Management commentary of Church & Dwight Co. Inc. (NYSE:CHD) clearly suggests another accretive deal is forthcoming, with debt capacity, rising cash balance, halted share repurchase in the fourth quarter and lower capex signaling management is poised to strike while conditions are favorable.
Church & Dwight is a leading manufacturer of sodium bicarbonate, used in consumer and specialty products sold under the ARM & HAMMER brand name. Product lines include household deodorizers and cleaners, laundry detergent, dryer sheets, oral care, deodorants and antiperspirants.
While organic growth trends for the laundry category and the company are clearly tepid and likely getting worse as other players position their brands ahead of P&G's well telegraphed mid-priced Tide launch, we continue to see a path to solid margin expansion and EPS acceleration going forward.
"As management clearly points out, the basic drivers of value creation are firmly in place and as we alluded to above, another accretive acquisition is likely in the short-term, which should again be a catalyst for a stock that has underperformed the market and peers this year," Deutsche Bank analyst Bill Schmitz wrote in a note to clients.
Even without a deal, there is compelling upside to expectations, driven by a benign commodity environment; relatively undemanding organic growth comparisons and sales and margin benefits from Avid gummy vitamin acquisition, which is now part of organic growth and should continue to boost gross margin as business are fully integrated.
Valuation is always the pushback on this one, but have a clear line of sight to further earnings potential upside from here, which means the optically high multiple on next year's estimates should come down as the company exceeds expectations.
Additionally, the pricing wheels are coming off the bus as growth-starved competitors like Henkel and Sun lower prices, forcing Church to follow to keep their fair share, even if it is negativel! y impacting category and company organic growth in the interim.
"In the near-term, it seems 4Q guidance is highly achievable with Avid joining the base this quarter, acquisition costs in the base period lapping and moderating commodity costs lifting gross margin," Schmitz said.
With likely upside in the quarter, the company should have decent momentum heading into 2014 with ample flexibility to respond to P&G mid-tier Tide launch and continue to believe this product if successful, will negatively impact Sun's Wisk and All brands more than Church's most lower prices (and going lower) Arm & Hammer and Xtra brands.
To be sure, there are clearly omnipresent challenges, including share losses and price competition in cat litter, generally weak consumption trends across the US Nielsen database and the aforementioned price wars in mid and value tier laundry.
"We believe these are reflected in valuation and management has promised a very active new product pipeline and potentially the accretion from another strategic bolt-on deal," Schmitz said.
With the addition of Avid, the company has added an OTC platform to build upon like it did historically in laundry (buying Xtra and OxiClean brands) and oral care (Mentadent, Close Up, Pepsodent, Spin Brush and Tooth Tunes) to add scale to its Arm & Hammer brands.
Looking closer at laundry, which is the overhang on the shares given forthcoming P&G launch activity and recent aggressive pricing, it doesn't seem like a sustainable strategy and one that likely irks the trade.
"The broader question in laundry remains what Sun/Huish plans to do strategically which clearly has implications for the company. Currently, the company's Wisk, All and Surf brands are entrenched in the mid price tier that is ceding share to premium brands at the high end and value brands like Arm & Hammer and Xtra on the low end," Schmitz said.
The risk over the medium term is what Sun decides to do to free itself from the shackles of! the mid-! tier and while it would create a profit squeeze that its balance sheet might have a tough time absorbing, the company may ultimately decide that the best positioning for its struggling brands is in the value tier, which would put incremental pressure on Church and Henkel.
Of course, retailers would have to decide that they need another brand in this tier that is already somewhat crowded and would likely drive category value growth lower, but it is certainly something to think about.
"Looking at the stock and despite the recent category challenges in laundry where management has promised to fight to the death and noting that we still believe P&G and Church are "frenemies" in the category competing for a different demographic, we still see upside potential in the name from here," Schmitz said.
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While another acquisition and accretion associated with it would be a welcome development, the standalone company and the growth tailwind from its vitamin business remains a compelling investment proposition.
While valuation doesn't look that compelling on first blush, there is potential upside to 2014 estimates and believe the multiple should hold and stock should track double-digit EPS growth in a moderating cost environment, with further return upside from dividend yield and potential acquisition accretion.
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