Spruce Point Capital Management Releases A Strong Sell Research Opinion On Church & Dwight Co., Inc. (NYSE: CHD)
NEW YORK, Sept. 5, 2019 /PRNewswire/ -- Report entitled "Arm Yourself To Get Hammered" outlines how Church & Dwight faces 35-50% downside risk to approximately $40 to $52 per share. The report explores how a material change in management culture and strategy has resulted in poorly-executed levered acquisitions, numerous aggressive accounting practices, and substandard corporate governance practices.
- A Culture Lost – Acquiring Brands As Financial Tools: Church and Dwight developed a reputation over time as a strong operator and smart acquirer of leading consumer brands in the United States. This strategy was successfully overseen by former CEO Jim Craigie, an old-school marketer who spent his early career learning consumer products at Kraft. In 2016, Craigie retired from C&D, the first in a number of executive exits that would soon follow. The current team is led by CEO Matt Farrell CEO, former C&D CFO and, previously, EVP and CFO of accounting-plagued Alpharma Inc. One former long-time C&D executive with whom we spoke referred to Farrell and Rick Dierker, CFO, as "financial magicians," and stated that their leadership ushered in "a deemphasis on manufacturing, R&D and supply chain investment in favor of greater financially-engineered acquisitions." Another former executive stated, "we lost the culture, lost the focus on brand and innovation and speed to market as far as I'm concerned" and "it's hard to convince the retail trade that the math [financially motivated acquisitions] makes good business sense because the customers sell brands, sell product solutions, they sell innovation, they're consumer-centric".
- Long-Term Growth Increasingly Dependent On A Poorly Executed-Acquisition Strategy: With the exception of anchor brand Arm & Hammer, all of C&D's "Power Brands" have been acquired since 2001. Per C&D management's own suggestions and confirmed by our research, we believe that 6 of the 10 acquisitions should be categorized as failures. With the shift in M&A strategy under the current management team, C&D's acquisitions have grown increasingly questionable. C&D paid $1 billion for Waterpik, an asset that has been passed around by private equity owners more than once, and which is already showing declining sales and margins. FLAWLESS, Farrell's other large acquisition, is believed by former employees to be a poorly-regarded and unproven hair product removal brand: one former executive told us, "Dump it! Oh God! Horrible, Horrible." As the businesses targeted and prices paid by management have grown increasingly perplexing, so has the structuring and accounting of the deals themselves. Our forensic analysis suggests that both recent deals are showing signs of struggles, and identifies several accounting anomalies associated with both. We believe that management's track record casts doubt on C&D's new approach to M&A, the linchpin of the company's current growth strategy.
- Signs Of Financial Strain, Aggressive Accounting And Management Self-Enrichment: While management would like investors to believe that the Evergreen Model's growth "algorithm" is on autopilot, slowing dividend growth and worsening cash conversion suggest otherwise. We believe that management's response to these challenges has been to attempt to financially engineer higher growth through a combination of greater receivable factoring, oddly-structured M&A, an undisclosed acquisition, and one-time gains to EPS. Conveniently, none of management's annual cash incentive targets are modified to correct for the flattering presentation of financials. Furthermore, we are unable to reconcile the company's reported financials with the "adjusted" metrics through which management hits its bonus targets.
- Slower Growth And Poor Earnings Quality To Drive Multiple Contraction: CHD stock has prospered from investors' flight to defensive equities: its valuation multiple is presently at an all-time high, and the stock trades at an 8% premium to the average analyst price target. C&D's stock is valued at 5x, 22x, and 32x 2019E Sales, EBITDA, and EPS, respectively – a significant premium to its peer group for a few extra percentage points of potential growth, which we believe the acquisition strategy will fail to deliver. In our opinion, the risk / reward is not favorable in light of future growth challenges and accounting shenanigans that could necessitate a financial restatement. Valuing C&D at peer multiples on our financial metrics – adjusted to reflect its mediocre brand portfolio, weak management, substandard governance practices, and failing acquisition strategy – we can justify a price range of $40 – $52 (35% – 50% downside).
The research note can be found at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
Spruce Point Capital has a short position in Church & Dwight Co., Inc. (CHD) and stands to benefit if its share price falls.
