CHD - Church & Dwight: A Transition Year

2023-11-06 07:16:31 ET

Summary

• Church & Dwight has seen solid topline sales growth in 2023, but earnings growth has lagged, creating margin pressure.
• The company has reduced leverage ratios and has the potential for M&A opportunities.
• Despite positive factors, the stagnant share price is still too expensive, as I am not willing to invest at current levels.

In September of last year, I took a look at Church & Dwight ( CHD ) after it acquired another brand to the empire. I believe that the long-term value creator found itself in harsh operating conditions, that of inflationary pressures and a reversal of post-pandemic demand trends.

Stagnation in the business threatened the premium valuation multiple, certainly in a higher interest rate environment. While the most recent deal looked nice, a softer share price performance did not automatically create appeal.

While the business has seen solid topline sales growth in 2023, earnings growth has been lagging compared to the topline sales results, creating some margin pressure on the business. The positive side is that leverage ratios have come down quite a bit, with M&A opportunities possible again.

While a transaction and operating leverage is reasonable to be expected in 2024, and this can drive earnings per share growth, I still find the stagnant share price too expensive to get involved here.

Power Brands Collection

Church & Dwight is a conglomerate of power brands, as the company has a strategy to create a diversified, asset-light, high-margin, and high-growth consumer product empire. Pre-pandemic, Church was a $4.4 billion business (that is for the year 2019), on which the company posted EBITDA of around a billion, with adjusted earnings coming in at around $2.50 per share.

With shares trading at $90 per share, valuation multiples were high, certainly as the company operated with a leverage ratio of 2 times EBITDA as well.

During the pandemic year 2020, Church grew sales by 12% to $4.96 billion, as adjusted rose to $2.83 per share, with more growth seen in 2022. Revenues did end up growing further to $5.2 billion for 2021 with adjusted earnings reported at $3.02 per share.

Back To The Fall Of 2022

In September of last year, Church announced a $630 million deal to acquire acne treatment product brand Hero Mighty, in a deal adding $115 million in sales, while posting substantial margins, as a $45 million adjusted EBITDA contribution revealed margins close to 40% of sales!

With earnings power seen flattish around $3 per share and the same shares trading at $80 per share, the resulting 26-27 times multiple was quite demanding in September last year, certainly with growth slowing down and interest rates being on the rise.

Trading Flattish

Since September, shares of Church & Dwight have traded between $70 in October 2022 and $100 in June of this year, now exchanging hands at $86 per share, largely trading in line with the valuation in September of last year.

Forwarding to February of this year, Church & Dwight posted a near 4% increase in full-year sales to $5.4 billion. The company incurred a substantial impairment charge related to the Flawless brand, with adjusted earnings down five pennies to $2.97 per share, due to inflationary pressures.

The original 2023 guidance was rather underwhelming with reported sales expected to be up 5-7%, with adjusted earnings per share seen between flat and up 4%. Net debt was reported at $2.4 billion, with EBITDA coming in at roughly half that number.

Following a solid first-quarter earnings report, the company hiked the full-year sales guidance, now seen sales to increase by 6-7%, with adjusted earnings per share seen up 2-4%. In July, the company hiked the sales guidance again after the release of the second quarter results, calling for full year sales growth of 8%, with earnings per share seen up 6% to $3.15 per share.

By now in November, Church & Dwight posted a 10.5% increase in third-quarter sales, prompting the company to hike the full-year sales guidance to 9%, while the company maintained a 6% increase in adjusted earnings to $3.15 per share.

Higher marketing expenses drive topline growth and investments in the future, but it hurts margins to a small extent, as third-quarter results were actually down two pennies on the year before. In the meantime, net debt was cut to $1.83 billion, with leverage rapidly coming down as EBITDA topped $1.3 billion.

And Now?

With shares of Church & Dwight having fallen some five dollars to $87 per share, this move has likely been the result of the full-year earnings guidance being left unchanged, while topline growth has seen a boost.

Trading at $87, the company trades at 27-28 times adjusted earnings. This multiple is largely in line with last year, but this comes as Church & Dwight now operates with considerably less leverage.

On the positive side, other than the lower financial leverage, is that margins have seen further pressure. That in itself is not a positive, but given the investments made into the brands (being the reason for margin pressure), it also means that there is potential for a recovery in margins in the next year, potentially driving earnings per share growth.

That said, interest rates have moved up considerably over the past year, raising the bar for all investments across the board.

While Church & Dwight has seen solid topline sales growth this year and remains resilient on the M&A front, I am still not happy and willing to chase the shares at current levels. Being willing to acquire the shares at a low twenty-times earnings multiple, I arrive at a potential entry target of $70 per share based on the full-year earnings outlook.

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