Here's Why I'm Keeping An Eye On Church & Dwight

Summary

• Church & Dwight sells products that show a repeatability of purchase patterns.
• Church & Dwight expanded its fundamentals through increased customer demand and acquisitions.
• Church & Dwight possesses a good balance sheet.

Source: Church & Dwight's SEC Filings

Owning stock means you partake in the ownership of a dynamic business. As a publicly traded business owner, it is optimal that your products represent something that is highly wanted or needed on a consistent basis. It's also good for your products to represent something that people will buy on a regular basis. This helps keep demand relatively smooth both in good times and bad.

Personal products company Church & Dwight (NYSE: NYSE:CHD) represents an example of one of these companies. Church & Dwight sells products needed in everyday life, such as laundry detergent, kitty litter, toothbrushes, deodorant, vitamins, etc. These products represent things that people need to buy on a regular basis. In addition, the company sells specialty chemicals used for industrial purposes as well as animal nutrition products. Let's examine what the company has done for shareholders.

Good fundamentals

Over the past five years, Church & Dwight expanded its revenue, net income and free cash flow 31%, 51% and 27%, respectively (see chart below). It managed to expand its fundamentals through a combination of positive levers including volume gains, acquisitions and productivity gains. It's always good to see volume gains on a consistent basis. This serves as an indication that a company knows how to appeal to the final consumer. Last year, innovation helped drive Church & Dwight's fundamentals higher. This represents a way to keep people interested in the brands.

CHD Revenue (NYSE:TTM) data by YCharts

However, Church & Dwight is struggling some in FY 2015. Its year-to-date revenue expanded 4%, year-over-year. However, its net income and free cash flow declined 2% each, year-over-year. Once again, a combination of positive levers, including acquisitions, price increases and volume gains, propelled top line growth. However, growth in revenue didn't outpace the growth in expenses.

Acquisition related expenses, pension settlement charges, equity in losses from affiliates and increases in interest expenses contributed to growth in expenses. Increases in capital expenditures as well as unfavorable changes in inventory and timing of customer collections made a negative impact on free cash flow.

Church & Dwight sits on a good balance sheet. In the most recent quarter, the company possessed cash amounting to $211 million that equated to 10% of stockholder's equity. I like to see companies with cash amounting to 20% or more of stockholder's equity.

I don't like long-term debt, even in this low interest rate environment. If a company accumulates enough of it, increasing interest expense will choke out profitability and cash flow. I like to see companies with long-term debt amounting to 50% or less of stockholder's equity. In the most recent quarter, Church & Dwight's long-term debt amounted to 34% of stockholder's equity. Year-to-date operating income exceeded interest expense by 22 times. The rule of thumb for safety lies at five times or more.

Church & Dwight's fundamentals translated into a market beating total return of 184% vs 94% for the S&P 500 over the past five years (see chart below).

CHD Total Return Price data by YCharts

Dividends

Church & Dwight pays a prudent dividend. I like to see companies pay out 50% or less of their free cash flow in dividends and retain the rest for other uses. So far this year this company only paid out 36% of its free cash in dividends. Interestingly, the dividend to free cash flow payout percentage resided at 36% for the past two full years.

Valuation

Church & Dwight's valuation resides in the high range even after a 6% correction off its 52 week high as of this writing. Currently, the company's P/E ratio clocks in at 28 vs 19, according to Morningstar. Church & Dwight's valuation and the S&P 500's reside close to a five year high. This makes Church & Dwight's market price risk especially high.

Conclusion

I think that Church & Dwight will continue to focus on innovation to keep the final consumer interested. I also think that Church & Dwight will make strategic acquisitions that will complement the company's product portfolio. Company management demonstrates prudence in handling its balance sheet. These factors will continue to drive its fundamentals forward. However, I think that its shares hover in the high range. Investors may want to take a small position, while adding during market corrections.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

Comments

[Ultrabase]

Y'all are not looking at the facts. Available on Seeking Alpha is the transcript of the company's Q32015 conference call, which is the most recent one available. It says:

"We continue to expect 3% organic sales growth and full-year gross margin expansion of 35 to 45 basis points....The full-year adjusted EPS [growth] range is now 7% to 8%."

So the company's earnings will be growing at 7 to 8 percent, the profit margin is 12%, and the return on equity is 20% with a low debt level. Conclusion: the stock is too cheap. You should be buying more.

If you disagree, please explain why in terms of FACTS and REASONING FROM THE FACTS, not random nonsense.

[moseharper]

Sounds like a lot of you should simply sell out and move on.

[DeepThought43]

Possibly. With a stock like this that I've owned a long time and done very well with, I'm slow to sell. I ponder. I decide maybe I should sell. But I don't sell just based on my analysis. I'll first wait for the stock to verify my thesis before acting. I give the stock the full benefit of the doubt about my analysis before finally selling.

If the stock violates it's 50 day or 50 week moving averages with conviction, then at that point I may cash out. Until then, I figure, I hope, that my analysis is flawed. Over that past 4 months it's been making lower highs and lower lows which is not comforting - but it happens. So for the moment I wait and watch. Uneasily.

[ClemTig]

Focus on the last 2 years of the first chart. Revenue, Net Earnings and FCF have stagnated the last 2 years. There is essentially NO growth over that time period. That for a company trading at a 27 P/E! This company boasts the HIGHEST PEG Ratio of any stock I have followed in the last 5 years. I'll take the other side of that bet. I think it is ripe for a fall. When bond yields rise and conservative investors leave this room, this stock is in MAJOR trouble.

[Ultrabase]

To DeepThought43: You mentioned that the stock was too expensive given its growth rate. What about profitability? The company earns a return on equity over 19%. Suppose the growth rate were nearly zero, but the company was highly profitable? What would you pay for that?

[DeepThought43]

It is a well run company and does have nice ROE. Good free cash flow too. Lots of companies do. But if the earnings will grow at 10% over the next 5 yrs, which would be astonishing but possible, the PE 28 still seems way too high to me. In round numbers it's 50% higher than the average PE over the past 15 yrs. It's higher now than it's ever been, let alone the average. Also, I don't pay too much attention to discounted cash flow, but the stock is not cheap on that metric either.

Not everyone will agree with me, obviously. You pays your money and you takes your choice. Note that I said I still hold the stock, just that I'm getting a bit nervous about its valuation.

[DeepThought43]

My apology, I skipped over your key question. If I somehow knew a company's growth rate were going to be zero (i.e. it's a cash cow) then valuing it becomes a simple calculation of Discounted Cash Flow. Higher ROE, higher cash flow produces a higher DCF.

The trouble with DCF, IMHO, is that it requires a lot of assumptions about growth rates and interest rates that essentially come down to crystal ball guesses. But if you stipulate up front the 0% growth rate and we assume 0% change in cash flows and such, then DCF gives an answer. And in CHD's case the DCF is below the market price last I looked.

ValuePro.net gives one a good stake in the ground for DCF values as do many other web sources.

[Ultrabase]

Okay, I looked at cash flow as you suggested. Here's my back-of-the-envelope analysis.

The company has $2 billion in shareholder's equity and $500 million in annual cash flow. So if you could buy it at the equity value, you'd be getting all your cash back in four years. Excellent.

Unfortunately, it is not selling at that price. The enterprise value is about $12 billion, so it'd require about 24 years to get your cash back. Not horrible, but not as good as four years.

One way to think about investing is, how long are you willing to wait for that payback? That determines the price you can pay.

[DeepThought43]

Great company, but the stock has become way the heck too expensive given its growth rate, IMHO. That said, I continue to hold it (warily). It has performed well for me over many years so I'm willing to cut it a little slack now until it violates a support level or some such.

Personally I expect it to continue to wander sideways for an extended period as it undergoes slow PE compression back to reality based levels. Perhaps one should trade around one's position between $80 and $90 for the next year or two? I'll have to ponder that when the stock hits $90 again.

Generally with a stock like this I'll trade options on it to boost the return as the stock wanders sideways. Unfortunately CHD is not a good options candidate.

[gonji]

"I don't like long-term debt" I couldn't agree more.

[Ultrabase]

Your statement about long-term debt makes no sense. The company has $699 million of long-term debt, but it also has $423 million of cash on the balance sheet, and more than $500 million in annual cash flow. In other words, they can pay off the debt easily in less than one year. What's the problem?

[gonji]

I prefer companies that can pay off their debt easily as you stated. Companies like V, GPC, VFC, TROW ( no debt ) come to mind.

[William Bias]

I appreciate your readership guys!

William

[moseharper]

I love this company and it's products- and it's stock. I add periodically, which increases my average cost basis, but it has been a stellar performer.

[fendermon]

Nice break-down William, Thank you