Urbem's 'Wonderful Business' Series: Church & Dwight
An easy-to-understand business with predictability, a moat and a growth engine
New Jersey-based Church & Dwight (CHD) is a leading U.S. consumer product business founded way back in 1846. The company mainly engages in the manufacturing and marketing of cleaning, hygiene and personal care products, such as baking soda, detergents, shampoos, pregnancy tests, toothbrushes and condoms. It sells its products domestically (82% of fiscal 2018 sales) and internationally (18%).
The main reason that we had Church & Dwight join our "Wonderful Business" universe is its predictability. The company has both an enduring competitive advantage and a consistent secular growth engine.
At Urbem, we appreciate easy-to-understand business models that sell repeatable, small-ticket, everyday-use B2C items. As for Church & Dwight, roughly 45% of total sales come from household items and another 48% from personal care. The recession-proof business nature also augments the visibility on the future cash flow at the company. As described below, both revenue and operating income managed to increase throughout all of the past four recessions (highlighted in gray). According to the management, premium and value products are approximately a 2:1 split.
In recent years, Church & Dwight generated an annual free cash return on assets that compares favorably to consumer staples giants Unilever (UN) (UL) and Procter & Gamble (PG) but underperforms the likes of more focused players like Clorox (CLX) and Colgate Palmolive (CL) (see below).
We believe that the portfolio of leading brands digs an economic moat for the business. More than 80% of the sales and profits are derived from the 12 so-called power brands, which are market-share leaders in respective categories. For instance, the Arm & Hammer brand has been around for over 170 years. It is now one of the nation’s most trusted trademarks for a broad range of consumer and specialty products, including, most notably, the baking soda. Today, you can find the brand in more than 85% of U.S. households. Furthermore, Trojan (the country’s number one condom brand), Waterpik (the number one power flosser) and First Response (the number one branded pregnancy kit) are all under the umbrella of Church & Dwight.
The management sees international expansion as an appealing growth opportunity. Currently, less than 20% of the total sales come from abroad for Church & Dwight, compared with almost 60% at Procter & Gamble and over 70% at Colgate Palmolive.
Product innovation is another internal source of growth, which is exemplified by the company’s success in the expansion of the Arm & Hammer family into categories like dental care and laundry. This factor is widely seen as a significant growth driver for the mature and crowded U.S. consumer staples sector.
Lastly, the company also seeks external growth opportunities over time. As a matter of fact, 11 out of the 12 power brands come from acquisitions since 2001. While long-term risk abounds regarding inorganic growth, it seems to us that management has a clear set of criteria when it comes to its acquisition strategy. For example, the target has to be a number one or number two brand with a superior profitability and growth potential, operated under an asset-light model and protected by a sustainable competitive advantage. We would warmly applaud such an acquiree if purchased at the right price.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Clorox.
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