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Investors in household-goods company Church & Dwight (NYSE: CHD ) have watched the stock almost double over the last five years. It's tempting for them to think that the outperformance of the stock is solely due to the nature of the company's products. Indeed, 40% of its sales come from the kind of value brands that the consumer has been trading down toward. However, events over the last year have demonstrated that the company's excellent management team is an even larger part of its success.
When the going gets tough...
The recent second-quarter results saw the company delivering good numbers in spite of an ongoing tough consumer market. Indeed, there are three reasons to suggest that conditions are going to remain difficult.
Firstly, full-year organic sales growth is now forecast to be just 2% from an earlier estimate of 3%-4%. One-third of the shortfall is due to weaker-than-expected sales within specialty products. The remaining two-thirds is due to plans to increase discounting in the face of price competition. When pressed on the categories facing pricing pressures, the management replied that cat litter and laundry were the main culprits.
Secondly, plans are being made to increase marketing spending in the third quarter in order to support some of its key brands. Again, this is a sign of a more difficult marketplace. Indeed, management outlined that in the conference call: "In fact, of the 14 categories that Church & Dwight operates in, five incurred lower category dollar sales in the second quarter versus the prior year and five more had category growth of less than 2% versus the prior year."
Thirdly, key rival Procter & Gamble (NYSE: PG ) recently discussed plans to release a cheaper version of its Tide laundry detergent in 2014. Although the launch is set for next year, Church & Dwight is likely to act in advance to try to protect market share for its XTRA brand. In addition, Germany's Henkel will also be pressured into protecting its Purex detergent brand.
....the tough get going
The good news is that its management team has long been acquainted with dealing with difficult conditions, and its excellent execution is a key reason why the company continues to do well. There are three near-term pathways to growth, and all of them are thanks to management's actions.
Firstly, full-year gross margins are now expected to increase by 50 basis points to 75 basis points instead of the 25-to-50 basis-point increase previously forecast. The key to this upgrade was better-than-expected cost savings with the integration of its gummy-vitamin manufacturer Avid.
Secondly, sales growth at Avid is "tracking ahead of expectations," and is expected to be a significant contributor to sales growth in the second half. Thirdly, on the conference call, Church & Dwight argued that it had a "great pipeline" of new products to be released next year.
What about its peer group?
Essentially, the mass-consumer market remains difficult, but Church & Dwight has already demonstrated that it can outperform the market and its peer group in such an environment.
Moreover, the company has a good opportunity to continue its outperformance. Its relatively small size gives it a significant amount of flexibility in responding to changing market conditions. Furthermore, unlike much larger peers Procter & Gamble or Kimberly-Clark (NYSE: KMB ) , it does not rely on premium brands for its profitability.
In previous economic cycles, such companies would have preferred to retain pricing during the downturn in order to benefit when the recovery came. However, this recovery has been so tepid (particularly for the mass market) that many large consumer goods companies are forced into discounting to retain market share.
A good example of this is with Procter & Gamble with the previously mentioned plans to release a cheaper version of Tide (rather than just cutting Tide prices), but also with its plans to downsize its Pampers diapers. Similarly, its key rival Kimberly-Clark is also used downsizing with its Kleenex brand. While such measures are innovative ways to try to keep pricing for premium brands, they are also emblematic of a weak consumer market.
Church & Dwight set to carry on outperforming
This sort of macro environment favors Church & Dwight's mix of value and power brands. In addition, its management has demonstrated that it can make earnings-enhancing acquisitions, and generate productivity improvements, even in a weak economy. Furthermore, at some point, a much larger rival may look to buy the company in order to generate some much-needed growth.
On a less positive note, Procter & Gamble appears to be stepping up the competitive pressure, and Church & Dwight's valuation of over 23 times current earnings suggests the stock is close to fair value. Consequently, long-term investors can look for the stock to 'do its earnings growth' in future years. Given that this implies double-digit returns, the stock remains attractive, particularly if its management can continue to wring every bit of growth it can from unhelpful market conditions.
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