No-Moat Church & Dwight's Sales Could Stumble in the Face of Mounting Competitive Pressures

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We’ve long held no-moat Church & Dwight lacks the scale, resources, and negotiating prowess of its larger brethren. We see this as an unenviable position, particularly when juxtaposed with persistent macro and competitive pressures, cost headwinds, and supply chain tension. Although Church has emphasized 40% of its mix skews toward value offerings, we're skeptical this alone will insulate it. Rather, we posit Church’s category mix makes the firm susceptible to consumers trading down or out if their financial position warrants. Beyond the top line, we surmise reaching its 45% prepandemic gross margin could be delayed by intensifying competition (from well-resourced peers and lower-priced private-label offerings) if promotional spending steps up from relatively dormant levels the past few years. As a smaller operator with less-entrenched retail relationships, we think this could put Church in the crosshairs, making further margin expansion harder to come by. Further, while inflationary headwinds in aggregate have died down, labor, transportation, and logistics remain elevated and could put added pressure on its margin trajectory.

Beyond the macro malaise, we think Church will remain a consolidator (although we refrain from including unannounced deals in our model). In our view, the firm had success with some of its earlier tie-ups, as evidenced by growth and market share gains. For one, Nair held just more than one fifth of the hair removal/bleach market when Church acquired the brand in 2001, but it had grown to around 50% share of late. While acquisitions had been anchored in home and personal care, the firm has started entering niche enclaves where we don’t believe it has the same expertise (like water flossers and electric hair removal). In addition, the firm acquired Zicam, a leader in the cough/cold-shortening category, in 2020. Although this complements its vitamin line, the rich valuation (trailing price/sales and EBITDA of 6 times and low to mid-teens, respectively) increases our skepticism in the durability of Church's growth-through-acquisition strategy; we think it may be challenged to extract the necessary efficiencies to justify the price.

Business Strategy & Outlook

For more than 100 years, Church & Dwight was a baking soda company, operating with only the Arm & Hammer brand. The company became an acquisition platform in 2001 and has acquired the bulk of its seven “power brands” since that time. Church & Dwight’s acquisitions of leading brands have diversified its reach across household and personal care. However, despite a mix that includes several well-known brands, we do not think the firm has carved out an economic moat. Even though returns on invested capital including goodwill look robust (at 12% on average over the past five years), the company’s ability to continue to outearn our 7% estimate for its weighted average cost of capital for more than 10 years could be challenged, especially considering its acquisitive nature, which can depress returns and lead to an accumulation of a significant amount of goodwill on the balance sheet ($2.4 billion at the end of 2023, up from $857 million at the end of 2010). Over the past 10 years, ROICs including goodwill trended down, from 24% in 2011 to 12% in 2023.

Moats in the consumer packaged goods industry usually result from intangible assets in the form of strong brands and entrenched retailer relationships, and/or through a cost advantage. Our Morningstar CPG brand strength framework evaluates a firm’s brand intangible asset using pricing power, conspicuousness of consumption, taste and safety concerns, private-label penetration, and market share/industry concentration. Each factor is assigned a rating of high, moderate, or low. We do not view conspicuousness of consumption or taste and safety concerns as particularly applicable to Church & Dwight’s product portfolio but assign a rating of moderate for private-label penetration and low for pricing power and market share. When taken together, we rate Church & Dwight’s overall brand strength as low, which underpins our assessment that the firm has failed to amass an intangible-sourced moat.

Church & Dwight has seven power brands that together make up 70% of its revenue. While these brands have recognition and some significant market share, the firm has not successfully passed inflationary pressures through to consumers, which is shown in the consistently negative price/mix adjusted for inflation it has generated (essentially flat on a percentage basis over the last 10-15 years). We don’t think its ability to raise prices will materially improve over the course of our explicit forecast without a potential hit to volume. Evidencing this lack of pricing power, Church & Dwight has posted impressive organic revenue growth for each of the past 10 years, amounting to 4% on average, in excess of the low-single-digit marks the beauty and personal care and the home care categories grew over the same period. However, this has come almost entirely from increases in volume realized at the detriment of price. And even in fiscal 2023, when prices shot up 6.5%, volumes languished and fell 5.1%, supporting our stance around its inability to raise prices without incurring a hit to volumes. We think Church & Dwight has attempted to counter its plight by expending a higher percentage of revenue on advertising and marketing expenses (nearly 12% on average between fiscal 2017-21 than its wide-moat competitors, which average 10%); we forecast its marketing spending will average more than 11% annually through fiscal 2033. However, we view a higher percentage of revenue directed toward marketing and advertising (in the hopes of gaining market share) as indicating a firm’s mix consists of weaker brands compared with competitors with leading products and more pricing power.

We think this lack of pricing power is particularly challenging given the intense competitive landscape in which the firm plays. For one, all 17 categories of products offered by Church & Dwight have at least some exposure to private label. Management has stated that pregnancy test kits (which we estimate account for around 2% of revenue), baking soda (midteens), vitamins (around 1%), oral care (midsingle digits), and cat litter (low double digits) compete with private-label products. However, according to Euromonitor, there is also significant (more than 10% share) private-label exposure in the surface care category. Market share of private-label fare in these categories accounts for approximately a low-double-digit market share on average in Church & Dwight’s categories. Although private-label fare has garnered small increases in market share (with increases generally in the low single digits of share in categories over the past five years with data available through Euromonitor) and could continue to do so against a weak macroeconomic backdrop, we see the loss of share to other brands or consumers trading out of its categories as more of an imminent threat to Church & Dwight than the loss of market share to private label.

The categories Church & Dwight is in are very competitive with virtually zero switching costs. While the firm has gained market share in some categories, since 2015 it has lost share in cat litter (50 basis points) and laundry aids (50 basis points), now holding just than 18% and 14%, respectively. Market share data from Euromonitor suggests Church & Dwight has very few broad category number-one products but has more subcategory leaders, which we suspect do not offer the same opportunities to entrench their business with retail partners because the categories are smaller and shelf space is limited. For example, wide-moat Procter & Gamble is the number-one laundry detergent company, holding share in the low-60s compared with Church & Dwight’s less than 13% share. In addition, Procter & Gamble has a market share about 3 times the size of Church & Dwight’s in laundry aids (a laundry subcategory) at more than 40%. We think Church & Dwight’s more muted share position has contributed to its inability to secure enduring retail relationships.

Further, Church & Dwight is significantly smaller than its main competitors in all of its power brand categories, which suggests it hasn't amassed much in the way of clout with retailers. Church & Dwight had annual net sales of less than $5.9 billion in fiscal 2023, compared with Procter & Gamble’s $82 billion and Unilever’s $64 billion in the most recently completed fiscal year. As a significantly smaller company, Church & Dwight does not have the same power as its larger competitors when negotiating with retailers. This could make the competition for shelf space more difficult, especially as 23% of Church & Dwight’s revenue comes from wide-moat Walmart. In support of this contention, management has expressed the difficulties faced in securing and maintaining shelf space (which is inherently limited in physical channels), particularly as retailers are more inclined to accommodate bigger brands with more negotiating power and lower-priced private-label products (which are higher margin for retailers). For example, Procter & Gamble’s scale and negotiating power has allowed the firm to deeply integrate itself with Amazon by sharing warehouse space to distribute e-commerce orders. We do not think Church & Dwight has the size or scale to entrench itself with larger retail partners in the way P&G and others have done.

We think its lagging standing with retail partners isn’t just limited to the physical channel. In 2023, 20% (about $1.1 billion) of Church & Dwight’s consumer revenue came from e-commerce (up from the single-digits prepandemic). Even though Church & Dwight has mentioned several power brand products are number one on Amazon, how this is achieved is ambiguous. Although e-commerce sales spiked initially in 2020 in response to social distancing mandates, we do not think online sales will continue to grow at the same cadence and could give up some ground now that consumers are more comfortable venturing outside the home. Regardless, because e-commerce makes up such a relatively small percentage of revenue, we do not view this as influential to the moat rating.

We believe Church & Dwight benefits from some cost advantages but not enough to warrant an economic moat. Although the specific quantities or costs of production for individual product lines are not disclosed, Church & Dwight manufactures a large volume of products across a fixed cost base, with manufacturing and distribution occurring across 21 separate locations. The firm also uses third-party contract manufacturers around the world that produced around one fourth of its consumer products (prepandemic), which cannot be deemed as a unique advantage, given that others throughout the space also have access to these suppliers. Further, we do not believe Church & Dwight has earned a cost advantage moat because there is nothing differentiated or specialized about its manufacturing process. We also do not believe the firm has a cost advantage stemming from economies of scale. Church & Dwight argues its small size is an advantage, but we do not believe it operates as efficiently as its larger competitors, with operating margins (19%-20%) that lag the low- to mid-20s of its larger peers. However, in the specialty products division, we believe that Church & Dwight benefits from a small cost advantage stemming from its vertically integrated supply chain, which allows the company a sourcing advantage for raw materials. The bulk of the specialty products in its mix use baking soda as the main ingredient (for animal feed, industrial baking, and industrial cleaning), which provides a raw material sourcing advantage for the firm. This segment does not affect our moat rating for the consolidated business, though, because the specialty products division accounts for less than 10% of total revenue.

We believe the low- to midteens ROICs achieved by the firm on average over the past 10 years (generally in line with the levels we forecast over the next five years) stem from its asset-light business model rather than from any sort of competitive advantage. In our opinion, this adds complexity to the supply chain and detracts from the firm’s competitive position, even though it keeps fixed costs low.

None

Economic Moat

Church & Dwight

Church & Dwight Co., Inc. engages in the development, manufacture, and marketing of household, personal care, and specialty products. It operates through the following segments: Consumer Domestic, Consumer International, Specialty Products, and Corporate. The Consumer Domestic segment offers household products, such as laundry detergents, fabric softener sheets, cat litter, and household cleaning products, and personal care products including antiperspirants, oral care products, depilatories, reproductive health products, oral analgesics, nasal saline moisturizers, and dietary supplements. The Consumer International segment sells personal care products, household and over-the-counter products in Canada, France, Australia, China, the United Kingdom, Mexico, and Brazil. The Specialty Products segment consists of sales to businesses which participated in different product areas, namely animal productivity, specialty chemicals, and specialty cleaners. The Corporate segment includes equity in earnings of affiliates from Armand and ArmaKleen in 2021, 2020 and 2019. The company was founded by Dwight John and Austin Church in 1846 and is headquartered in Ewing, NJ.

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