AGB 2022.15 - Church & Dwight (CHD)

Steady Acquirer of Consumer Brands

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Church & Dwight

Church & Dwight is a leading consumer packaged goods (CPG) company with a focus on personal care and household goods. Founded in 1846, the company is best known for its baking soda brand, Arm & Hammer. Church & Dwight commands over 75% market share in this category and the brand generates over $1B in revenue per year including adjacent categories such as laundry detergent, kitty litter and oral care products. The company has leveraged the strength and cash flows of the Arm & Hammer brand to acquire 14 other power brands since 2001.

Power brands are #1 or #2 in their respective categories, asset-light and have the potential to outgrow the market. These power brands include: Trojan (acquired in 2001), Xtra (2001), First Response (2001), Nair (2001), Spinbrush (2005), OxiClean (2006), Orajel (2008), Batiste (2011), Vitafusion (2012), Waterpik (2017), Flawless (2019), Zicam (2020), TheraBreath (2021) and Hero (2022). Over 85% of the company’s revenues and earnings are from these 15 power brands. The company targets 2/3 of its power brands to outgrow their category every year, but that has been difficult with supply challenges over the past two years.

Church & Dwight views itself as an acquisition platform for consumer brands that need scale (manufacturing and purchasing) and distribution to get to the next phase of growth. The company helps these brands by leveraging its stronger relationships with retail channel partners to increase points of distribution and improve household penetration. With increased distribution, marketing also becomes more efficient.

The company competes with larger CPG companies like Procter & Gamble and Unilever. These companies generated 15x and 12x more annual revenues than Church & Dwight in their last fiscal year. While this is a relative disadvantage when it comes to negotiating with customers and suppliers, Church & Dwight’s size allows the company to execute this acquisition platform strategy effectively. Brands that are acquired will stand to benefit from Church & Dwight’s larger scale and distribution reach yet still move the needle for the company.

The company does need to be cautious of brands that are on the decline or won’t stand to benefit from increased distribution. Church & Dwight’s acquisitions have added $2.3B in goodwill and $3.4B in intangible assets to the balance sheet, not including the Hero acquisition which closed in October 2022. This is in comparison to the company’s $5.2B in revenues in 2021.

Church & Dwight’s U.S. segment represents 76% of revenues, international 17.5% and specialty products 6.5%. The largest geographies in the international segment are Europe (33% of international revenues), Canada (26%), Australia (8%) and Mexico (7%). The international segment has slightly lower gross margins vs. the U.S. consumer segment (average of 2.2% over the past 5 years) but much lower operating margins (10.5% differential). This is due to the scale efficiencies lost due to the much smaller size (4x smaller than U.S. consumer segment) and running a global operation vs. concentrating in a single country.

The specialty products division consists of a feed additive to dairy producing animals under the Arm & Hammer brand. This segment is much more volatile than the other segments and is highly correlated to dairy prices. Church & Dwight recently expanded this segment to include specialty chemicals and cleaners.

The company’s acquisition platform strategy has resulted in consistent organic and M&A related growth. Church & Dwight’s evergreen model is +3% organic growth (+2% from the U.S., +6% international and +5% from specialty products), +8% in EPS with +25bps of gross margin and +50bps of operating margin expansion. Over the past 10 years, Church & Dwight has performed better than its evergreen model, averaging +4.3% organic growth and +2.8% growth from M&A.

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Why is it a good business?

As of one of the leading CPG companies, Church & Dwight benefits from scale economies and its intangible assets. Scale allows the company to better negotiate with suppliers and customers. This is especially true for its acquired brands that come from a much smaller negotiating position. Admittedly, Church & Dwight doesn’t have the scale of the larger CPG companies like Procter & Gamble and Unilever, so it’s still difficult to gain an advantage in shelf space at many retail channel partners. Also, Walmart is Church & Dwight’s largest retail partner at 24% of revenues.

But as a mid-sized CPG company, Church & Dwight is much more nimble and is able to successfully run its acquisition platform strategy. The company has the highest revenue per employee across CPG companies, reaching $1M/employee in 2021. As mentioned before, due to the company’s size, Church and Dwight stands to benefit from acquiring new brands and the brands have much better reach into households and points of distribution. When the company acquired Avid, the maker of Vitafusion and L’il Critters gummy vitamins, points of distribution increased from the low 60%s to the low 70%s just in the first year.

The company also benefits from better working capital management with scale. Church & Dwight’s cash conversion cycle has dropped from 40 days in 2010 to 15 days in 2021. This would be even better without the two acquisitions of Flawless and Waterpik, which have much longer sales cycles than the remainder of the categories.

For intangible assets, most of the company’s brands have staying power and some have enough brand equity to expand into adjacent categories. Church & Dwight’s Arm & Hammer brand has been able to successfully expand into categories outside of baking soda like laundry, oral care, kitty litter and as a dairy feed additive.

Church & Dwight is also mindful of competing in categories with low private label exposure. As we saw with Hershey, low private label competition means better pricing and margins. Of the 18 categories that Church & Dwight competes in, only 5 have meaningful private label exposure. The 5 categories are pregnancy kits (~30%), baking soda (~25%), gummy vitamins (~15%), oral pain relief (~20%) and kitty litter (~15%). The weighted average private label exposure for the company is around 12%. Interestingly, for baking soda, the Arm & Hammer brand commands 75% of the category and the remainder is private label, with no other meaningful branded competitor.

And lastly, the company has benefited from increasing its eCommerce exposure over the past 6 years. This channel represented 2% of revenues in 2016 and moved higher to 16% in 2022. Most of the eCommerce activity is selling through platforms such as Amazon, Chewy and others. During the pandemic lockdowns, having online options for certain brands like Flawless and Waterpik helped since some of their key points of distribution were closed down (hair salons for Flawless and dental offices for Waterpik). Margins are similar for online vs. offline sales but that is partially due to the current higher mix of personal care products vs. household goods online, which tends to have higher margins.

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Returns on incremental capital?

Over the past 10 years, Church & Dwight has spent 13% of its capital on capex, 14% on R&D and 73% on M&A. Capex spend is mostly related to the company’s manufacturing plants and distribution processes. Capex as a % of revenues has stayed close to the company’s evergreen model target of 2% since 2010, but is expected to increase to 3.2% in 2022 and 5.2% in 2023. Interestingly, capex spend also jumped in 2008 and 2009 to 4.1% and 5.4% of revenues, respectively.  

The company aims to run an asset-light business, relying on contract manufacturers and co-packers for ~30% of manufacturing capacity. However, over the past 1.5 to 2 years, Church & Dwight has had supply disruptions including raw material and packaging capacity, which has led to demand outpacing supply in certain categories. The company specifically called out the laundry, kitty litter and vitamin categories, which are in need of increased investment to shore up supply capacity. Fill rates have improved in 2022, going from below 80% in Q1 to 89% in Q2 and 93% in Q3. It seems like the company is increasing its capex spend to make sure supply disruptions aren’t as severe going forward, something that Church & Dwight had less to be concerned about pre-pandemic.

R&D spend is mainly related to innovations from existing brands. For example, the company expanded its Arm & Hammer brand during the pandemic to release a line of disinfecting wipes as part of a licensing agreement with CR Brands. These wipes were considered to be value oriented and priced below the market leaders Clorox and Lysol (69% combined market share). The company also releases newer versions of its product line each year. For the gummy vitamin category, Church & Dwight released 22 new items in 2019, 12 in 2020 and 11 in 2021.

On the acquisition front, the company makes at least one meaningful acquisition almost every year. Church & Dwight claims that the M&A department is just one person. While that may be true during the initial screening of deals, the management team does get involved during the negotiation process. The point the company was trying to make is that Church & Dwight only looks for targets that meet the company’s power brand criteria and that are actually available for sale.

Over the past decade plus, the company has made many meaningful acquisitions:

• 2011 - Batiste was acquired for $65M.

  • Sales of $20M implies a multiple of 3.3x.

  • As of 2019, revenues exceed $150M and there’s still room to grow. Household penetration of 7.5% in the U.S. is lower than the U.K. at 9%.

  • 2/3 of women in the U.S. don’t wash their hair every day.

• 2012 – Avid (Vitafusion) was acquired for $650M.

  • Sales of $230M implies a multiple of 2.8x.

  • In 2012, the adult vitamin market was 16x the size of kids, and gummies only commanded 3% market share.

• 2017 – Waterpik was acquired for $1B.

  • Sales of $265M and $80M EBITDA, implying multiples of 3.8x and 12.5x, respectively. Synergies of $10M from supply chain improvements implies a multiple of 11x (9% ROIC).

  • 90% share of oral water flossers and 17% of replacement showerheads.

  • 22% penetration rate in the U.S. and 3%-5% in Europe vs. 40% for electric toothbrushes (as of 2019)

  • Averaged single digit topline growth from 2017 to 2021.

  • 60% of consumer purchases are driven by a dentist recommendation.

• 2019 – Flawless was acquired for $475M + $425M earn-out based on sales targets.

  • Sales of $180M and EBITDA of $55M, implying multiples of 2.6x-5x and 8.6x-16x (6%-12% ROIC), respectively.

  • 90% of revenues from the U.S. with more opportunities to increase distribution.

  • Shorter sales cycle of 6 months vs. Waterpik’s 3-5 years.

• 2020 – Matrix (Zicam) was acquired for $530M.

  • Sales of $90M and EBITDA of $36M, implying multiples of 5.9x and 14.7x, respectively. $5M in cost synergies implies a multiple of 12.9x (8% ROIC).

  • 73% share of the cold shortening market. Competes against Cold-EEZE (16% share).

• 2021 – TheraBreath was acquired for $580M with $85M in tax benefits.

  • Sales of $100M and EBITDA of $31M, implying multiples of 5.8x and 18.7x, respectively. $6M in synergies implies a multiple of 13.4x (7.5% ROIC) with tax benefits included.

  • #2 alcohol-free mouthwash with 15% share. Competes against Crest (24%) and Listerine (12%).

  • 68% ACV is expected to ramp to 80%.

• 2022 – Hero was acquired for $630M.

  • Sales of $115M and 46M in EBITDA, implying multiples of 5.5x and 13.7x (7.3% ROIC), respectively.

  • 63% share in acne patch category, 14% of total acne category.

  • Only has 8% ACV, mainly relying on Amazon, Target and Ulta for distribution. 80%-90% ACV is the target.

We estimate that Church & Dwight generated returns on incremental capital between 12%-18% over the past 5 years. The returns for 2020 were better due to pantry stocking in certain categories like gummies and cleaning supplies. Church & Dwight’s consistent organic growth profile and lean capital structure would imply a much higher return on incremental capital. But, the returns on capital for most of its acquisitions are only in the high single digits.

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Reinvestment potential?

Church & Dwight’s growth opportunity in the U.S. is primarily growing its power brands, especially the newer brands with lower distribution reach. For example, TheraBreath at the time of acquisition (end of 2021) was 5th in terms of points of distribution after Scope (1.5x more reach), ACT (2.3x), Crest (4.3x) and Listerine (9.1x). Fast forward to 3Q 2022 and Church & Dwight increased the brand’s points of distribution by 2.5x with TheraBreath reaching the #4 spot and only trailing ACT (1.6x), Crest (3.9x) and Listerine (5.5x). The company is expecting to do similar things to Hero as the brand trails Clearasil (5.8x), Clean & Clear (10x) and Neutrogena (34.5x) in terms of points of distribution.

Internationally, the growth story is continuing to increase brand awareness in foreign countries, leveraging the brand equity built up domestically. Aside from the big four international regions Europe, Canada, Australia and Mexico, the rest of the world presents a significant growth opportunity. This group of 130 countries called the Global Markets Group. Here is Steve Cugine, EVP of International, discussing the opportunity at the company’s 4Q 2019 earnings call:

“The GMG business is certainly an engine of growth for the division and for the company. Since 2014, when we initiated the start of our new growth strategy for International, this business has delivered 19% CAGR throughout its lifecycle. And again, 2019, we did 19.2%, a lot of 19s in there. And it's driven by our core brands. So we're driving Arm & Hammer, Batiste, Waterpik, VMS, OxiClean, Sterimar, Femfresh and now Flawless. Because we feel that we have a scaled global business for the first time, we're going to make a new commitment and that commitment is not only organic growth, but we're going to continue to expand operating margin year in and year out.”

With profitable growth internationally, especially in the high teens percentages, margins should continue to improve in that segment. The other international regions also outpace domestic growth, but are notably more volatile. Australia saw -5% decline in 2019 and Mexico -15% in 2020.

With a reinvestment rate between 50%-70% and a return on incremental capital between 12%-18%, we estimate that Church & Dwight has increased its intrinsic value between 8%-9% over the past 5 years. While the acquisitions mute the incremental returns, the reinvestment rate remains high. Furthermore, acquisitions lead to better organic growth opportunities as Church & Dwight incorporates the brands to the company’s distribution and supply chain capabilities.

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What else is important?

Inflation vs. Pricing

Similar to other consumer goods companies, inflation has negatively impacted Church & Dwight’s margins. Increased input and manufacturing costs increased 500bps ($250M in dollar terms) in 2021, which was offset by 250bps from pricing and 120bps from productivity improvements. The company is expecting an incremental hit to gross profit of $135M in 2022 and a lot of that will be offset by price increases that were announced in 3Q 2022.

The company raised prices for 33% of its product portfolio in April 2021 and another 17% in July. The company announced more price increases covering 80% of its product portfolio in early 2022. Price increases were in the 8%-12% range, inline with most of rest of the CPG companies. Church & Dwight also implemented pack size changes, which are another form of price increases.

Generally, the company doesn’t have as much pricing power as some of the larger CPG companies, especially in categories where private label has a bigger presence. However, the company has gotten more sophisticated with pricing in recent years, only having an official pricing department since 2017. The company usually increases price only to protect gross profit (meaning they can justify increases to their customers due to cost inflation), but this can hamper gross margins during times of rapid cost inflation.

Church & Dwight has been able to offset some of the cost inflation through productivity gains in recent years. Over the past 4 years, productivity programs have resulted in an average gross margin benefit of 1.2% per year. The company also hedges some of their commodity cost exposure, reducing the volatility of certain input costs.

Recent stock performance vs. 2000/2001 and 2008/2009

As a consumer staples stock, CHD has been one of the most resilient during prior large market drawdowns. In 2000, CHD was down -15.6% (total returns) vs. the S&P500 -9.7%, but then proceed to return +21% and +15.4% in 2001 and 2002, respectively. The S&P500 was down in both those years by -11.8% and -21.5%. And in 2008, while the S&P500 suffered a -36.4% down year, CHD was up +4.4%. The last year prior to 2022 when CHD was down was 2005 when it returned -1%.

So why is the stock down much more than the S&P500 (as of 11/12/22) in 2022? There are a few plausible reasons for this. First, with the quick ramp up in inflation, the company has shown that its business has limited pricing power. Price increases are only mitigating a part of the inflationary pressures and gross margins are being negatively impacted. Furthermore, supply disruptions are resulting in losses of market share in certain categories.

Second, the higher cost of debt would imply that future acquisitions would have higher hurdle rates or lower returns. While the company does generate significant cash, some of the larger acquisitions require new debt issuance for funding.  For the company’s debt on its balance sheet, 75% is fixed and part of the remaining 25% is hedged through swap agreements.

Third, the mix of the company’s products are different from prior recessions. Church & Dwight is no longer just a baking soda company (as was the case in 2000) and some of its newer brands are more discretionary purchases than staples. Flawless and Waterpik combined represent 10% of revenues and the sales cycles for these products are much longer than typical household goods or personal care items. These two brands also negatively impact working capital improvements relative to the rest of the company. At the CAGNY Conference in 2021, Church & Dwight showed that these two brands were a 9 to 13 day drag to cash conversion cycles.

Optionality

Church & Dwight benefits from its strong acquisition platform and upside potential comes from future acquisitions. If these acquisitions have a long runway for growth, the relatively high multiple paid will matter less due to the contribution to future organic growth.

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