CHD – A Dividend Aristocrat – Introduction

On April 29, 2021, Church & Dwight Co., Inc. (CHD) held its Q1 earnings call. On this analyst call, management indicated the 44.5% gross margin was a 120 bps decrease from Q1 2020. Although CHD is a Dividend Aristocrat facing input pricing headwinds, market conditions are such that CHD’s valuation does not appear to reflect these challenges. With the recent release of quarterly results and FY2021 guidance, I now take this opportunity to determine whether to acquire additional shares of this Dividend Aristocrat.

A Dividend Aristocrat is a component of the S&P 500 Index with at least 25 consecutive years of dividend increases. Although CHD has paid a regular consecutive quarterly dividend for 120 years, and is one of the few stocks paying a dividend for 100+ years, it was not until recently that it became a Dividend Aristocrat. On January 29, 2021, CHD announced an increase in its quarterly dividend thus marking the 25th consecutive year in which it has increased the dividend.

My Experience As A Shareholder

I do not spend much time monitoring my holdings. Instead, I try to restrict my investments to high-quality companies so I do not NEED to monitor my holdings. Looking at my April 2021 holdings review, we see companies where you can ‘sleep well at night’; this list reflects CHD as my 3rd largest holding behind Visa (V) and Mastercard (MA).

In early 2005 I initiated a position in CHD shortly after acquiesced to my wife’s/daughter’s insistence that we add a cat as a member of our family. Our cat, as I quickly learned, goes through a lot of kitty litter; I found myself regularly going to our local Walmart to buy some. I tried a variety of kitty litters but found the inexpensive litter was inexpensive for a reason. Eventually, I settled on Arm & Hammer kitty litter. Amazingly, CHD makes a variety of kitty litter!

After speaking with members of the Walmart staff and observing the extent to which Arm & Hammer kitty litter was turning over, I analyzed CHD as a potential investment. Much to my pleasant surprise, CHD’s had Trojan condoms, Nair, 1st Response, and Xtra laundry detergent in its arsenal of products. I was familiar with the Trojan and Xtra brands and liked that these were all non-reusable products. I like these types of products because it means consumers need to keep purchasing them. Based on my analysis I initiated a position and have never regretted this investment. In fact, I have reinvested the quarterly dividends and have periodically acquired additional shares.

The vast majority of my CHD holdings are in a retirement account for which I do not disclose details. Interestingly, the value of this holding has appreciated in excess of 5.7X my average cost. As recently as October 29, 2020, I acquired CHD shares for one of the ‘Core’ accounts that is a component of the FFJ Portfolio.

CHD – A Dividend Aristocrat – Business Overview

A comprehensive overview of the company and a host of risks and uncertainties, as well as other factors, that could have a material adverse impact on CHD’s business, reputation, financial results, financial condition and/or the trading price of the Common Stock is found in Part 1 – Items 1 and 1A of the 2020 10-K.

The April 29, 2021 Annual Shareholders’ Meeting presentation provides an overview of the company’s recent history and management game plan to grow the company.

Source: Church & Dwight Shareholder Meeting Presentation

Additional information about CHD and what lies ahead is found in the January 29, 2021 Analyst Day presentation.

CHD – A Dividend Aristocrat Financial Review

Q1 2021 Results

CHD’s Q1’s earnings release can be found here and the Q1 10-Q is available here.

On the Q1 earnings call, management indicates this Dividend Aristocrat is facing input pricing headwinds. The Texas freeze resulted in raw material shortages and exacerbated raw material and transportation costs. Management expects the tight supply and higher input costs to continue for the balance of the year. To mitigate the cost increases, price increases in CHD’s laundry products and across the international portfolio have been instituted. Couponing and promotional spending have also been reduced.

Source: Church & Dwight Shareholder Meeting Presentation

Q1 gross margin was 44.5% or a 120 bps decrease from Q1 2020. The drop is the result of a 350 bps increase in manufacturing costs, primarily related to commodities, distribution, tariffs and COVID impacts. Negative impacts on Gross Margin are as follows:

• Higher commodity costs: 90 bps; and
• Tariff costs: 40 bps.

The spike in commodities and the tight transportation market are partially offset by the following favorable variances:

• Price/volume mix: 190 bps;
• Productivity Programs: 170 bps; and
• Favorable currency swing: 10 bps.

CHD’s January 29, 2021 Analyst Day presentation outlines the 2021 category expectations. Management’s full-year thinking remains the same as at the end of January.

Source: Church & Dwight Analyst Day Presentation

Demand for vitamins, laundry additives, and cat litter are expected to remain elevated in 2021. Condoms, dry shampoo, power flossers, and women’s grooming products are to deliver year-over-year growth as the economy reopens and consumers have greater mobility. Baking soda, pregnancy test kits and oral analgesics are expected to decline from COVID highs.

The $0.05 variance between GAAP diluted EPS of $0.88 and adjusted diluted EPS of $0.83 is due to the acquisition terms of the FLAWLESS™ and FINISHING TOUCH™ brands of hair removal products. The $0.83 is better than the prior $0.80 outlook and is primarily due to the continued increase in consumer demand.

As a comparison, the Q1 2020 variance between GAAP diluted EPS and adjusted diluted EPS is $0.09; $0.08 is the earn-out payment.

Toward the end of March 2019, CHD announced the acquisition of the market leader in women’s electric hair removal products FLAWLESS™ and FINISHING TOUCH™. Terms of the acquisition include an earn-out payment. The purchase price was ~$0.475B in cash plus an additional earn-out payment of up to a maximum of $0.425B, in cash, based on a twelve-month net sales target ending no later than December 31, 2021.

FY2021 Guidance

CHD is a Dividend Aristocrat facing input pricing headwinds but management continues to expect FY2021 adjusted EPS growth of 6% – 8%. This is in line with the Evergreen target; CHD’s Evergreen Business Model calls for 3% organic sales growth and 8% EPS growth.

Given expectations, for consumer consumption, the full-year outlook for reported sales growth is increased from 4.5% to 5% – 6%. Organic sales growth expectations are now 4% – 5% versus the prior 3%.

Recently, CHD has seen a large increase in raw materials and transportation costs; it is absorbing $0.09B of incremental costs for FY2021. Higher sales, reductions in promotions, and price increases across all three divisions representing ~33% of the brand portfolio offset a large part of the cost increases.

The full-year gross profit margin is forecast to be flat because of higher raw material and transportation costs and the Texas freeze in March. The previous gross margin expectation was an expansion of 50 bps for the year. Management expects gross profit margin expansion behind pricing and promotional actions to occur in the 2nd half of FY2021.

CHD – Free Cash Flow (FCF)

The cash from operations outlook continues to be $1B while CHD continues to pursue accretive acquisitions.

Looking at the Condensed Consolidated Statement of Cash Flow (page 5 of 37 in the Q1 10-Q) we see ~$0.1B of net cash from operating activities and ~$0.026B of additions to property, plant, and equipment. This gives us a FCF of ~$0.074B versus ~$0.22B in Q1 2020.

On the Condensed Consolidated Statement of Cash Flow, we see a higher level of Inventory to support increases in sales due to continued sales recovery. Accounts payable and accrued expenses also decreased due to the timing of payments. In addition, CAPEX of $26.3 million is $9.5 million greater than Q1 2020; this is due to an increase in production capacity related to increased demand.

The full-year CAPEX plan continues to be ~$0.180B as CHD continues to expand manufacturing and distribution capacity, primarily focused on laundry, litter, and vitamins. By way of comparison, CAPEX (in millions of $) is $60, $74, and $92 (net of $7 proceeds of sale from assets) in FY2018, FY2019, and FY2020.

For further comparison, FCF in FY2011 – FY2020 (in millions of $) is: 361, 449, 433, 470, 544, 606, 637, 703, 791, and 891.

I do not expect FCF to reach FY2020’s level but envision FY2021 FCF will be in the $0.5 – $0.7B range which CHD can then deploy accordingly.

Source: Church & Dwight Analyst Day Presentation

CHD – A Dividend Aristocrat – Credit Ratings

When I initiated a position in CHD in 2005, Moody’s rated the company’s senior unsecured long-term debt Ba3. This rating is the lowest tier of the non-investment grade speculative category. The rating defines CHD as being LESS VULNERABLE in the near term than other lower-rated obligors. It does, however, face major ongoing uncertainties and exposure to adverse business, financial, or economic conditions. This can lead to an inadequate capacity to meet its financial commitments.

I typically do not invest in non-investment grade rated companies. I did, however, make an exception with CHD since I viewed it as taking the appropriate steps to achieve investment-grade status. Fast forward to the present day. CHD’s unsecured long-term debt ratings are A3 from Moody’s and BBB+ from S&P Global; Moody’s rating is one notch higher than S&P Global’s rating. Both ratings are investment grade.

Moody’s rating defines CHD as having a STRONG capacity to meet its financial commitments. The company, however, is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

S&P Global’s rating defines CHD as having an ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity for CHD to meet its financial commitments.

CHD’s ratings satisfy my prudent investor profile.

CHD – Dividends and Share Repurchases

Dividend and Dividend Yield

CHD’s dividend history on its website includes the stock splits which have occurred over time. The company has raised the dividend for 25 consecutive years making CHD a Dividend Aristocrat.

The current $0.2525/share/quarter dividend ($1.01/year) is a ~1.2% dividend yield on the basis of the current ~$87.20 share price.

Dividend increases in the last 3 years have hovered around 5% – 5.5%. CHD generates ample FCF to enhance the dividend and to reduce share count. The return of cash to shareholders, however, is CHD’s 5th priority (see image above).

Share Repurchases

The weighted average diluted common shares outstanding in FY2011 – FY2020 is 291.6, 285.4, 282.4, 275, 267.2, 262.1, 256.1, 250.7, 252.1, and 252.2 (million shares); share count reflects a 2-for-1 stock split on September 2, 2016.

On November 1, 2017, the Board authorized a share repurchase program, under which CHD may repurchase up to $0.5B in shares of common ctock; this program has no expiration date.

CHD also has an evergreen share repurchase program authorized by the Board on January 29, 2014. Under this program, CHD may repurchase common stock to reduce or eliminate dilution associated with issuances of common stock under the company’s incentive plans.

In December 2020, CHD entered into an accelerated share repurchase contract with a commercial bank to purchase common stock. It paid $0.3B to the bank, inclusive of fees, and received an initial delivery of shares equal to $0.27B or 3.1 million shares. Cash on hand and short-term borrowings funded this purchase.

Upon the completion of the accelerated share repurchase contract, which ended in February 2021, the bank delivered to CHD an additional 0.4 million shares. The final shares delivered to CHD were determined by the average price per share paid by the bank during the purchase period and all 3.5 million shares were purchased under CHD’s evergreen program. As a result of these common stock repurchases, $0.21B of share repurchase availability remains under the 2017 Share Repurchase Program as of December 31, 2020.

CHD – Current Valuation

Despite the impressive returns generated for me over the past ~16 – ~17 years, the past is the past. Any decision to acquire additional CHD shares depends on the current valuation and guidance for the upcoming year.

Many investors try to determine a company’s valuation using future earnings estimates over several years. I am reluctant to do this. Too much can change which could very easily throw off future earnings and, ultimately, valuation estimates.

In many of the financial results I review, I typically see adjusted earnings in excess of GAAP earnings. In CHD’s case, however, the FLAWLESS™ and FINISHING TOUCH™ earn-out payments result in GAAP earnings greater than adjusted earnings. CHD generated $0.88 of diluted EPS in Q1 versus $0.92 in Q1 2020 and it generated $3.12 in FY2020.

In the Q1 earnings call with analysts, management states it continues to expect FY2021 adjusted diluted EPS of $3.00 – $3.06. In Q1 we see $0.83 of adjusted diluted EPS and Q2 guidance of $0.69. This means CHD needs to generate at least $1.48 in Q3 and Q4. This certainly appears to be achievable.

I anticipate GAAP earnings of $2.80 – $2.86; I arrive at this range by extrapolating the $0.05/share variance between GAAP earnings and Y2021 adjusted guidance. Using the current ~$87.20 share price I get a forward diluted P/E in the range of ~30.5 – ~31.15.

On the basis of management’s FY2021 adjusted diluted EPS of $3.00 – $3.06 guidance the adjusted diluted P/E is ~28.5 – ~29.1.

Current FY2021 adjusted diluted EPS guidance from 20 analysts is a mean of $3.04 and a $2.97 – $3.07 range. Using the current $87.20 share price I get a forward adjusted diluted P/E of ~28.4 – ~29.4.

On October 29, 2020, I disclosed the purchase of additional CHD shares at $86.12. Using FY2020 adjusted EPS guidance of $2.79 – $2.81 ($2.80 mid-point), the forward adjusted diluted P/E was ~30.76. My opinion was that shares are richly valued which is why I limited my purchase to only 100 shares. In hindsight, I should have been more patient as CHD’s valuation became attractive shortly after my purchase.

CHD – A Dividend Aristocrat – Final Thoughts

CHD operates in a ‘land of giants’. Its peer group consists of Procter & Gamble (PG), Clorox, (CLX), Colgate-Palmolive (CL), Kimberly-Clark (KMB), and Reckitt Benckiser (RBGLY). Both Clorox and Kimberly-Clark may be good dividend growth stocks to watch in 2021. Nevertheless, CHD’s return on investment over my length of ownership far exceeds that of the ‘giants’.

CHD is a Dividend Aristocrat facing input pricing headwinds. The company was founded in 1846 and this is not the first time CHD has had to overcome headwinds.

The current valuation is certainly not a bargain but very rarely are CHD shares a bargain; a mid to upper 20s P/E that is based on GAAP earnings is typically what you can expect from CHD.

Regrettably, so many companies are currently overvalued. I continue to be of the opinion a broad market correction WILL occur but I just do not know when. My intent is to acquire additional CHD shares. I am, however, applying the first 2 of Charlie Munger’s 13 Personal Attributes To Improve Investment Success.