Church & Dwight: Be Thankful When Good Companies Are Punted To The Curb

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About: Church & Dwight Co Inc. (CHD)
by: Charles Fournier
Summary

CHD released Q4 results February 5th. Unlike November 1st when Q3 results were released and shares were bid up over 9%, Mr. Market has just lopped off ~7.5% from CHD’s.

CHD continues to generate strong Free Cash Flow and has an exemplary cash conversion cycle.

Following the release of recent results, FY2019 guidance, and the share price pullback, I now view CHD as reasonably valued and acquired additional shares.

Introduction

I have held a position in Church & Dwight (CHD) since early 2005 and have benefited from two 2 for 1 stock splits, multiple dividend increases, regular share buybacks, and have witnessed the transformation of a company that generated $1.462B in Net Sales in FY2004 to a company which just reported Net Sales of $4.146B in FY2018.

Despite CHD being one of my top 10 holdings within disclosed and undisclosed accounts, the company’s performance and management impresses me so I am not averse to increasing my exposure (over and above the automatic reinvestment of dividends) if reasonably valued.

From a high level perspective, I am somewhat hesitant to acquire shares in our current market conditions and in a recent article at Financial Freedom is a Journey I indicated that:

‘I am of the opinion that a pullback in the overall market is likely to occur within the next couple of months. I have, therefore, been combing through my current holdings in an effort to identify companies that appear to be richly valued so I can employ this conservative out-of-the money covered call option strategy.’

Having said this, I am always on the lookout for investment opportunities where I think the investment community has ‘punted’ a company to the curb.

Given that on February 5th CHD released its Q4 and FY2018 results, FY2019 guidance, and announced a 4.56% dividend increase (the regular quarterly dividend has been increased from $0.2175 to $0.2275/share or $0.91/share/year) marking the 23rd consecutive year in which it has increased its dividend, I am taking this opportunity to review CHD.

As an FYI, CHD has paid a regular consecutive quarterly dividend for 118 years!

Before reading further I draw your attention to my November 2, 2018 article in which I touched upon Q3 2018 results and guidance for the remainder of FY2018. I concluded my November 1, 2018 article by saying:

‘At some point in time CHD’s share price will pull back and I would patiently wait for a better valuation.’

Following the release of the Q3 results, CHD’s share price stock price jumped to $64.87 and ultimately rose to just a shade under $70 by December 13th.

Fast forward to February 5, 2019 and CHD’s share price has been knocked back over 7% to $60.46 from the February 4 close of $65.37.

With recently provided FY2019 guidance I now take a look at whether this is an opportune time to acquire additional CHD shares.

Business Overview

I have provided a high level overview of CHD’s business in previous articles but for the benefit of readers who have not read those articles and who are unfamiliar with the company I provide the following very brief high level overview.

CHD was founded in 1846 and was incorporated in 1925.

It develops, manufactures, and markets a broad range of consumer household and personal care products and specialty products focused on animal productivity, chemicals and cleaners.

The consumer products marketing efforts are focused on 11 “power brands” which generate more than 80% of sales and profits.

These well-recognized brand names include:

  • ARM & HAMMER which is used in multiple product categories such as baking soda, cat litter, carpet deodorization and laundry detergent;
  • TROJAN condoms, lubricants and vibrators;
  • OXICLEAN stain removers, cleaning solutions, laundry detergents and bleach alternatives; SPINBRUSH battery-operated toothbrushes;
  • FIRST RESPONSE home pregnancy and ovulation test kits;
  • NAIR depilatories;
  • ORAJEL oral analgesic;
  • XTRA laundry detergent;
  • BATISTE dry shampoo;
  • WATERPIK water flossers and showerheads; and
  • the combination of the L’ILCRITTERS and VITAFUSION brand names for its gummy dietary supplement business.

CHD has a well-balanced portfolio of household and personal care products with the percentage of sales broken down as follows:

  • Personal Care Products: 48%
  • Household Products: 45%
  • Specialty Products: 7%

65% of its products are premium products and the remaining 35% are value products.

Much of CHD’s growth has come via acquisition. This image shows the extent to which it has been a serial acquirer since 2004.

CHD - Growth Through Acquisition - February 5 2019

Source: CHD – Investor Presentation - February 5, 2019

While this presentation is 156 pages in length, I highly recommend that a review of it be included in your analysis process if you are of the opinion that CHD may be a worthwhile potential investment.

Q4 and FY2018 Results

CHD’s February 5th Press Release can be accessed here.

FY2019 Guidance

In FY2018, CHD generated diluted EPS of $2.27 and management has forecast a 7% - 9% increase to $2.43 - $2.47 for FY2019.

CHD - 2019: 7 - 9% EPS Growth Source: CHD – Investor Presentation - February 5, 2019

FY2019 sales growth of ~3.5% is projected and full year gross margin is expected to increase from FY2018’s 44.4% level by 35 bps when excluding the impact of U.S. tariffs, or up 10 bps when including U.S. tariffs.

Productivity and pricing are expected to offset continued pressure from commodities, transportation, and U.S. tariffs.

Full year marketing spend is expected to increase as CHD invests in its ARM & HAMMER “More Power to You” power brand campaign.

Further details can be found in CHD’s Press Release for which I provided a link above.

Free Cash Flow

One feature I find extremely attractive is its ability to consistently generate strong Free Cash Flow. This consistency provides CHD with the ability to acquire additional brands, reduce debt, develop new products, make capital expenditures for growth purposes, and/or increase dividends or repurchase shares.

CHD - Best in Class FCF Conversion - February 2019

Source: CHD – Investor Day Presentation – February 5, 2019

I also draw to your attention the extent to which CHD tightly manages its cash conversion cycle. An explanation of a company’s cash conversion cycle is provided here for the benefit of readers unfamiliar with this terminology.

CHD - Cash Conversion Cycle - February 5 2019

Source: CHD – Investor Day Presentation - February 5, 2019

Credit Ratings

Moody’s continues to rate CHD’s long-term debt Baa1 and Standard & Poor’s rates the debt BBB+. Both ratings are the upper tier of the lower medium grade category; these ratings are investment grade.

Neither agency has CHD's debt under review.

The debt level has grown in recent years due to the company's expansion via acquisition. Total Bank Debt/EBITDA peaked at 2.6X in FY2017 but is expected to be below 2.0X by the end of FY2019.

CHD - Strong Balance Sheet - February 5 2019

Source: CHD – Investor Presentation - February 5, 2019

Dividend, Dividend Yield, and Dividend Payout Ratio

CHD’s dividend history can be found here.

The just announced $0.01/share/quarter 4.6% increase from $0.2175 to $0.2275/share will not excite many investors. Furthermore, with CHD having closed at $60.46 on February 5, 2019, the forward dividend yield is only 1.51%. If you are turned off by this dividend yield I know how you feel as I felt the same way when I initiated a position in early 2005. When I look in the quarterly growth in the dividend income received over the years, however, I am forever thankful I did not cast CHD aside as a potential investment just because of its low dividend yield.

CHD - Dividend Growth History

Source: Seeking Alpha

I have benefited from two 2 for 1 stock splits during the time in which I have held shares but I do not envision stock splits any time soon. With CHD, however, you get annual dividend increases like clockwork. Furthermore, the dividends have historically been a return on capital which is unlike some high yielding investments out there where the dividend/distribution regularly consists of a return of capital.

In FY2018, for example, CHD generated EPS of $2.27 and its dividend amounted to $0.87. That ~38.3% dividend payout ratio is just a shade lower than the FY2012 – FY2017 levels; you can feel reasonably confident that CHD can adequately service its dividend and can most likely continue to grow its dividend at its ~9%+ 5-year compound annual growth rate without much risk.

Share Repurchases

In my November 1, 2018 article I indicated that in fiscal 2011, the weighted average shares outstanding (Basic and Diluted) amounted to 286.4 million and 291.6 million, respectively. In fiscal 2017, these figures were 250.6 million and 256.1 million. At the end of FY2018?....245.5 million and 250.7 million.

Just another way in which CHD rewards its shareholders!

Valuation

At the time of my February 7, 2018 CHD article I had just acquired another 200 CHD shares on February 6th at $48.0799 and CHD’s management had just forecast 2018 adjusted EPS of $2.24 - $2.28. Using this range and the stock price of ~$48, I arrived at a forward adjusted PE range of ~21 - ~21.4.

When I wrote my May 8, 2018 article, management still had the same adjusted EPS outlook and CHD was trading at $47.73. As a result, there was negligible difference in valuation between February and May.

After the Q3 earnings release, CHD’s stock price jumped to $64.87; there was a $5.50/share jump on the date of the release of Q3 results! In my opinion, that jump was overdone.

At the time of that November 1, 2018 article, the EPS and adjusted EPS outlook for FY2018 was $2.27 (a decline of 22% due to 2017 tax law changes and adjusted EPS growth of 17%). That meant CHD’s forward PE and forward adjusted PE was ~28.6 which was much higher than that I reported in my February and May articles.

Now that CHD has released Q4 and FY2018 results and FY2019 guidance and the share price has dropped to $60.46 let’s check out CHD’s valuation.

The current valuation is ~26.6 based on $2.27 EPS and the forward valuation is ~24.48 - ~24.9 based on $2.43 - $2.47 guidance.

CHD is certainly not a bargain but it is rare that it is a bargain. You would have to go back to 2009 – 2012 to find a valuation in the high teens/low 20s.

Final Thoughts

I recognize CHD operates in a land of giants, but when I look at its historical performance and growth prospects, I cannot help but be impressed.

CHD - Operating In a Land of Giants - February 5 2019

Source: CHD – Investor Day Presentation – February 5, 2019

I am not, however, prepared to acquire shares at any cost regardless of whether the company impress me or not. This is why I chose to be patient when I wrote my November 1, 2018 article.

Now that CHD has been ‘punted to the curb’ following the release of its Q4 and FY2018 results and FY2019 guidance I am of the opinion that it is reasonably valued (not attractively valued). I have, therefore, acquired additional shares @ $60.4692/share on February 5, 2019; all shares are held in one of our retirement accounts for which I do not disclose details other than to say that CHD is one of my largest holdings.

I wish you much success on your journey to financial freedom.

Thanks for reading!

Disclosure: I am/we are long CHD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.