Church & Dwight: Declining Pricing Benefits and Valuation Concerns (NYSE:CHD)

Investment thesis

Church & Dwight Limited (New York Stock Exchange:CHD) Should continue to see revenue growth benefiting from increased promotional spend, distribution gains of recent high-growth acquisitions Hero and TheraBreath in international markets, and strategic M&A. However, organic Sales growth should moderate as pricing benefits dissipate as CHD prices rise from last year. While the company’s margins should benefit from leverage, productivity improvements, and moderate inflation, diminishing pricing benefits and increased promotional spending should act as headwinds. With the stock already trading at a slight premium to its historical P/E, I don’t see much upside from current levels. Therefore, I have a Neutral rating on CHD stock.

Church & Dwight’s revenue analysis and forecast

In my previous article last year, I discussed the company’s good growth prospects and benefits Increase prices, ease comparisons, and increase fill rates. The company has recorded good growth since then. Last month, CHD reported its Q1 FY2024 earnings, and similar dynamics were seen.

In Q1FY2024, the company saw good volume growth, and the carryover effect of previous price increases also helped revenue growth. This helped the company offset headwinds from the divestment of MEGALAC, part of the animal nutrition business within the Specialty Products segment, as well as the underperforming dental floss and gummy vitamins categories due to lower consumption.

The company’s total sales increased 5.1% year over year to $1.5 billion. Excluding a 0.3 percentage point benefit from favorable foreign exchange and a 0.4 percentage point headwind from liquidation, organic sales increased 5.2% year over year. Organic sales growth reflects a 3.7 percentage point benefit from volume growth and a 1.5 percentage point benefit from favorable price/mix.

On a segment basis, the Domestic Consumer segment achieved revenue growth of 4.3% YoY on a reported and organic basis, benefiting from price increases and volume growth due to market share gains and healthy demand. The international consumer segment also benefited from higher prices and volume growth driven by market share gains due to continued expansion in international markets. This resulted in year-on-year sales growth of 10.6% YoY and 8.8% YoY organically. Finally, the Specialty Products segment achieved sales growth of 1% year-over-year on a reported basis, and excluding headwinds from the divestment of MEGALAC, organic sales grew 7.2% year-over-year due to price increases and volume growth driven by improved demand. And corporate relief.

Looking ahead, I expect the company to continue to grow in the coming quarters. Management is looking to increase promotional spending in the coming quarters, which should help sales. For FY24, management is targeting a marketing spend of approximately 11% of sales, which is higher than the 10.9% for FY23. However, it is still 70 to 80 basis points below pre-Covid levels. As inflationary headwinds fade and gross margins return to normal levels, I expect a portion of the increased gross profit will be invested back into marketing, and marketing spend returning to pre-Covid levels should help sales grow.

The company has seen good volume growth in recent quarters, which should continue going forward as well. The company is benefiting from expansion in distribution as a result of the recent acquisitions of TheraBreath and Hero, which should continue to support growth, especially internationally over the next two years. The company has a strategy of acquiring smaller, high-growth brands and then leveraging its existing network both nationally and internationally to increase their distribution. With the company’s net debt to TTM EBITDA currently around 1.6x, I think more such mergers and acquisitions are likely going forward, which should help the company’s sales grow.

But the downside is that the pricing advantage the company has seen in recent years won’t be a meaningful contributor to the company moving forward. The company should implement the majority of the price increases it implemented in response to post-coronavirus inflationary conditions in the second quarter of 2024, and the contribution of price growth to the top line should be minimal going forward. Therefore, while organic revenue growth should remain positive supported by volume growth, the pace of growth should slow in the coming quarters as the benefit from pricing contribution diminishes.

Church & Dwight margin analysis and forecasts

In the first quarter of fiscal 2024, the company’s margins benefited from the carryover effect of price increases and favorable mix, which collectively provided a benefit of 130 basis points year over year. Another 130 bps y/y benefited from productivity gains, and 80 bps y/y benefited from lower transportation costs due to moderate inflation compared to the previous year quarter, also supporting margins. This helped the company offset headwinds of 110 basis points year-over-year due to higher manufacturing costs and 10 basis points year-over-year due to unfavorable foreign exchange rates. As a result, gross margin increased by 220 basis points year-on-year to 45.7%.

However, adjusted operating margin decreased 10 basis points year-over-year to 20.8% as benefits from the increase in gross margin were offset by higher SG&A and marketing expenses as a percentage of sales compared to the prior-year quarter.

Looking ahead, the company’s margin growth should continue to benefit from productivity gains and moderating inflation. However, the benefit of the pricing carryover effect that the company saw through Q4 will no longer exist as it will cover most of the price increases in Q2 2024. Therefore, the extent of gross margin improvement should decline going forward. Moreover, management plans to increase promotional spending in the future. Therefore, this should negatively impact operating margin.

Evaluation and conclusion

Church & Dwight is currently trading at a consensus estimate of 31.16 times fiscal 2024 EPS of $3.46, which represents a slight premium versus its 5-year average forward P/E of 29.26 times.

Although I am optimistic that the company can continue to deliver revenue growth benefiting from increased marketing spending, international distribution gains, and mergers and acquisitions, the pace of organic growth should slow in the coming quarters as pricing benefits decline. Also, while margins should continue to benefit from improved productivity and increased volume, diminishing pricing benefits and increased promotional spending should offset them to a good extent.

With stocks trading at a modest premium to their historical averages and the pace of organic growth expected to slow, I don’t see much potential upside from these levels. It is difficult to justify valuing premiums compared to historical averages when organic growth is expected to slow. Even if we look at the FY25 consensus EPS estimate of $3.75 and apply the 5-year average P/E (FWD) of 29.26 times, we get a price target of $109.73, which doesn’t mean much upside. about current levels. I believe the company’s growth prospects are already priced in at the current valuation. Hence, I prefer to wait on the sidelines and rate the stock as Neutral for now.