Description

Here’s another 160-year old company that was never written up on VIC and fits right into a long-short portfolio: Church and Dwight.

CHD’s historic performance is amazing and attributable to both the fact that they own Arm & Hammer and superior management (management of Arm & hammer and value that has been added in many other ways over the years). This write-up is going to be quite short because the stock speaks for itself to a significant degree. Looking at the stock price over the past 20 years, there is clear outperformance of PG and even CL. The 2008 downturn is barely visible on their chart. Total return over the past 10 years has been 19% and I don’t see any reason why it wouldn’t continue to compound faster than the index.

Overview

CHD makes household products, personal care products and a few non-consumer specialty items. The top-line mix is roughly 45% domestic household, 25% domestic personal care, 20% international and 10% specialty.

The Company has 8 “power brands” which generate 80% of profits plus dozens of other brands that are not recognized widely but loved by certain market segments. The biggest of the 8 is Arm & Hammer (the baking soda, products containing the baking soda such as carpet deodorant, and products that are branded Arm & Hammer but contain no baking soda – this is new). The 7 others: Trojan condoms, XTRA laundry detergent, Oxiclean pre-wash laundry additive, NAIR depilatories, First Response home pregnancy and ovulation test kits, Orajel oral analgesics and Spinbrush battery-operated toothbrushes.

The company is #1 in almost each of its power brands. It has acquired many of them and added value post-acquisition, and not just with synergies but in cost management as well as on the creative side, new products etc. Organic sales in the recent past have been up 4%. Over the past 10 years they’ve been the only company of size in their industry with double digit EPS growth. EPS has increased 467% from $0.39 to $2.21.

Management

The company’s management is solid, conservative, opportunistic, long-term oriented and straight-shooters. In a recent presentation, CEO Jim Craigie said: “I have to give you the safe harbor statement which basically says that if you believe what I say and you buy the stock that’s your problem”.

Craigie describes himself as a long-term pessimist on the macro-economy. Out of their “top 10 initiatives”, #1 is to build a recession-resistant portfolio. Their current portfolio is exceptionally well-balanced at 60% premium brands and 40% value brands and this should allow continued success in all economic environments. People are already moving down to the value tier, which has taken over the mid-price tier, and that’s a positive for CHD. In the recent presentation Craigie pretty much wished for a recession to lower asking prices for companies who want to get acquired. It seems they are very in tune with economic issues.

The company has a very lean cost structure as overhead and gross margins are both managed aggressively. CHD has the highest revenue per employee in the CPG industry.

Tenures in important functional areas are very long and encouraged. Management bonuses are tied directly to 4 factors: net sales growth, gross margin expansion, earnings per share growth, and generation of free cash flow.

Product Portfolio and Growth

It’s worth making a few observations about what they sell now and where they might be going.

Arm and Hammer always has new products (e.g. laundry detergent, cat litter...). That brand name is found on more aisles in the grocery store than any other brand name. It has also been stamped on many products that have no actual baking soda content - like the Spinbrush.

Execution is very strong. A good example of execution is Oxiclean which is #1 in its category. Oxiclean grew its share from 27% in 2006 to 38% in 2009. P&G entered the market but Oxiclean still came out on top despite CHD’s smaller marketing budget. Market share is now even greater.

CHD is an acquisitive company and prefers to spend money on prudent acquisitions of businesses they can improve, as opposed to doing buybacks and increasing dividends (although they’ve done these too). They consistently grown the market share of companies they acquire. After having searched for years for a substantial acquisition, CHD recently found Avid, makers of vitamin supplements delivered in ‘gummy’ form rather than capsules (ideal for children). Here too, CHD seeks to capture a dominant share.

Avid is already the leader, anyhow, in both adult and children gummy vitamins. They have has a cost and taste advantage because they manufacture themselves vs. competitors who outsource. Avid has grown at 25% CAGR over the past 3 years. Current revenue is $250mm and CHD paid $650mm. The adult supplement market is much bigger than the kids market ($3B vs. $0.2B) but of course, not s many adults will switch to gummy bears the way kids are. Among kids, 58% are already taking the gummy form. Still, adult conversion to gummy is continuing to occur rapidly and CHD believes it will top off at a point far away from today’s negligible 3%. Also, internationally the product is barely sold and that’s a huge opportunity.

Finally, in a general way, CHD has a tremendous amount of international expansion ahead of it. In 2001 only 2% of sales were international and that’s now 20%. Those sales are mainly personal care, not much household. And not many countries either:France, the UK, Mexico, Australia and Brazil account for 90%. So the company’s full line of products, in time, should be discovered by a much greater portion of the developed world (not to mention emerging markets).

Valuation

This is no special situation, just a company that will perform better than the average, especially when the global recession is apparent tothe market.

Currently the stock trades at 23x 2012 EPS & 19x 2013E EPS. This compares to 21x & 18x for CL and 19x & 16x for PG. Extrapolating their outperformance a couple of years out would eliminate that small premium, at which point an apples-to-apples comparison would set the stock up to further outperform vs. those two peers. When comparing to the market as a whole, CHD is growing faster and is more recession-resistant, so outperformance should continue. The only thing that would make this a bad choice is if CHD is either overhyped or subject to lots of operational or financial leverage that would hurt in a recession. None of these conditions are satisfied.

Catalyst