Church & Dwight: Solid Growth At A Fair Price

| About: Church & (CHD)

Business Description

Church & Dwight Co. (NYSE:CHD) is a diversified manufacturer of consumer products including Arm & Hammer baking soda, Oxiclean, Kaboom, Nair, Trojan, and Extra. The company's operations are divided into three divisions, domestic consumer products, international consumer products, and specialty products. The domestic consumer products division accounts for approximately 74% of the company's revenues and 79% of its profits. This division primarily sells cleaning, contraceptive, baking soda, hair care, and vitamin products to retailers and drug stores throughout the US. The international division accounts for 17% of sales and sells similar products abroad primarily in the Western Europe, Brazil, Mexico, and Canada. The Special Products division (8.7% of revenues) sells sodium bicarbonate (baking soda) related products, specialty cleaning, and animal feed products.

Investment Thesis

Power brands have further room to grow. The company has eight so-called "power brands" that together account for 80% of the firm's revenues and profits. These brands include Arm & Hammer, Orajel, Oxiclean, Nair, Spin Brush, Xtra, First Response, and Trojan. Each of these brands is the number one brand within its product category in the U.S. These brands have continued to gain share, with six of the eight brands gaining share in 2012.

International expansion will drive long-term expansion. The international market remains a large potential market for Church Dwight going forward and could help drive further gains to Church Dwight's top line. For example, Trojan only has a 20.7% market share in Mexico compared with a 76% share in the U.S. Over the course of the last five years the company has grown by high single digits in all but one of its international markets. Management has demonstrated a willingness to allocate resources toward further inroads into international markets.

New products can catalyze further growth. Historically the firm has been able to grow its profits by exploiting under served niches that were devoid of competition from larger players. Church Dwight has recently announced several new product offerings that have both extremely high margins and a dearth of significant competitors. These products include personal lubricants, adult toys, single dose cold sore treatments, dish-washing additives, and music-playing toothbrushes. The total market size for these new categories is approximately $1.4 billion.

Cost control efforts should result in margin improvements. Gross margins have risen by 500 basis points to 44.2% (2012), but still remain below their peers Colgate and Proctor & Gamble (NYSE:PG) each of which has gross margins in excess of 50%. The company recently completed a new plant in Victorville, CA, that will help reduce the cost of laundry and cat litter products. Package changes and industry wide laundry compaction wherein the concentration of laundry is increased will help to increase gross margins without significant capital expenditures.

Current and future acquisitions will be a major engine for growth. The company's recent acquisition of Avid Health will add 5% to Church Dwight's EPS growth in 2013 and only slightly dilute margins. Avid manufactures gummy vitamins and supplements. Lil' Critters, its children's gummy brand is currently the number one player in the $200m children's vitamin market. The adult gummy market size is $3.3 billion with gummies only constituting 3% of the market at present. In 2013 alone, Church Dwight anticipates $15 million in operating synergies from the acquisition. Church Dwight plans to turn Avid into a power brand by doubling market spending in 2013 and by using its relationships with retailers to get the brand more shelf space.

Valuation. Church Dwight is currently fairly valued or trading at a premium compared with most of its peer competitors. However, as seen in the chart below, the company has grown EBITDA over the last five years by 10x faster and Net Income 5x faster than its peers including Proctor & Gamble, Clorox (NYSE:CLX), and Colgate-Palmolive (NYSE:CL). Furthermore, Church Dwight is substantially smaller with an $8.78 billion market cap that is 25 times smaller than its largest peer. As a result, the company can more easily make acquisitions that are accretive to its bottom line. Furthermore, the company may be a potential acquisition target as its business lines could provide significant synergies to larger integrated consumer products companies. As a result, I believe Church Dwight warrants a forward P/E multiple of 28x consensus 2013 earnings of $2.80 implying a valuation of $78.40.

Investment Risks:

Although the firm's laundry detergent division has gained 3.5% market share from 11.4% to 14.9%, it could at any point face increasing price competition from the market leader Procter & Gamble. Church Dwight is relatively more resilient to macroeconomic concerns than other consumer product companies because of the 40% of its brands that are value focused, however a prolonged downturn in the U.S. and global economies could result in lower or negative sales growth. Conversely a rise in commodity prices could compress the firm's margins especially in the laundry and householder cleaner segments that are highly dependent upon the price of petrochemicals.

Recommendation and Price Target: Buy on a comparable forward P/E basis. Blended Price Target: $78.40, Current Price: $63.27, Potential Upside: 23.9%

Disclosure: I am long CHD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own shares in CHD and am part of a student run investment fund that holds a position in the company.