2023-05-03 21:15:35 ET
Summary
- CHD's revenue should benefit from price increases, volume recovery due to improving fill rates and good demand for the company's value-priced products.
- Margin should also benefit from price increases along with moderating inflation and volume leverage.
- Valuation is above historical averages.
Investment Thesis
Church & Dwight’s ( CHD ) revenue is expected to benefit from price increases, volume recovery, and good demand for its value-priced products in an inflationary environment. Additionally, the company’s margin is expected to benefit from favorable price/mix impact, volume leverage, and moderating inflation. As a result, I am optimistic about the company's growth prospects. However, CHD stock price has seen a good run up post my last bullish article and is trading at a premium to historical valuation. I believe the current higher-than-historical valuation already reflects these growth prospects. Therefore, I am moving to a neutral rating.
Q1FY23 Earnings
Church & Dwight reported better-than-expected results for the first quarter of 2023 last week. The company's revenue increased by 5.7% organically or by 10.2% YoY on a reported basis to $1.42 billion, exceeding the consensus estimate of $1.35 billion. Adjusted EPS grew by 2.4% YoY to $0.85, surpassing the consensus EPS estimate of $0.77. The gross margin also increased by 90 bps YoY to 43.5%. The revenue growth was driven by price increases and strong demand for the company’s value-priced products. Adjusted EPS and margin growth were due to price increases, improved productivity, and cost savings.
Revenue Analysis and Outlook
In my previous coverage of CHD in December, I gave a bullish rating to the company given the good end-market demand for 80% of its product portfolio, which offset the softness in the remaining 20%. Since then, the stock price has increased by more than 20%.
In Q1 FY23, the good demand momentum in 80% of the product portfolio (household products and some personal care categories) continued to support sales growth. Furthermore, the recent acquisition of the Hero brand in Oct'22 also contributed to the top line. Organically, the company benefited from price increases over the last year and improved fill rates, leading to increased shipments, resulting in a 10.2% YoY increase in sales to $1.42 billion. Acquisitions contributed to a 5.2 percentage point benefit to the top line, while FX was a 0.7 percentage point headwind. Excluding acquisitions and FX, net sales increased 5.7% YoY organically, reflecting a 5.7 percentage point benefit from pricing and a flat volume.
CHD’s Historical Revenue (Company Data, GS Analytics Research)
Looking ahead, I believe Church & Dwight will continue to deliver sales growth, driven by price increases, improving volume growth and strong demand in most of the portfolio.
Over the past year, Church & Dwight has responded to inflationary pressure by increasing prices across its portfolio, which has helped to drive organic sales growth. The company implemented additional price increases at the beginning of February and towards the end of March. I expect the impact of these increases, combined with the carryover impact of price increases from late last year, to support sales growth in the coming quarters.
Furthermore, Church & Dwight's sales growth will benefit from volume recovery. In recent quarters, the company has been able to sequentially recover volume levels, as seen in the chart below, due to an improvement in fill rates. Since the beginning of 2022, the company has faced supply chain constraints, leading to input and labor unavailability, plant shutdowns, and lower fill rates, which negatively impacted volume and caused market share loss.
CHD’s Historical Organic Sales Analysis (Company Data, GS Analytics Research)
As 2022, progressed, and supply chain constraints gradually eased, the company was able to improve the production process to meet the end-market demand. CHD’s fill rates increased to 93% in Q1 2023 from 72% in Q1 2022. The company is expecting production to accelerate further and fill rates to reach 97% to 98% towards the back half of the year. This should help in further volume recovery and market share gains. As a result, I expect volume to turn positive in the 2H23. This along with price increases should help sales growth.
Additionally, CHD's 80% of the product portfolio, including laundry, cat litter, dry shampoo, acne treatment, and oral hygiene products, is experiencing good demand due to low private-label exposure and diversified price points. The company's value products are gaining market share as price-sensitive consumers trade down to affordable options. This is resulting in market share gain for the company’s brands.
For example, the Arm & Hammer liquid laundry detergent (having value products at lower price points) grew consumption by 9.3% Y/Y while the overall liquid laundry category grew by 3.6% Y/Y in Q1, leading to an 80 bps market share gain for Arm & Hammer liquid laundry detergent. So, I believe the company should gain market share through its value products as consumers continue to trade down in an inflationary environment. This good demand for value products in 80% of the product portfolio should continue to offset the softness in the remaining 20% of the product portfolio comprising the discretionary brands (Waterprik, Flawless, and VitaFusion) due to lower consumer spending. So, I am optimistic about the company’s growth prospects despite challenging macros.
Margin Analysis and Outlook
In Q1 2023, the company was able to achieve year-over-year margin growth in addition to sequential improvement, as price increases and productivity savings fully offset inflationary costs. Price/mix provided a 160 bps benefit for margins, while acquisitions and productivity contributed 120 bps and 160 bps, respectively. These tailwinds more than offset the 300 bps headwind from higher manufacturing and raw material costs, resulting in a 90 bps YoY increase in gross margin to 43.5%.
CHD’s Historical Gross Profit Margin (Company Data, GS Analytics Research)
Looking ahead, I anticipate CHD should achieve margin expansion as it benefits from the carryover impact of last year's pricing, along with recent price increases. Management expects price/mix to be an average 160 bps benefit in the first half of the year, with an average benefit of 180-190 bps in the second half. As a result, CHD should see a full-year price/mix benefit of approximately 180 bps, more than offsetting the expected $125 million in inflationary costs in 2023. Furthermore, gross margin should also benefit from volume leverage as volume turns positive in the second half of the year. CHD is also anticipating less inflation in the latter half of the year due to moderating transportation and resins and ethylene costs, which should support margin expansion.
Valuation and Conclusion
CHD is currently trading at a 31.21x FY23 consensus EPS estimate of $3.11 and a 28.77x FY24 consensus EPS estimate of $3.37, which represents a premium compared to its historical 5-year average forward P/E of 28.40x. I believe that, following the recent outperformance, the stock price has already factored in the good revenue and margin growth prospects. The current valuation no longer provides an attractive entry point. Therefore, while I remain optimistic about the growth prospects ahead, I am downgrading my rating to neutral for now and would prefer to wait for a better entry point in the stock before turning positive again.
For further details see:
Church & Dwight: Moving To The Sidelines Post Recent Outperformance