible assets on the balance sheet.
Management (4/5)
CEO Farrell and CFO Dierker have been with Church since 2006 and 2009, respectively. CEO Farrell is also the Chairman of the board, which is not always an ideal situation. It would be nice to see those positions separated. These two executives were from the company Alpharma, which if one Googles that company, it does not appear to have the best history, including times when Farrell was the CFO.
Executives are incentivized by Net Sales, Gross Margin, Diluted EPS, and Cash from Operations. There are not the worst incentives, but it would be nice to see incentives like free cash flow, return on invested capital, and organic growth.
Over the last decade, the company generated $7.1B of free cash flow (FCF) while spending $4.7B on acquisitions. Management has spent $3.2B on share repurchases. The median return on invested capital (ROIC) is 13%, which gets weighed down by acquisitions. Stock-based compensation (SBC) is less than 1% of total revenues, and management owns about 2% of shares outstanding. At least that is some insider ownership, but I would like to see more.
Demand Creation (3/5)
Church has some demand creation ability, which I believe to be almost entirely from its brand. There has to be a reason why this company has been around since 1846! None of its products seem superior in any way. I have tried many Church & Dwight products myself. The toothpaste, for example, seems no better than Proctor & Gamble’s toothpaste. I may prefer the taste of Arm & Hammer toothpaste compared to Crest, but that is about it. If Arm & Hammer toothpaste disappeared tomorrow, that would be a sad story, but I would just buy Crest or some other alternative instead. It is the same for laundry detergent. I do not notice any major difference in my laundry when I use Church’s brands instead of P&G's. Again, if Church’s laundry brands disappeared tomorrow, I would be disappointed for like five minutes, but I would buy a different brand and continue on.
I can see some brand power related to stopping odors. When I see the Arm & Hammer logo on a diaper bin, I would rather buy that one than the one without it. I would even pay a few more bucks for it. It also could make you feel better buying more important items from a trusted brand, like condoms or pregnancy tests. For the most part, though, especially if one is on a tight budget, one is going to buy the cheapest product in these categories.
Church spends around $500M or 10-11% of total sales on marketing. That is a solid amount, unfortunately, though, the company operates in a market with giants, P&G and Unilever. If you go into a store, you will most likely find that P&G and Unilever brands have better shelf placement and more dedicated space than Church. P&G and Unilever can also outspend Church on advertisement across media formats. Finally, switching costs, as mentioned in the last paragraph, is low for consumers. Church’s products are generally not mission critical and can be easily replaced with a competitor’s product. Church also suffers from high concentration at a handful of retailers, giving it low bargaining power.
Valuation & Pricing (1/5)
Attached below is my discounted cash flow (DCF) analysis:
Feel free to download the spreadsheet and update it with your own assumptions. I have done DCF analysis of Church & Dwight for the last seven years and my estimated value is almost always about half of the current stock price. The starting EBIT margin now seems way too low due to acquisition troubles. I debated setting EBIT higher but it is hard to predict if Church will have further acquisition-related charges in the future. My estimated value per share comes out to $39. CHD stock has hardly been below $60 over the last five years, so this case seems unlikely.
Turning to pricing, it does not look a lot better. CHD’s next-twelve-months P/E ratio is currently 28X compared to the 20-year mean of 23X. Here is a comparison to a peer group I created on Finchat.io:
To me, it seems like CHD should be more in the 20-25X range with WMT, PG, KO, PEP, CL, HSY, MKC, and CLX. It could be higher depending on which peers adjust out amortization of acquired intangibles. Church’s EPS could get to around $3.25 over the next 12-18 months, so a 23X multiple on that would leave a $75 price.
Combining my valuation and pricing, I get a target buy-below price of $57/share. That is almost 40% lower than today’s price. I owned CHD in the past, usually buying shares when they get below the 20-year mean P/E, so that would probably be a more reliable buy point if you are interested in this stock. Let us take a look at the risks first, though.
Risks
Church’s reliance on Walmart WMT 0.00%↑ , contributing ~25% of total revenue, is a big risk. If Walmart decides to stop carrying one of the company’s products or pushes back on price, it would cause a major negative impact on Church’s revenue. In addition, the last few years have shown Church’s trouble with pricing. Being so much smaller than competitors P&G PG 0.00%↑ and Unilever, Church is unable to push through enough price to offset inflationary pressures. It also has trouble maintaining its limited physical shelf space in retailers. In addition, the company faces competitive threats from private label brands. Here is management discussing losing shelf space in its November 2023 call:
Yes. Well, it's kind of a simple problem. We weren't able to supply in 2022. So we got punished by retailers in 2023, losing shelf space, a little interest in taking new product launches, et cetera. And so consequently, you lose shelf space, you're going to lose consumers. And so now the whole game is win in the resets in 2024, which now do we have a lot of visibility to that. We have some right now. We'll have more we talk to everybody in January. But the fight is really to win back more shelf space in 2024.
The other big risk is Church’s acquisition strategy. Here is management discussing its acquisition strategy in its June 2023 call:
And here's our acquisition criteria. This is very important, particularly to our long-term investors. #1 or #2 shares, high growth, high margin. I call attention to the fast-moving consumables. We got a black eye. And when we acquired FLAWLESS, we acquired that business in 2019. It was a devices -- or device, I should say, for facial hair removal prior to putting on makeup, but there might be a change in consumer behavior, we were wrong about that.
Flawless was a big miss. Management claimed it was forming a new category of women’s hair removal with this acquisition. In reality, it was an “as-seen-on-TV” product that had no growth. CEO Farrell jokingly said, “we’d like to have a big party in three years” in regards to the Flawless acquisition and unusual deal structure. What they got instead was a large write-off. Yikes!
It seems in recent years, management is acquiring more “discretionary” products as opposed to “staples”. Flawless is an example, along with Waterpik’s water flossers and showerheads. These are devices that you buy once every 5+ years. Other recent buys include Zicam, which you are supposed to take as soon as you get cold symptoms in order to shorten your cold. Again, this does not seem like a staple product. I personally gave Zicam a try last time I started getting a cold and it did nothing for me. It is definitely not a steady, repeat purchase like toothpaste or laundry detergent. Therabreath, a mouthwash, is the other recent buy. This has the potential to be more of a staple product. While Church’s acquisition strategy worked well for about 20 years, there is no guarantee that it will keep working. Management says it has 14 “power brands” today and that it wants “20 tomorrow”, so there is the potential that they could keep chasing poor acquisitions to hit that number or make their incentives each year.
To conclude, Church & Dwight scores a 15/25 in my latest review of the company. See where it stacks up with the other companies I follow, now on Tableau!
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Disclosure:
I do not own CHD stock. Please see my holdings disclosure located in the Google Sheets link.
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