Contents
Summary
- CHD released Q3 and YTD2019 results and provided Fy2019 guidance on October 31st.
- CHD continues generate strong Free Cash Flow and has an exemplary cash conversion cycle.
- Moody’s upgraded CHD’s long-term debt credit rating in early October.
- CHD’s sees long-term growth potential in the Asia Pacific region where sales only amount to ~$50 million yet is an increase from ~$10 million just a few years ago.
- CHD is currently one of my Top 10 holdings and I have just acquired additional shares.
Introduction
In my February 5, 2019 Church & Dwight Co., Inc. (CHD) article I concluded that:
‘Now that CHD has been ‘punted to the curb’ following the release of its Q4 and FY2018 results and FY2019 guidance I am of the opinion that it is reasonably valued (not attractively valued). I have, therefore, acquired additional shares @ $60.4692/share on February 5, 2019; all shares are held in one of our retirement accounts for which I do not disclose details other than to say that CHD is one of my largest holdings.’
A quick look at CHD’s stock chart and we can see that CHD’s share price subsequently rose to ~$80 in August. I could not justify acquiring additional shares at that level but we see from CHD’s stock chart that the share price has retraced to the upper $60s.
Let’s have a look at whether CHD’s valuation and outlook warrants the purchase of shares.
Q3 2019 Results
Q3 2019 results can be accessed here. While there is no accompanying Investor Presentation I draw your attention to CHD’s September 3, 2019 presentation from Barclays Global Consumer Staples Conference.
In Q3, CHD generated $0.66 in adjusted EPS compared to $0.58 in 2018; the outlook called for $0.60/share. The $0.06/share beat is attributed to a favorable ruling on the appeal of Tier two tariffs which contributed $0.03/share. The remainder was $0.02 from business performance and $0.01 of marketing timing.
On the gross margin front, Q3 gross margin of 46.6% was a 230 basis points (bps) increase from a year ago. It is also 100 bps better than CHD’s outlook and this is due to the tariff exception benefit. The full year net impact on gross margin related to tariffs in 2019, however, is neutral.
FY2019 Guidance
Adjusted EPS of $0.54 is expected in Q4 as a result of planned investments and a higher tax rate.
Organic sales growth of ~4% is projected and reported sales growth of ~5%, previously 6%, is expected partially due to the FLAWLESS integration starting November 1 versus October 1 as well as foreign currency headwinds.
Management now expects full year gross margin to expand 100 bps or 60 basis points excluding the FLAWLESS acquisition accounting.
FY2019’s adjusted operating margin is expected to increase 50 bps and FY2019 adjusted EPS of $2.47, 9% growth, is expected.
As a result of strong YTD results and tariff relief, CHD intends to make incremental investments in Q4. It anticipates significantly higher marketing spending and investments as it accelerates ~$10 million of spending in R&D, predictive analytics, supply chain, and sustainability.
CHD also intends to accelerate $4 million of investments in its long-term Asia Pacific relationships; this area of CHD’s business was less than $10 million just a few years ago and now it is approaching $50 million. Although this amount is negligible when compare to company-wide YTD revenue of $3.213B, management sees long-term growth potential in the Asia Pacific region. In fact, CHD’s long-term organic growth target for international is 6% although this area of business has averaged 8% organic growth from 2015 - 2018 and 2019 is on track to be another exceptional year.
Free Cash Flow
CHD continues to consistently generate strong Free Cash Flow. This consistency provides CHD with the ability to acquire additional brands, reduce debt, develop new products, make capital expenditures for growth purposes, and/or increase dividends or repurchase shares.
Source: CHD – Barclays Global Consumer Staples Conference Presentation – September 3, 2019
CHD also continues to tightly manage its cash conversion cycle.
Source: CHD – Barclays Global Consumer Staples Conference Presentation – September 3, 2019
Credit Ratings
In early October, Moody’s upgraded CHD’s long-term debt one notch to A3 (lowest tier upper medium grade) from Baa1 (top tier lower medium grade). Standard & Poor’s continues to assign a BBB+ rating to CHD; this is one notch lower than Moody’s rating.
CHD’s grew in recent years due to the company's expansion via acquisition with Total Bank Debt/EBITDA peaking at 2.6X in FY2017. Management’s expectation is that this metric will be below 2.0X by the end of FY2019.
Source: CHD – Barclays Global Consumer Staples Conference Presentation – September 3, 2019
Dividend, Dividend Yield, and Dividend Payout Ratio
CHD has paid a dividend for 188 consecutive years although the entire dividend history found here does not go back that far in time.
With shares currently trading at ~$68.25, the $0.2275/share quarterly dividend ($0.91/share annually) provides a yield of ~1.33%. This dividend, however, is covered by profits generated from normal business operations.
In FY2018, CHD generated EPS of $2.27 and its dividend amounted to $0.87. That ~38.3% dividend payout ratio is just a shade lower than the FY2012 – FY2017 levels.
In the first 9 months of the current fiscal year, CHD has generated $1.87 in diluted EPS and it has paid out $0.68/share in dividends. For the comparable period in FY2018, CHD generated $1.70 in diluted EPS and it distributed $0.65 in dividends.
Let’s suppose:
- CHD conservatively ends up generating ~$2.40 - ~$2.45 in diluted EPS for the current fiscal year;
- Announces at the beginning of February 2020 a ~5% dividend increase in to $0.2390/quarter or $0.956/year.
The annual $0.956 dividend would be ~39% - 39.8% of the projected diluted EPS in FY2019. I certainly view this as adequate coverage.
As an aside, some investors have adopted a strategy in which attractive dividend yielding stocks are their sole/primary stocks of interest. In many cases, I highly suspect many of these investors do not fully comprehend the risks associated with this strategy. In my opinion, investors would be wise to question the sustainability of a lofty dividend yield in this current low interest rate environment.
In my November 1, 2018 article I indicated that in fiscal 2011, the weighted average shares outstanding (Basic and Diluted) amounted to 286.4 million and 291.6 million, respectively. In fiscal 2017, these figures were 250.6 million and 256.1 million. At the end of FY2018...245.5 million and 250.7 million.
We see a slight uptick as at September 30, 2019 to 246.4 million and 252.5 million. If history is any indication, I expect the average shares outstanding (Basic and Diluted) at the end of the current fiscal year to be lower than FYE2018.
Valuation
At the time of my February 7, 2018 CHD article I had just acquired another 200 CHD shares on February 6th at $48.0799 and CHD’s management had just forecast 2018 adjusted EPS of $2.24 - $2.28. Using this range and the stock price of ~$48, I arrived at a forward adjusted PE range of ~21 - ~21.4.
When I wrote my May 8, 2018 article, management still had the same adjusted EPS outlook and CHD was trading at $47.73. As a result, there was negligible difference in valuation between February and May.
After the Q3 earnings release, CHD’s stock price jumped to $64.87; there was a $5.50/share jump on the date of the release of Q3 results! In my opinion, that jump was overdone.
At the time of that November 1, 2018 article, the EPS and adjusted EPS outlook for FY2018 was $2.27 (a decline of 22% due to 2017 tax law changes and adjusted EPS growth of 17%). That meant CHD’s forward PE and forward adjusted PE was ~28.6 which was much higher than that I reported in my February and May articles.
When I wrote my February 2019 article, CHD had just released Q4 and FY2018 results and FY2019 guidance. With the drop in CHD’s share price to $60.46 I arrived at a valuation of ~26.6 based on $2.27 EPS; the forward valuation amounted to ~24.48 - ~24.9 based on $2.43 - $2.47 guidance.
CHD is now trading at ~$68.25 and guidance calls for $2.47 in adjusted diluted EPS giving us a forward adjusted diluted PE of ~27.6. If we use my conservative ~$2.40 - ~$2.45 in diluted EPS for the current fiscal year, then the forward diluted PE range is ~27.9 - ~28.4. This range is certainly not low but very, very rarely does CHD’s valuation drop to the low 20s or below.
Final Thoughts
I have been a CHD shareholder since early 2005 and have benefited from management’s ability to create long-term shareholder wealth. The significant appreciation in CHD’s share price over the years has resulted in CHD now being one of my Top 10 largest holdings.
Despite the recent drop in CHD’s share price, CHD is still not on ‘sale’. In addition, the low dividend yield will prompt many investors to overlook CHD as a potential investment. I, however, am approaching my CHD investment from a long-term perspective and I acquired additional shares on November 1st for an account in which I do not disclose details.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long CHD.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
