Church & Dwight (NYSE:CHD) is arguably most famous for its Arm & Hammer baking soda brand, but it actually owns 11 "power brands" that include: Trojan, Nair, First Response, OxiClean, Orajel, and a few others. These brands might not be as iconic as the brands found in Procter & Gamble's (NYSE:PG) portfolio, such as Tide, Head & Shoulders, and Gillette - but this doesn't necessarily make Church & Dwight inferior in my opinion.
The size discrepancy can be better visualized in the below graphic presented in Church & Dwight's earnings call slides for the fourth quarter:
This appears to be a "David versus Goliath" type situation when comparing the two, but I'd like to present the case for why I think Church & Dwight might be the better quality company.
Outperformance in the past could very well continue
Church & Dwight has averaged returns on par with the S&P 500 over the past five years, significantly outperforming its peers:
Source: CHD 2017 10-K
This stacks up favorably against Procter & Gamble's returns over its past five fiscal years.
Source: PG 2017 10-K
P&G lags by a decent-sized margin, and unlike Church & Dwight, has had some struggles growing the top-line. To be fair, P&G has been busy transitioning its business, by shedding underperforming brands, which could explain some of its share-price related struggles. Church & Dwight is the opposite of its larger peer, as it continues to acquire companies and integrate them into its business for growth.
Return on equity analysis
Moving away from the top-line and focusing on earnings, I'd next like to look at return on equity.
Procter & Gamble recorded a sizable one-time gain after selling its beauty business, so I decided to use earnings from continuing operations in the below DuPont analysis for fiscal 2017. Church & Dwight booked tax-reform related gains during its fiscal 2017, so I adjusted its numbers by extrapolating adjusted net income using the adjusted effective tax rate provided by management in the guidance section of its 8-K report.
The effective tax rate is expected to fall further for both companies, but Church & Dwight's mostly domestic business will likely benefit disproportionately more than its larger competitor (that maintains a far larger international presence). Church & Dwight's CEO said in the 8-K that:
The new tax law is expected to reduce our tax burden by lowering our effective tax rate to approximately 24-25% compared to 32% (excluding tax reform) for 2017. Our estimate is based on our current understanding of the new Tax Act which may change as regulations are finalized.
This should boost its ROE even further, as its tax burden is further alleviated going forward. It will also help close the gap between its relatively high tax rate and the lower effective tax rate that P&G enjoys (mostly because of its large presence outside the U.S.).
Despite a drop in its asset turnover ratio year-over-year to 0.73x, CHD still generates far more revenues in relation to its assets than PG does (asset turnover of only 0.53x) - indicating better efficiency as well. PG still maintains higher operating margins, though, as CHD's sunk year-over-year (and could continue to sink if it continues to spend more money on advertising and acquisitions).
Church & Dwight maintains higher overall ROE than P&G, however, largely due to better asset efficiency and higher leverage (which magnifies return on equity overall). Its inferior margins aren't that much slimmer than P&G's, either, so I'm not sure how much of an advantage this is - especially if Church & Dwight continues to grow not only its size-and-scale, but also its pricing power.
Conclusion
Procter & Gamble is usually the default company for dividend growth investors in the packaged consumer goods space - and for good reason. It's the largest player in a recession-resistant industry with over six decades of sequential dividend increases. Its size enables it to maintain high margins, and its iconic brand portfolio (coupled with its size) allows it to sustainably earn excess returns on its capital. The top-line could continue to stagnate going forward (although about 2% organic growth is expected) - while dividend growth has definitely slowed down considerably - with the last increase coming in at only 3%.
Church & Dwight is smaller, but also nimbler. It's expecting 8% growth in revenues for 2018, largely due to (potentially riskier) acquisitive growth. Core organic top-line growth (which is adjusted to account for acquisitions, divestitures, and FX/Other) is still expected to come in at 3% as well. It also faces a very favorable tailwind going forward, as its traditionally high tax rate in the mid-to-low thirties will fall closer to 24% to 25% going forward. It's also turning into a legitimate dividend growth stock, with over a decade of increases under its belt. It just bumped its dividend by 14%, in fact.
Don't get me wrong - I don't think there's necessarily anything wrong with Procter & Gamble; I just think Church & Dwight has better prospects going forward in regards to growth in revenues and earnings (as well as dividend growth). It also generates higher return on equity, and will likely continue to do so - even if it accomplishes this just by maintaining a noticeably lighter tax burden going forward.
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Church & Dwight will be discussed in more detail using my Inverse Pyramid Process with members of my private investing community, Harry's High-Quality Club.
