EUR 850.00 For Business Accounts Only

Morningstar | Despite Runup in 3Q Sales, Church & Dwight's Valuation Strikes Us as Quite Heated

Even after accounting for no-moat Church & Dwight’s continued favorable sales trajectory in the third quarter (up 4.7% on an organic basis and 5.4% in the global consumer arm, which included a 1.7% benefit from increased price and favorable mix), results through the first nine months of the year, as well as the firm’s full-year expectations, continue to align with our forecast for 9.2% sales growth and $2.28 in EPS. As such, we don't expect to alter our $44 fair value estimate outside of a modest bump from the time value of money, which will probably add $0.50-$1. After a high-single-digit pop, the shares now trade at almost 30 times on a fiscal 2018 price/earnings basis and around a 45% premium to our valuation, which we view as lofty. For investors looking for a presence in the household and personal-care arena, we’d suggest wide-moat Procter & Gamble and Colgate, which each trade around a 10%-15% discount.

Although top-line gains persisted, we still question the sustainability of this performance, particularly in the face of intense competitive and commodity cost pressures, which we believe could impede the firm’s progress especially as it opts to raise prices to offset these inflationary headwinds. These pressures took a toll on gross margins to the tune of 220 basis points in the quarter and were only partially offset by productivity savings, resulting in a 100-basis-point downdraft in gross margins to 44.3%. Despite the potential benefit to profits, the firm could incur volume erosion as consumers opt to trade down or out within the categories in which it plays, issues that are probably compounded by its lack of a competitive edge as it goes head to head with peers that maintain significantly more resources. As a result, we anticipate that over the longer term, Church & Dwight's sales will be driven almost entirely by increased volume and may be prompted by increased promotional spending.

While the firm’s business is anchored on its home turf, which drives 85%-90% of total sales, management has selectively looked to build out its presence abroad, most recently announcing a partnership with Shanghai Jahwa, a leading consumer packaged goods manufacturer in China. No financial details were disclosed, but Church & Dwight anticipates this deal should help it carve out a space in this attractive market (from which we estimate it presently derives just a low-single-digit percentage of sales), with an emphasis on the baking soda, toothpaste, dry shampoo, and feminine hygiene categories. This deal is too small to move the needle on our outlook for the consolidated operations, but we believe the strategic implications could be favorable over a much longer horizon, facilitating a better understanding of local consumer preferences and supporting our mid-single-digit annual sales growth forecast for the international operations longer term.