PG - Church & Dwight: Good Growth Prospects But Expensive Valuation

2023-07-31 15:50:46 ET

Summary

• Church & Dwight Co. reported better-than-expected Q2 2023 earnings, with revenue increasing by 5.4% organically and adjusted EPS growing by 21.1% YoY.
• The company's sales growth is driven by consumer trade down to lower-priced products, price increases, and acquisition synergies.
• Church & Dwight is expected to continue delivering sales growth through price increases, volume recovery, and increased marketing investments, but the stock is already priced at a premium.

Investment Thesis

Church & Dwight's ( CHD ) revenue growth should benefit from volume recovery due to easing comparisons and improving fill rates. In addition, the company's revenue should also benefit from the price increases, and increase in marketing activities.

On the margin front, the company is expected to benefit from moderating inflation, carryover price increases, favorable product mix, and volume leverage. So, I remain optimistic about the growth prospects of the company. However, these growth prospects are already reflected in the company's stock price at the current premium valuation. Hence, I continue to have a neutral rating on the stock and wait on the sidelines for a better entry point despite good growth prospects.

Q2 2023 Earnings

Last week, Church & Dwight reported better-than-expected results for the second quarter of 2023. The company's revenue increased by 5.4% organically or by 9.7% YoY on a reported basis to $1.45 billion, which exceeded the consensus estimate by $30 million. Adjusted EPS grew by 21.1% YoY to $0.92 and exceeded the consensus EPS estimate by 12 cents. The gross margin increased by 270 bps Y/Y to 43.9%. The revenue growth was driven by price increases, good demand for lower-priced products due to trade downs, and acquisition synergies. Gross margin increased due to price increases, and productivity and cost synergies, whereas adjusted EPS grew as a result of good gross margin growth and lower tax rates.

Revenue Analysis and Outlook

In my previous article , I discussed Church & Dwight's sales growth prospects, driven by good demand for its lower-priced value products due to consumer trade down in an inflationary environment. However, I preferred to stay on the sidelines due to the high valuation, which was already factoring in the growth prospects ahead. The company has reported its earnings for the second quarter of 2023 since then, and similar trends were seen there as well with the company beating estimates, but the stock is underperforming.

In the second quarter of 2023, the sales growth momentum continued to benefit from consumer trade down to CHD's lower-priced products in the Household and Personal Care categories, helping the company gain market share. In addition, the company also benefited from the carryover impact of price increases from the last few quarters. Moreover, the Hero acquisition in October 2022, also boosted the top line inorganically as the brand gained good distribution and grew consumption.

This resulted in a 9.7% YoY growth in revenue to $1.45 billion. Acquisitions contributed a 4.5 percentage point benefit to the topline while FX was a 0.2 percentage point headwind. Excluding acquisitions and FX, net sales increased 5.4% YoY organically.

Looking forward, I believe the company should be able to continue delivering sales growth as it benefits from price increases, recovering volume growth, and an increase in marketing investments.

In 2022, the company, in order to offset inflationary pressure and protect its margins, started increasing the prices of its products. This supported the company's sales growth through good price/mix contribution. The last price increase was made towards the end of the first quarter, and the company plans to introduce further price increases in certain product categories in the second half of the year. I expect that the carryover pricing impact as well as new price increases should continue to benefit the company's organic growth in the coming quarters.

Moreover, volume recovery should also contribute to sales in the second half of the current year. CHD faced challenges with its volume levels in the past year. This was primarily due to lower fill rates caused by supply chain constraints, starting from the beginning of FY 2022 and things got worse in the back half of FY 2022. The company experienced difficulties with input availability, labor shortages, and plant shutdowns. This led to a decrease in volume and market share loss as the company was not able to meet the end market demand. Moving into the second half of 2023, easing volume comparisons should help in the Y/Y volume growth. Moreover, CHD's fill rates have also improved to the high 90s as supply chain constraints have eased meaningfully. This should also aid in the recovery of volume levels as the company would be able to increase shipments and meet the demand for its lower-priced valued product portfolio in personal care and household categories.

The company also lowered its marketing investments in 2022 from historical levels as the company did not want to drive consumers to shelves when there was no product available on those shelves due to lower fill rates. Now that fill rates are back up and the company is operating at its full capacity, management is targeting to gradually return to historical levels of 11% to 12% marketing investments as a percentage of sales. This should help the company further increase traction for its lower-priced value products in an inflationary environment and support revenue growth moving forward.

Hence, I remain optimistic about the sales growth prospects of the company.

Margin Analysis and Outlook

In the second quarter of 2023, the company benefited from price increases and productivity savings, which helped it fully offset inflationary costs. Price/mix was a 280 bps benefit for margins, whereas acquisitions and productivity were 120 bps and 160 bps benefit to the margin respectively. In addition, favorable currency also contributed to a 10 bps benefit to margin growth. These tailwinds more than offset the 300 bps drag from higher manufacturing and raw material costs. This resulted in a 270 bps Y/Y increase in gross margin to 43.9%.

Looking forward, I expect the company to continue expanding its margins. The company is seeing moderating inflationary pressure. In the first quarter of 2023, the company saw a 360 bps headwind from higher manufacturing and raw material costs, which decreased to 300 bps in the second quarter. With raw material prices easing, inflation should continue to moderate in the coming quarters. CHD should also benefit from carryover price increases, helping margin expansion.

Moreover, as volume recovers in the second half of the current year, sales leverage should also contribute to margin growth. Additionally, the company expects the product mix to also improve. CHD's personal care category has a higher margin product portfolio as compared to household products. The company's personal care categories returned to positive growth organically in the second quarter after three quarters of seeing a decline, and management expects positive organic growth to continue in the coming quarters. This means that a higher composition of personal care products moving forward should help in improving the mix and support margin growth.

Valuation and Conclusion

CHD is currently trading at a 30.66x FY23 consensus EPS estimate of $3.17 which is at a premium to its historical 5-year average forward P/E of 28.82x. The stock is also trading at a meaningful premium compared to Procter & Gamble ( PG ) which has similar EPS growth prospects and is available at 24.6x current year consensus P/E. The company has good future prospects as it should benefit from volume recovery, price increases, increase in advertising, and moderating inflation. However, these growth prospects seem to be already reflected in the stock price at the current valuation. So, I believe the attractive entry point is no longer available. Hence, while I remain optimistic about the growth prospects ahead, I continue to rate the stock neutral and wait for a better entry point.

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