Church & Dwight Has A Strong Economic Moat

| About: Church & (CHD)

Summary

Church & Dwight is a lesser-followed dividend growth stock than its competitors in the household products industry.

Although the company’s dividend yield is smaller than most of its competitors, the company should not be ignored.

I used a 20-criterion evaluation to assess the strength of Church & Dwight’s moat.

Church & Dwight has a score of 76 which suggests a strong moat.

Church & Dwight (<a href=

Church & Dwight Co. Inc. (NYSE:CHD) is one of the less-followed household products stocks on Seeking Alpha. Only 7,542 investors follow CHD while 149,339 investors follow Procter & Gamble (NYSE:PG). CHD may be followed less, particularly by dividend growth investors, because of the difference in dividend yield. CHD's dividend yield is only 1.59% while PG is currently 3.27%, which is literally twice the yield. CHD has paid an annual dividend for 20 years compared with PG, which has done so for 60 years. CHD's dividend CAGR has been double or better compared with PG over the past year (8.1% vs. 3.9%), 3-year (11.8% vs. 6.0%), 5-year (34.0 vs. 6.9%) and 10-year (27.3% vs. 9.2%) time periods. Is CHD's economic moat stronger than PG's? This article will evaluate CHD's moat. PG's moat was evaluated in this previous article.

My methodology for evaluating the moat using the 20 criteria listed below is explained in detail here. I will explain a little bit of each criterion in this article, but due to the length of the methodology, I will refrain from including it here.

Gross Margin

One of the hallmarks of a company with a moat is its gross margins. Gross margins demonstrate how much the company profits from its sales. Gross margins above 40% suggest a strong business moat.

CHD has a growing profit margin trend line over the past 10 years, but one notable observation from the chart below is how gross margins have not really advanced higher over the past 6 years. The gross margins have settled in a range between 44% and 45%. Regardless, the company demonstrates that it has pricing power and is consistent having an average gross margin of 42.9% over the past 10 years.

Score = 5

Click to enlarge

Source: Old School Value, chart created by the author

SG&A Ratio

In terms of the SG&A, it is best that these expenses not eat into gross profits too much.

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

66.88%

64.85%

64.98%

64.31%

61.57%

59.44%

57.79%

56.73%

55.87%

55.40%

Click to enlarge

Source: Old School Value

Similar to PG, CHD has had a SG&A ratio that has averaged around 61% for the past 10 years. A strong moat would be less than 30%. What is good to see is that this ratio has been declining each year (with the exception of 2009) for the past 10 years. Although SG&A is absorbing less of the company's income, the ratio remains high and accounts for an important amount of the company's expenses.

Score = 3

Depreciation Ratio

This ratio is also known as the depreciation-expense ratio. The ratio elaborates on the amount of income that is required to maintain the capital being used by the business. For this ratio, I compared CHD depreciation/gross profit to Kimberly Clark (NYSE:KMB), Colgate-Palmolive (NYSE:CL), The Clorox Company (NYSE:CLX) and PG. The company with the competitive advantage has the lowest ratio. Ideally, this would be below 5% and no more than 15%.

Click to enlarge

Source: Old School Value, chart created by the author

CHD has up until this past year consistently had the second lowest depreciation ratio among its competitors, suggesting that compared to its peers, it is using less income to maintain the capital used by the business. Although it has fallen to third place in 2015 among its peers, the ratio has remained consistent around 6.5%.

Score = 3

Interest Expense Ratio

One of the indicators of a company with a competitive advantage is its lack of debt because it demonstrates that the company is capable of generating sufficient cash to meet its operational needs and growth. The interest expense ratio is important because this is cash that is being lost to pay the company's outstanding debt. Although some debt may be good and necessary, it becomes burdensome when the interest being paid on that debt is high. Warren Buffett favors companies that have an interest expense ratio below 15%.

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

21.43%

19.31%

13.79%

8.61%

6.24%

1.77%

2.57%

4.45%

4.27%

4.52%

Click to enlarge

Source: Old School Value

CHD has come a long way since 2006 when its interest expense ratio was over 21%. The company has retired much of its debt even until it was its ratio was 1.77% in 2011. Since then the interest expense ratio has risen but only to 4.52%. The 10-year average is 8.70% while the 5-year average is only 3.52%. The interest payments on CHD's debt is not considered burdensome.

Score = 5

Net Earnings Ratio

This ratio looks at how much profit the company is generating from total revenues after expenses are accounted for. Companies with a net earnings ratio of 20% or more have a competitive advantage.

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

7.14%

7.61%

8.06%

9.66%

10.45%

11.26%

11.97%

12.35%

12.55%

12.09%

Click to enlarge

Source: Old School Value

The net earnings ratio of CHD has steadily improved generally each year since 2006 when it was a low of 7.14% compared to its high in 2014 of 12.55%. The net earnings ratio decreased slightly in 2015 but remains above 12% and remains above the 10-year and 5-year average of 10.31% and 12.04% respectively. However, CHD has not reached and is currently not generating 20% of its revenues as profits after expenses but is above 10% for a score of 3.

Score = 3

EPS

CHD's EPS chart is a thing of absolute beauty. The company has a consistent upward trend and has not had any declines even during the financial crisis of 2008-09. The EPS has had great growth over this 10-year period but appears to have slowed since 2014 and is leveling off. CHD reported $1.57 in EPS in 2015 which is nearly triple the EPS reported in 2006 of $0.54.

Score = 5

Church & Dwight (<a href='http://seekingalpha.com/symbol/CHD' title='Church & Dwight Co Inc.'>CHD</a>) 10 year EPS history Click to enlarge

Source: Old School Value, chart created by the author

The growth trend appears to continue over the next several years based on analysts' estimates. Analysts estimate that CHD will earn $1.75 at the end of this FY2016 and estimate an EPS of $2.17 at the end of FY2019. That would represent a 7.43% CAGR over the next 3 years.

Click to enlarge

Source: Simply Wall St

Inventory and Net Income

The company with the competitive advantage has an inventory and net income that rise together. As inventories are sold, net income is likely to rise so long as expenses are controlled. A negative indicator would be net inventories that is greater than net income this would suggest that the company is unable to sell its products or that demand has weakened.

Click to enlarge

Source: Old School Value, chart created by the author

CHD had an issue in 2006 and 2007 when its net income was below its net inventories however since 2008, the company has corrected the issue and now both net income and net inventories are rising together, with net income surpassing net inventories. There is a slight concern in 2015 with inventories rising and net income dropping somewhat, however the separation between both is still large.

Score = 5

Net Receivables Ratio

The net receivables ratio divides the net receivables of a company by the gross sales. The purpose is to determine the percentage of sales represented by net receivables. Net receivables is money owed to the company subtracting for money that will likely never be paid. A company with a competitive advantage will have the lowest ratio as it means that it has booked its sales and is capable of receiving payments from its customers.

Click to enlarge

Source: Old School Value, chart created by the author

CHD is currently second among its peers for the net receivables ratio. In 2015, CHD's net receivables represented 8.14% of its sales. Over the past 10 years, the ratio has ranged from 8.14% to 11.89% and has averaged 9.78% over that period. PG leads the group with the lowest ratio at 6.46% in 2015.

Score = 3

Return on Assets

The ROA provides an indicator of how efficient the company is in generating revenue with the assets the company already has. Naturally, we would want to see a high ROA but not overly high.

CHD finds itself in the middle among its competitors. Its ROA peaked in 2011 at 9.93% and has been attempting to return and exceed that level since. However, unlike its competitors CL, PG and KMB, CHD's ROA remains in an uptrend. CLX is in a similar position as CHD after peaking in 2006 at 13.99%, the company took 9 years to return and exceed that percentage. CHD's ROA has averaged 8.35% over the past 10 years.

Score = 3

Return on Assets (ROA) between procter & gamble, clorox, colgate palmolive, kimberly clark and church & dwight Click to enlarge

Source: Old School Value, chart created by the author

Short-Term Debt

Short term debt usually requires a higher interest rate and is best to be used sparingly or in time of need. If the short-term debt is greater than the cash and cash equivalents, the company could be in poor financial health.

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

127.10%

59.53%

37.75%

48.97%

47.57%

1.03%

73.99%

30.95%

93.76%

108.24%

Click to enlarge

Source: Old School Value

CHD has frequently used short-term debt. The company nearly eliminated it in 2011 but since then has acquired more of it. The short-term debt currently stands at 1.08x its cash and cash equivalents. This is not far from its 10-year high of 1.27x its cash and cash equivalents back in 2006. However, short-term debt remains a problem that is siphoning money out the company.

Score = 1

Current Ratio

Although the short-term debt is not covered by cash and cash equivalents, the current ratio helps us assess whether the short-term debt is covered by the company's assets should they ever need to sell them to pay off this debt.

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

1.25

1.61

1.72

1.64

1.45

1.97

1.29

1.71

1.12

1.04

Click to enlarge

Source: Old School Value

PG has sufficient assets to cover its short-term debt as the current ratio currently stands at 1.04, but this is the lowest it has been over the past 10 years. It can also be said that the current trend is not positive and could be an area of concern. However, because the current ratio remains above 1.00, the company earns a score of 5 but one that should be monitored closely.

Score = 5

Long-Term Debt

There are many reasons for companies to carry long-term debt but it should not become a burden on the company. A company should need little to no long-term debt to maintain operations. In this low interest rate environment, many companies have glutted themselves with debt. The question is whether they can pay it back within 3-4 years using their net income.

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

5.71

4.18

4.00

2.45

0.92

0.81

1.86

1.65

1.67

1.69

Click to enlarge

Source: Old School Value

Based on the current long-term debt levels of CHD and their net income, it would only take 1.69 years based on 2015 net income to pay back its long-term debt which is excellent. It appears that 2012 was a significant year for CHD because the company was reducing its debt, even being able to pay back its long-term debt in less than 1 year in 2011 from over 5 years in 2006, to suddenly accumulate more long-term and short-term debt. This may be something to explore more in depth; however, the long-term debt is still quite manageable and could be paid off entirely in short order.

Score = 5

Debt to Shareholder's Equity Ratio

This ratio is used to measure a company's financial leverage. It indicates how much debt a company is using to finance its assets compared to the amount of value the company has which is represented by the shareholder equity. A ratio below 0.80 indicates that the company has a competitive advantage.

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

1.61

1.29

1.07

0.93

0.57

0.50

0.85

0.73

0.78

0.71

Click to enlarge

Source: Old School Value

The same story as observed and elaborated on in the long-term debt segment plays out here in the debt to shareholder equity ratio. At present, the ratio stands at 0.71 and has been below 0.80 for the past 3 years and 5 out of the 6 years. It should also be noted that the company has reduced this ratio by over 50% compared to 2006.

Score = 5

Preferred Stock

This one is quick. CHD has not issued any preferred stock in the past 10 years. It earns top marks for this.

Score = 5

Retained Earnings

Retained earnings demonstrate what a company did with its profits such as reinvested back into the business or to pay debt. It is not a cash surplus. A company with a competitive advantage is one that is capable of growing retained earnings each year.

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

$740

$892

$1,064

$1,275

$1,502

$1,714

$1,929

$2,169

$2,415

$2,650

Click to enlarge

Source: Old School Value, figures in billions

CHD's retained earnings has risen each year over the past 10 years. The 5-year CAGR is 9.11% while the 10-year CAGR has been 15.23%. This shows fairly decent growth.

Score = 5

Treasury Stock Effect on ROE

Shares that are bought back can be held as treasury stock. This has the effect of increasing ROE artificially. A high ROE is a sign of a competitive advantage but can be financially manipulated by increasing the treasury stock. In this part, ROE is calculated by adjusting for treasury stock and compare it to the usually reported ROE to determine how much manipulation is taking place.

Click to enlarge

Source: Old School Value, chart created by the author

Up until 2012, the ROE and treasury stock adjusted ROE were nearly identical as the two lines were literally close or hugging each other from 2006 to 2011. In 2012 is when a divergence between the two emerged which shows that after that year, the ROE appears to have been financially engineered. Even until 2013, the treasury adjusted ROE was fairly constant, but it too has turned downward over the last few years, which has widened the gap between the two further. As of 2015, the ROE is calculated to be 20.28% whereas the treasury adjusted ROE suggests the ROE should actually be 13.12%.

Score = 1

Capital Expenditures Ratio

This criterion examines the difference between the past 10 years of total Capital Expenditures by the past 10 years of total Net Income to determine how much the net income is absorbed by the capital expenditures needed to generate that income. The capital expenditures ratio of CHD is 25.71%, which is an indication of a competitive advantage but it falls just outside of the desired range below 25%.

Score = 3

CROIC

A CROIC consistently above 15% shows that the company has a strong competitive advantage. This is an indication of the company's ability to generate FCF with its investments. This is a good metric for dividend growth investors to follow.

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

7.73%

10.32%

10.87%

10.98%

16.50%

15.75%

15.15%

13.94%

14.73%

17.71%

Click to enlarge

Source: Old School Value

I struggled to assign an appropriate score to CHD on this criterion. I believe the key word used is consistent. CHD currently has a CROIC above 15% and has had one over 15% in 4 out of the past 6 years. Even the 10-year average is 15.46%. However, it had two down years (2013 and 2014) where the CROIC dropped below 15% and although it was too far off, it still shows some inconsistency. As a result, I will score this a 3 in order to also control any bias I may have.

Score = 3

EPV

If someone could reproduce PG easily then PG would have no competitive advantage. The EPV measures its earnings power and whether it could be easily reproduced.

church & dwight net reproduction value, EPV

Source: Old School Value

The EPV value for CHD is above the net reproduction value, which means that CHD has a moat.

Score = 5

GPA

The gross profits to total assets, or GPA, ratio is an indicator of how well the company generates profits based on the existing assets. A GPA above 50% indicates a strong moat.

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

32.61%

34.27%

34.69%

35.31%

39.31%

38.96%

31.51%

33.76%

33.33%

35.51%

Click to enlarge

Source: Old School Value

The GPA of CHD has not exceeded 50% at any time over the past 10 years however there were some instances where it nearly reached 40%. The GPA has averaged 34.61% over the past 10 years, which is solid. At the moment, the GPA score is above that average at 35.51%.

Score = 3

CONCLUSION

Here is a summary of the evaluation.

Church & Dwight economic moat score, moat, competitive advantage rating

Based on this 20-criterion evaluation, I have found that CHD has a total score of 76, which suggests the existence of a strong moat. Compared to PG whose score was 64, CHD appears to be a stronger company. I will not say that it is the strongest in the household products industry yet since I have not evaluated the company's other competitors in their entirety.

There are a number of strong points to CHD. The first and foremost is the consistent growth of the EPS. The EPS chart was a thing of beauty as the EPS kept rising without drops over the past 10 years, which also includes the financial crisis. Gross margins also remain consistent, showing that the company does have pricing power. It was also nice to see the turnaround of the inventory and net income. Both are headed in the right direction, and the company appears to have a good handle on inventory levels in order to generate income.

There are also a number of concerns. First and foremost is the use of short-term debt by the company when it could easily take on more long-term debt in order to take advantage of lower interest rates. As a potential investor, I would likely read the 2011 and 2012 year-end reports in order to understand why several ratios deteriorated considerably after the company had worked so hard to improve them over the years. One such example was the treasury adjusted ROE vs. the ROE which was nearly identical for 6 years until this time period where it began to separate, leading to the suggestion that the ROE is being financially engineered.

The evaluation was limited to 2015 data since CHD does not report full year results until February 2017. Based on twelve trailing months data for several ratios (but not all otherwise I would have used them), it appears that CHD's moat may strengthen even further.

At the moment, I do like the looks of the company. There are other things that I need to do first before I pull the trigger such as evaluate its dividend and the future growth prospects of the dividend (as well as its safety) as well as the fair value of the stock price since I do not believe in over paying for companies. Having said that, this is a company that I will keep an eye on as I see it as one of the better choices in this space.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CHD over the next 72 hours.

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: Nothing in this article should be construed as a recommendation to buy, sell or short any equities herein mentioned. All investors are encouraged to perform their own due diligence.