Church & Dwight Q4: Reiterate Buy Rating As Growth Outlook Remains Bright (NYSE:CHD)

Overview

My recommendation for Church & Dwight (NYSE:CHD) is a buy rating, as I believe CHD is able to grow at the high end of its FY24 guide and see momentum follow through for the coming years given the strong innovation slate, increase in marketing spend, and contribution from Hero and TheraBreath. Note that I previously rated the buy rating for CHD as I liked the near-term setup for CHD given that it beat consensus estimates and raised FY23 estimates. I expected a 15% return over the next 2 quarters previously, with a target price of $109, and the share price did touch $103 at its peak (last week).

Recent results & updates

CHD FY23 revenue performance tracked pretty well against my estimates, growing 9.2% vs. my expectation of 10%. The 9.2% growth was mostly driven by pricing growth of ~4.5%, volume growth of 1%, and M&A of ~4%. That said, earnings came in weaker than I had expected. FY23 saw $786 million in earnings vs. my expectation of $887 million. As for 4Q23, organic sales saw growth of 5.3%, where consumer domestic organic sales grew 5.7%, international organic sales saw 9% growth, and specialty products organic sales declined by 9.2%. EPS came in at $0.65. Looking ahead, management guided FY24 net sales growth of 4% to 5% (in line with its organic sales growth expectations). And at the bottom line, EPS is expected to grow 7% to 9%, or $3.42 at the midpoint. In terms of cadence, for 1Q24, management expects organic sales growth of 4% and adjusted EPS of $0.85 (vs. GS/FactSet consensus $0.97/$0.93).

While earnings performance was weaker than I expected, I am still positive about CHD, as I am optimistic that it will be able to meet its FY24 guidance, which is going to be a major catalyst to support CHD’s current premium valuation. For context, CHD top line guidance for 4 to 5% organic growth implies an acceleration of growth back to pre-covid levels (FY18: 4.3%, FY19: 4.4%). I believe the market has been worried about CHD’s growth strength because the 3-year average growth from FY20 to FY22 (which should smooth out the COVID impact) is only 3.5%, which implies a slowdown compared to pre-COVID levels. The debate here is that some investors might point out that the drivers for this 4 to 5% growth are not plausible. Specifically, management expects volume to contribute two-thirds to the top line growth ahead, which means volume growth of ~3%. The issue is that volume growth has not been spectacular over the past few quarters. FY21 saw 1% volume growth, FY22 saw -5% growth, and the first half of FY23 saw flattish volume growth as well. However, I am positive that the guided volume growth is achievable because of the upcoming innovations, focus on key brands (and more marketing dollars), and contributions from Hero and TheraBreath.

Firstly, on innovations, management especially noted that the new product pipeline is the best in his 17 years with CHD and that innovation will contribute to around 100 to 150 bps of organic sales growth contribution. I believe this is possible given how broad and incremental the 2024 innovation slate is. Some of the key innovations mentioned during the analyst day that I think are worth highlighting are:

1. Deep Clean Liquid and Deep Clean Unit Dose Laundry Detergent. This will help CHD to drive incremental sale as it penetrates the middle tier group
2. Power Sheets Laundry Detergent launch in the brick and mortar stores. High incremental sales are also likely for CHD given the product’s track record on Amazon (it became the #2 detergent sheet seller in just four weeks after launch and the #1 seller in the laundry category on Amazon Prime Day).
3. Hardball Clumping Litter will be launched nationwide (in early 2024) with the goal of capturing a larger portion of the lightweight litter category. In this regard, upper management has pointed out that CHD’s Arm & Hammer has a 29% share of traditional weight litter and a 25% share of total clumping litter, but only a 4% share of lightweight litter—a gap that represents a $100 million opportunity to close.

Secondly, I really like the refocus to just 7 core brands instead of the previous 14 given that the 7 core brands contribute around 70% of revenue and profits. These 7 brands include Arm & Hammer, Hero, TheraBreath, Vitafusion, Batiste, OxiClean, and Waterpik. The reason I am positive about this is because it indicates that more resources are going to be allocated to these brands. For instance, marketing dollars should see better ROI given that these are strong brands. This comes at a time when management has signaled their intention to step up marketing investment. This is huge because CHD has been underinvesting in marketing relative to the past, on marketing expenses as a percentage of sales, which could be a reason for the weak volume growth. Now that marketing expenses are going to ramp up with a focus on key brands, I expect organic sales growth to improve.

Lastly, Hero and TheraBreath were great acquisitions that should continue to drive growth, as there is still significant room for distribution growth. Importantly, these two brands have shown that they are meeting consumers’ needs, given the increase in penetration over the years. With CHD stepping up their marketing expenses and its track record of integrating acquired targets to drive growth, I believe these 2 brands will continue to contribute to the positive growth ahead.

Valuation and risk

According to my model, CHD is valued $114, representing a 15% increase. This target price is based on my growth forecast of 5% for the next 3 years, using management FY24 guidance as a base. I am modelling CHD to grow at the high end of the guide given the upcoming innovations, increase in marketing spend, and contributions from Hero and TheraBreath. Volumes should be muted in FY24 as management steps up on marketing spend, but as CHD growth improves, it should see operating leverage that drives CHD earnings margin back to historical levels. As I mentioned above, if CHD is able to grow 5% with margins improving, it should support the current valuation in the near-term because the market will start to price in the fact that CHD growth strength has not deteriorated vs pre-covid.

However, the risk with CHD is that the upcoming innovations slate might not do as well as I expected given consumers preferences can change anytime. Suppose demand fails to materialize and CHD stepped up on marketing spend, it will have a negative impact on earnings margin (low growth + high cost base = weak net margin).

Summary

In summary, I reiterate my buy rating for CHD given the positive growth outlook. I am optimistic about CHD’s ability to meet its FY24 guidance, signaling a return to pre-COVID growth levels. The focus on core brands, coupled with the upcoming innovations, positions CHD for improved organic sales growth. The acquisitions of Hero and TheraBreath should continue to contribute positive growth, leveraging further distribution opportunities.