In January 2022, Church & Dwight (CHD) became a member of the S&P 500^® Dividend Aristocrats^® Index; the S&P 500 Dividend Aristocrats are high-quality companies that have grown their dividends for at least 25 consecutive years. Church & Dwight’s Dividend Aristocrat status is irrelevant, however, because it is a past performance metric. Investors should focus on a company’s potential performance.

My previous post about CHD as a Dividend Aristocrat was published over a year ago. I also last reviewed it at Financial Freedom Is A Journey on January 30, 2022.

At the time I wrote these posts, CHD’s valuation was too rich. I did, however, indicate I would consider adding to my exposure if CHD’s valuation retraced to a more reasonable level.

CHD’s earnings outlook has been scaled back from when I last analyzed it. The share price has also pulled back considerably. Now that we have Q3 and YTD2022 results and a revised FY2022 outlook, it is an opportune time to revisit CHD.

Business Overview

CHD was founded in 1846 and incorporated in Delaware in 1925. It develops, manufactures and markets a broad range of consumer household and personal care products and specialty products focused on animal and food production, chemicals and cleaners. The consumer products marketing efforts are focused principally on 14 ‘power brands.’

Source: CHD – Barclays Global Consumer Staples Conference – September 6, 2022

I encourage you to visit the company’s website and review Part 1 (Business and Risk Factors) in the FY2021 Form 10-K to familiarize yourself with the company.

Financial Review

Q3 and YTD2022

Please refer to CHD’s Form 8-K and Form 10-Q which reflect CHD’s Q3 and YTD2022 results and FY2022 outlook.

CHD’s US portfolio grew consumption in 11 of 17 categories. Its ARM & HAMMER Liquid detergent achieved an all-time high market share and ARM & HAMMER Clumping litter, BATISTE dry shampoo, and THERABREATH mouthwash also achieved all-time market share highs. OXICLEAN Stain Fighters and ARM & HAMMER baking soda delivered double-digit consumption growth. CHD also reported a market share gain on 7 of its 14 power brands; expectations are for market share gains to continue in Q4.

Hero Mighty Patch^® Acquisition

On September 6, CHD announced that it had signed a definitive agreement to acquire the Hero Mighty Patch^® brand and other acne treatment products for $0.63B. The purchase will consist of cash and CHD-restricted stock. Mighty Patch^® is the:

• #2 brand in the acne category in the US
• #1 patch brand in acne.

Source: CHD – Barclays Global Consumer Staples Conference – September 6, 2022

Expectations are for a Q4 2022 close with the transaction subject to customary closing conditions.

Hero’s net sales for the trailing twelve months through June 30, 2022, were ~$0.115.

The acne patch is the fastest-growing acne treatment form and the products are currently only marketed in the US.

Despite strong performance with several brands, some CHD brands are experiencing challenges.

In the case of the following 3 product lines, management has implemented strategies to address the risk, including lowering production costs, investing in new product ideas, and developing new creative advertising. However, significant adverse changes in demand, operating plans or economic factors in the future could reduce the underlying cash flows that could trigger a future impairment charge.

Flawless

CHD’s global FLAWLESS business is experiencing declining customer demand for many of its products. This is primarily due to lower consumer spending for discretionary products from inflation. In addition, the FLAWLESS business has also started to experience margin contraction. This is because CHD has been unable to implement price increases in a highly competitive category to offset higher labour, material and transportation costs. This is contributing to a reduction in expected future cash flows. Management expects that, if these factors persist or continue to worsen, cash flows may be insufficient to recover the carrying value of the long-lived assets of the business.

Trojan

In recent years the TROJAN® business, specifically the condom category, has not grown and competition has increased. Social distancing requirements due to the COVID-19 pandemic further negatively impacted the business. As a result, TROJAN sales and profits are stagnant. This is resulting in lower expected future cash flows thus eroding a portion of the excess between the fair and carrying value of the tradename.

More recently, TROJAN has experienced a recovery in sales and profits as it has benefited from an easing of COVID-19 social restrictions which led to an increase in sexual activity. The Company expects this trend will continue with the adoption of vaccines, the reduction of social distancing restrictions and the benefit of management strategies to improve sales and profitability.

Passport Food Safety

On March 8, 2018, CHD acquired Passport Food Safety Solutions, Inc. This line of business focuses on providing pre- and post-harvest food safety solutions for beef, poultry, and swine primarily for the application to carcasses to reduce food-borne pathogens.

This business has experienced sales and profit declines due to decreased demand driven by the COVID-19 pandemic and pressures from new competitive activities resulting from the loss of exclusivity on a key product line.

In Q4 2021, management’s review of the outlook for the Passport business indicated an assessment of the recoverability of the long-lived assets associated with the business was necessary. That review determined that the estimated future cash flows would not be sufficient to recover the carrying value of the assets resulting in an impairment of the associated tradename and other intangible assets of $11.3 million in Q4 2021. The charge was recorded in selling, general and administrative expenses. The assets have a current net book value of ~$8.5 million and are being amortized over their remaining weighted average life of 6 years.

Free Cash Flow (FCF)

In the first 9 months of FY2022, CHD generated ~$0.534B Net Cash from Operating Activities. It also incurred ~$0.098B in CAPEX giving us a YTD FCF of ~$0.436B.

FY2022 Outlook

Management continues to expect FY2022 reported sales growth to be ~3%, the midpoint of CHD’s previous 2% – 4% range.

The outlook for full-year organic sales growth is ~1%. The strong consumption across many of CHD’s businesses in 2022 has offset the slowdown in discretionary brands such as Waterpik and Flawless, and lower consumption growth in the vitamin category.

CHD continues to anticipate the FY2022 reported gross margin to be down versus 2021 with expectations for inflation to outpace pricing and productivity. The company remains committed to offsetting inflation with additional pricing and productivity efforts in 2023.

Credit Ratings

Details of CHD’s Short-Term Borrowings and Long-Term Debt are found on page 18 of 43 in the Q3 Form 10-Q.

I encourage investors to dial back risk and focus on investing in companies which have investment-grade credit ratings.

CHD’s current domestic unsecured long-term debt ratings are:

• Moody’s: A3 (this is the bottom tier of the upper-medium-grade investment-grade category);
• S&P Global: BBB+ (this is the top tier of the lower-medium-grade investment-grade category).

Moody’s rating defines CHD as having a strong capacity to meet its financial commitments. It is, however, 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 is one level lower than that assigned by Moody’s. This rating defines CHD as having an adequate capacity to meet its financial commitments. Adverse economic conditions or changing circumstances, however, are more likely to lead to a weakened capacity to meet financial commitments.

The outlook assigned by both rating agencies is stable.

Dividends and Share Repurchases

Church & Dwight’s Dividend and Dividend Yield

CHD’s dividend history includes an enviable record of dividend distributions for 121 consecutive years.

On October 26, CHD declared its 487th regular consecutive quarterly dividend. It is payable on December 1, to stockholders of record at the close of business on November 15, 2022. This dividend will mark the 4th quarterly $0.265 dividend.

Toward the end of January 2023, investors can expect CHD to declare a dividend increase. If recent history is indicative of what investors can expect, I envision a $0.01 increase.

Source: Portfolio Insight*

CHD shares currently trade at ~$78.60. If CHD increases its quarterly dividend to $0.275, the forward dividend yield is ~1.4% which is well below the rate of inflation. Investors would, therefore, be wise to approach a CHD investment from a total potential long-term investment return perspective (i.e., dividend income AND capital gain potential).

Source: Portfolio Insight*

Share Repurchases

The weighted-average diluted shares outstanding (in millions) in FY2009 – FY2021 are 286, 289, 292, 285, 282, 275, 267, 262, 256, 251, 252, 252, and 250. The weighted-average diluted shares outstanding for the 9 months ending September 30, 2022 is 246.4.

In FY2018 – FY2020, share repurchases were $0.2B, $0.25B, and $0.3B. Repurchases were briefly paused in 2020 as a result of COVID-19 but CHD’s strong cash position enabled it to resume purchases in FY2021; it repurchased $0.5B in FY2021.

On October 28, 2021, CHD’s Board authorized a new 2021 Share Repurchase Program, under which CHD may repurchase up to $1B in shares. The 2021 Share Repurchase Program does not have an expiration.

In December 2021, CHD executed open market purchases and also entered into an accelerated share repurchase contract. Following these share purchases, there remains ~$0.730B of share repurchase availability under the 2021 Share Repurchase Program as of September 30, 2022.

Looking at the Condensed Consolidated Statements of Cash Flow in the Q3 Form 8-K, CHD has yet to repurchase any shares YTD2022.

NOTE: Dividends and share repurchases are the lowest priority in the use of FCF.

Valuation

CHD’s diluted PE levels in FY2012 – FY2021 are 21.87, 24.46, 27.36, 28.01, 25.47, 28.83, 20.05, 28.83, 28.23, and 31.25.

When I wrote my previous guest post at Dividend Power, CHD’s share price was ~$87.20 and management’s FY2021 adjusted diluted EPS guidance was $3.00 – $3.06. This resulted in a forward-adjusted diluted P/E ratio of ~28.5 – ~29.1.

The FY2021 adjusted diluted EPS guidance from 20 analysts was a mean of $3.04 and a $2.97 – $3.07 range. Using the $87.20 share price, the forward adjusted diluted P/E levels ranged from ~28.4 to ~29.4.

At the time of my January 30, 2022 post at Financial Freedom Is A Journey, management’s FY2022 guidance was ~$3.14 – ~$3.26. Shares were trading at $103 thus giving us a forward adjusted diluted P/E range of ~31.6 – ~32.8.

The projected adjusted diluted PE levels based on broker guidance derived from the two discount broker platforms I use and the ~$103 share price were:

• FY2022 – 19 brokers – mean of $3.21 and low/high of $3.10 – $3.33. Using the mean, the forward adjusted diluted PE is ~32.
• FY2023 – 14 brokers – mean of $3.49 and low/high of $3.40 – $3.62. Using the mean, the forward adjusted diluted PE is ~29.5.

CHD shares currently trade at ~$78.60. Management now projects an FY2022 adjusted diluted EPS range of $2.93 – $2.97. This gives us a forward-adjusted diluted PE range of ~26.5 – ~26.8.

The projected adjusted diluted PE levels based on broker guidance derived from the two discount broker platforms I use and the current share price are:

• FY2022 – 20 brokers – mean of $2.95 and low/high of $2.92 – $3.00. Using the mean, the forward adjusted diluted PE is ~26.6.
• FY2023 – 21 brokers – mean of $3.12 and low/high of $2.90 – $3.25. Using the mean, the forward adjusted diluted PE is ~25.2.
• FY2024 – 13 brokers – mean of $3.38 and low/high of $3.23 – $3.55. Using the mean, the forward adjusted diluted PE is ~23.3.

I am very reluctant to rely on earnings projections beyond FY2023 because much can change between now and the end of 2023.

Final Thoughts

The terms assigned to companies with a certain number of consecutive years of dividend increases might suggest these companies are good potential investments. Investors, however, should not get lulled into thinking this is the case.

A case in point is Church & Dwight’s Dividend Aristocrat status. I initiated a CHD position in 2005 and it has been a wonderful investment over this timeframe. CHD, however, was a very different company in 2005 than it is today. Its annual revenue in FY2005, for example, was ~$1.7B. Its annual revenue over the first 3 quarters of FY2022 is ~$4B.

While it is easy to compare past and present performance, it does not add much value when trying to determine if a company is a good investment. This is why thinking a Dividend Aristocrat is a good long-term investment is unwise. Investors should, rather, focus on a company’s potential performance and gauge the company’s risk and valuation.

CHD has significantly improved its credit risk over the years going from non-investment grade when I initiated a position, to its current investment-grade ratings.

Over the past few years, CHD has consistently been overvalued as noted in my most two recent CHD posts. While CHD’s current forward-adjusted diluted EPS estimates are well below those at the end of January 2022, CHD’s share price has also plunged from its 52-week high of ~$105. Now, CHD’s valuation is just slightly rich. I am reluctant to recommend buying CHD shares, however, because I envision a broad market pullback in 2023; a common theme in all the earnings call transcripts I read is the expression of concern about a challenging 2023 economic environment.

I suggest investors adopt a wait-and-see approach with CHD to:

• ascertain how its soon-to-be-acquired HERO brand performs; and
• whether it can improve the results of its ‘challenged brands’ I reference earlier in this post.

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