CHD - Church & Dwight: Interesting H2 2023 Setup Makes Me Positive About The Near Term (Rating Upgrade)

2023-09-07 03:12:48 ET

Summary

• Church & Dwight is now a buy recommendation with a potential attractive return over the next 1-2 quarters.
• CHD's 2Q23 results exceeded expectations, driven by organic sales growth and improved margins.
• Management's guidance suggests a deceleration in the latter half of the year, but potential factors may lead to better-than-expected results.

Overview

My recommendation for Church & Dwight ( CHD ) is now a buy as I see an appealing setup that could return an attractive 15% return over the next 1 or 2 quarters as CHD beat consensus estimates and raise FY23 guidance. Note that I previously gave a hold rating for CHD , as I believe the equity story is already fully priced into the valuation multiple of 30x forward PE. I believe this is still true to a certain extent, but near-term outperformance could continue to support this level of valuation for longer than I expected.

Recent results & updates

CHD is a company with a rich history of effectively managing and growing its brand portfolio, often through value-enhancing acquisitions. Reflecting on my previous analysis of the company, FY22 posed some challenges, but the results for 1Q23 surpassed our expectations. As we dive into the 2Q23 results, it becomes evident that CHD's financial performance has improved significantly, with reported results exceeding estimates. Notably, the 2Q23 EPS outperformed consensus expectations, coming in at $0.92 compared to the expected $0.80.

These earnings beats in the second quarter can be attributed to robust organic sales growth and improved gross margins, despite a substantial increase in marketing expenses (+28% YoY). Organic sales growth of 5.4% was driven primarily by a 5.8% increase in pricing, partially offset by volume declines. Within the domestic consumer segment, organic sales grew by an impressive 6.3%, fueled by favorable price/mix dynamics. International organic sales also saw a healthy increase of 6.1%, driven by both price/mix and volume growth. However, specialty products experienced a 6.5% decline in organic sales, primarily due to a 4.2% drop in volumes and a 2.3% decrease in pricing and mix. Turning our attention to the income statement, the highlight here is that even though marketing (we will talk more about why this is important below) increased by 28%, EBIT margin still came in at 20.7%, beating the consensus estimate by 100 basis points.

From a tactical long-term perspective (short-term trade), I think CHD's current set-up may be appealing to some investors. Here is the catch: despite the strong second-quarter performance, there seems to be a hint of caution in management's guidance for the latter half of the year, which suggests a deceleration in both revenue and profit. Management upgraded their guidance from 3-4% organic growth to more than 5%; this implies FY23 revenue of around $5.81 billion with adj. EPS expected to be $3.15. With that, we can back into 2H23 implied performance, which is revenue of $2.926 billion, a 6% growth vs. 2H22. This is a deceleration in growth rate from 1H23, which grew 10% vs. 1H22. I thought this was rather interesting considering management has invested a lot into marketing, which should drive accelerating sales growth into 2H23. In addition, this additional spending is earmarked for brands that have already experienced significant distribution gains, such as Therabreath and Hero. As such, it is clear that these investments are effective. Moreover, management has hinted at an upcoming turning point in organic growth within the higher-margin personal care portfolio. They also anticipate continued positive impacts from strong brands like Batiste in the second half.

So first half, they're both down year-over-year. The expectation is up in the second half. So you're right about that. They're going to start contributing to the inflection of personal care starting to grow.

...And BATISTE would be the other one that we haven't completely lapped…all the price increases. So that's going to be part of the story for price in the second half. from: 2Q2023 earnings call

This raises the intriguing possibility that management might be sandbagging the numbers and keeping some room to potentially revise its guidance upward in the next quarter. This could become particularly relevant if their plans for nationwide distribution of the higher-margin Hero brand come to fruition. As such, I hold a strong belief that the results for the third quarter will surpass management's expectations. If my expectations were to come true, the stock could see a short rally back to a 30x valuation as CHD beats and raises guidance.

Valuation and risk

The question is how much would it be worth in the near-term if CHD beat 2H23 estimates?

The possible short-term bull case is that management is sandbagging their estimates and that 2H23 might do just as well as 1H23. In my model, I assumed CHD to grow 10% for 2H23, leading to FY23 overall growth. Since the higher margin profile is expected to see a strong 2H23, I forecasted margin improvements as well. As CHD beat estimates and its own guidance, the headline growth profile will certainly be in favor of the stock, thereby possibly pushing valuation back to its previous high of 30x forward PE. Putting these together, the share price could go back up to $110, a 15% upside. The risk here is that I am expecting 2H23 to outperform. If volume decline is greater than expected due to factors such as price changes, shifts in demand after the COVID-19 pandemic, persistent weakness in the discretionary product portfolio, and declining demand in certain categories, it will definitely hurt top-line revenue and earnings. Note that from a historical perspective, valuation is still high relative to the average, so if earnings were to disappoint, reversion to mean is very likely.

Summary

In conclusion, CHD presents an intriguing short-term investment opportunity given my positive outlook for the near-term. Recent results and upgrades have bolstered confidence in the company's performance. Strong 2Q23 earnings were driven by robust organic sales growth and improved margins, even amidst increased marketing expenses. While management's guidance suggests a deceleration in the latter half of the year, potential factors like continued marketing investments and promising product portfolios may lead to better-than-expected results in 2H23. The stock's short-term upside potential lies in the possibility of management exceeding their guidance, potentially pushing the valuation back to previous highs of 30x forward PE. This scenario could result in a 15% upside, with a target share price of $110.

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