Kraft Heinz Model Challenged by Arm & Hammer Maker

(Bloomberg Gadfly) -- As the biggest packaged-food companies scramble to post satisfactory growth figures and maintain grocery shelf space -- potentially by resorting to risky acquisitions -- it's useful to look across the aisle at consumer-goods maker Church & Dwight Co.

It's been 171 years since brothers-in-law Dr. Austin Church and John Dwight began selling baking soda to the masses, forming what has grown into a $12 billion consumer-products company with a brand that continues to be a household name: Arm & Hammer.

Church & Dwight ranks at best No. 3 in terms of North American market share in its product categories, which are dominated by Procter & Gamble Co., Colgate-Palmolive Co., Clorox Co. and Unilever. Still, the Ewing, New Jersey-based company is admirable in other ways: It knows itself and is managing to grow the business without overburdening its balance sheet. This disciplined approach could serve as a lesson for Church & Dwight's overanxious friends in the food department. 

Leading brands in the U.S. are fighting to protect their premium real estate on supermarket shelves as millennial consumers shake up the marketplace. Church & Dwight is no different -- it's had to ramp up promotions for its laundry products this year and sacrifice some margin, for example. But while the company is plagued by the same challenges as everyone else, it looks to be comfortable posting steady if small revenue and profit gains, even though it knows it could deliver far more impressive figures temporarily via big acquisitions. 

Church & Dwight's strategy contrasts with that of Kraft Heinz Co., the packaged-food manufacturer that's managed by folks from 3G Capital. The private equity firm is known for being ruthless cost-cutters with a preference for megadeals over investing in internal growth opportunities that may take longer to pay off, but also may be longer-lasting. Kraft Heinz's high-return, short-term-oriented method has set a new bar for its peers in terms of growth, forcing the industry to chase after unsustainable standards that may be harmful to other stakeholders -- e.g. employees and the towns they hail from, as well as creditors. 

On an unadjusted basis, Kraft Heinz's net debt of about $30 billion is quadruple the Ebitda it generated in the past 12 months -- and analysts are projecting that Ebitda is nearing its peak for the next few years, unless Kraft Heinz does another big deal. It probably will. 

Last month I warned that Kraft Heinz's rivals may soon jump on the M&A bandwagon, now that the industry is beginning to feel the added pain of Amazon.com Inc.'s takeover of Whole Foods Market Inc. And this will only be exacerbated by more supermarket mergers, rumors of which have begun to bubble up just this week. There's nothing inherently wrong with exploring transactions, and it's important to protect market share and meet consumers' changing needs, but the risks are in overpaying and taking on a unsettling amount of debt. Just look at Hain Celestial Group Inc., which has an activist shareholder pushing for a sale at valuations that would rank among the most expensive ever for a maker of food and consumer products. 

Church & Dwight, meanwhile, is chugging along with 2 percent to 3 percent organic growth and a clean balance sheet. Its acquisitions have been small but solid, though it did recently close its largest purchase ever, Water Pik oral water flossers and showerheads for $1 billion in cash. That raised its debt-to-Ebitda ratio to 2.5, but it's expected to drop back to below 2 by mid-2019. It's also continually investing in the Arm & Hammer brand to deliver new products. Ironically, it's for these reasons and more than Church & Dwight could find itself stalked by these same desperate acquirers.

But the company is a reminder that we should step back and ask, what's wrong with humble, steady growth for huge companies if their businesses are healthy, durable and support the communities around them? We're approaching a period where the long-term health of businesses and entire industries may be starting to become afterthoughts to unrealistic expectations of growth and stock-price gains. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

To contact the author of this story: Tara Lachapelle in New York at tlachapelle@bloomberg.net.

To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net.