EUR 850.00 For Business Accounts Only

Morningstar | Church & Dwight Milks Sales and Profit Gains in 1Q but Headwinds Loom; Shares Rich

Church & Dwight posted a solid start to the year. Organic sales grew 4.5% (marking the third consecutive quarter of mid-single-digit underlying gains), gross margin edged up 20 basis points to 45.1%, and operating margin improved 120 basis points to 23.1%. However, we’re skeptical this performance will prove sustainable, in light of the intensely competitive landscape, which includes peers that maintain significantly more resources and ultimately are more entrenched in retailer supply chains.

As such, we don’t anticipate altering our $46.50 fair value estimate (beyond a low-single-digit bump to account for additional cash generated since our last update) or long-term forecast (calling for 3% organic sales growth over the next 10 years and operating margins remaining in the low-20s). However, we view shares as lofty, trading at a more than 50% premium to our valuation and 30 times on 2019 price/earnings (versus the high-teens implied by our forecast); we’d suggest investors refrain from building a position in this no-moat name.

Although management seemed quite optimistic that the recent pullback in promotional spending in a handful of categories in which it plays (including laundry and cat litter) would persist, we have our doubts. For one, this sentiment runs in direct contrast to that expressed by wide-moat Clorox recently, suggesting an increased level of promotions in a few of its household categories weighed on its volumes and share (and appears to have become more challenging just over the past few months). We posit that if input inflation begins to abate over the course of the next few quarters, the competitive environment may not remain sanguine (as manufacturers opt to sacrifice a bit of profits to gain share). Further, because firms across the space have raised prices to offset commodity headwinds, we believe consumers could ultimately balk (particularly in categories where Church plays) by reducing their consumption, trade down, and/or trading out.

Further, we don’t believe the degree of margin gains Church chalked up in the quarter reflects an underlying improvement in its fundamentals. Rather, a portion of the operating margin gain was realized as the firm ratcheted back its marketing spend in the quarter (down 50 basis points to 9.4% of sales). While this doesn’t appear to have had an impact on its sales or retail relationships in the quarter, we posit that over a longer horizon this more muted level of spend could not only detract from its efforts to sustain its top-line trajectory (as even value-added innovation can fail if consumers don’t know about such offerings) but could jeopardize its retail relationships (particularly in an environment where retailers are favoring manufacturing partners that aid in their efforts to elevate traffic trends). As such, we believe that in the face of heightened competition, Church & Dwight will need to spend behind its brands to withstand competitive angst. We model that Church will allocate around 12% of sales toward marketing each year over the next decade (in line with the level spent on average annually since fiscal 2014).