2023-05-22 03:12:46 ET
Summary
- The current valuation at near 30x forward PE has already factored in the anticipated growth and earnings expectations.
- CHD has shown promising signs of improvement, including the stabilization of struggling brands and growth in its domestic household business.
- The ramp-up in marketing spend should support accelerating growth in the short-to-mid-term.
Investment thesis
Church & Dwight ( CHD ) is a business with decades of experience in its building up portfolio brands, conducting value accretive acquisitions, etc. My previous view on the company was that FY22 was a tough year but it is going to emerge stronger in the next upcycle. I believe the upcycle is now coming to play in FY23 after looking at the 1Q23 results.
CHD's numbers were more encouraging than expected. Despite continuing organic sales declines in its domestic personal care business, I was heartened to learn that the company's struggling Waterpik and Vitafusion brands have leveled off. As these two brands compare to a poor FY22, they should begin to show increased growth. At the same time, its domestic household business grew by the mid-teens, and I expect this trend, bolstered by its pricing and marketing strategies, to continue. On top of that, management effectively increased their FY23 guidance for organic sales growth to a range of 3% to 4%, which is an improvement from the 2% to 4% range previously provided and the 6-7% growth in reported sales. As things look to be improving in 2H23, I think CHD has a good chance of exceeding its own guidance. Sales momentum has increased, and spot prices of key inputs costs have decreased since the previous quarter.
As a whole, I think the company has turned a corner, and I anticipate a continued beat-and-raise cycle throughout the year as management restores its credibility following a year of disappointing earnings forecast revisions. However, I am changing my rating to a hold as I think this equity story is already fully priced into the valuation multiple of 30x forward PE.
Volume to improve in 2H
While volume remained flat, CHD's effective pricing grew by 5.7% in 1Q23, helping the company achieve organic sales growth that surpassed its own guidance of 1% growth. When broken down by segment, it's clear that growth in organic sales was led by Consumer International (11.6%) and Consumer Domestic (5.5%). Some of CHD's most important brands-including Therabreath, Hero, A&H litter - are driving this growth, and even some of the company's weaker performers, like Waterpik and Vitamins, are showing encouraging signs of recovery. Fill rates of 93%, up 300 bps from the previous quarter, also contributed to the increase in revenue.
While 1Q23 growth was impressive, it was driven primarily by price increases, and CHD expects price increases to slow in 2H23 as the company laps pricing action from the base period. In my opinion, this indicates that 2H23 volume will improve, as management has increased its guidance range despite pricing benefit to taper. In addition, I'd like to point out that this 2H23 volume growth will come on top of a weak 2Q23 volume (management commented it is going to be negative), so growth will be accelerating on a sequential basis.
I anticipate this upward trend to continue as CHD increases its marketing spending, bringing it back to pre-covid levels as a percentage of revenue. Management has mentioned they can now take a longer-term view and increase marketing from 10.5% to higher in the earnings call. In my opinion, CHD was hamstrung in its ability to invest in the market by a combination of supply chain problems and case fill problems over the past two years. CHD can now unleash their previously restrained marketing machine, driving growth, as they are no longer restricted by those issues. Within the next year to two years, I anticipate a return to an 11% marketing spend as a percentage of revenue, which should lead to an acceleration of growth in the near and medium term, followed by growth that is more in line with historical norms.
Valuation
I believe the current valuation of near 30x forward PE has fully factored in the upcoming growth momentum as well as earnings expectations (unlike the previous time when I was writing about it, the stock was trading near its average). To put this in context, the market is effectively pricing CHD at 26x FY25 consensus $3.67 EPS, which is the average multiple at which CHD previously traded.
Now, I believe the business fundamentals are improving, and the outlook is unquestionably optimistic. However, I believe that a hard landing (deep recession) could negatively impact the business outlook, and that the current high multiple also poses a risk of sharp re-rating downwards (i.e. plenty of room to fall). A mean reversion today would result in a 14% drop in value.
Conclusion
The current valuation of CHD already reflects the expected growth and earnings. While the company has shown promising signs of improvement, including stabilizing struggling brands and growing its domestic household business, the market has priced in this positive outlook. The high valuation poses a risk of a sharp re-rating downwards, especially in the event of a deep recession. While the business fundamentals are improving and the outlook is optimistic, I recommend a hold rating to wait for a better buying opportunity.
For further details see:
Church & Dwight: Valuation Has Already Priced In The Upcoming Growth Momentum (Rating Downgrade)