Dr Pepper, Church & Dwight: A Household-Name Pair Trade

Morgan Stanley advocated a pair trade in Dr Pepper Snapple Group Inc. DPS and Church & Dwight Co., Inc. CHD, and accordingly upgraded the shares of the former and downgraded the shares of the latter.

Similar On Many Counts

Analysts Dara Mohsenian, Bob Doctor and Filippo Falorni noted both companies are similar on many counts, including being mid-sized, U.S.-skewed companies that have prospered in low growth product categories against much larger competitors, led by strong management teams.

The analysts said their pair trade call is driven by their belief that the two companies have fairly similar fundamental outlooks, with slightly more perceived strategic potential at Church & Dwight.

Notwithstanding this, the analysts noted that the shares of the company trade at a clearly too high 35 percent calendar year 2018 P/E estimate and 28 percent calendar year 2018 EV/EBITDA estimate premium to Dr Pepper Snapple.

Morgan Stanley believes there are three market inefficiencies, offering investors a strong entry point into a pair trade.

1. First, the firm believes the market has priced in too much risk from the Bai acquisition into Dr Pepper Snapple stock.
2. Second, the firm believes the market is giving Church & Dwight too large a potential consolidation halo post the Unilever plc (ADR) UL bid, given limiting company specific factors at Church & Dwight that it believes the market is not fully considering.
3. Third, the firm doesn't believe the market has fully priced in improving Dr Pepper Snapple fundamentals over the last couple of years, nor a deteriorating Church & Dwight outlook.

Rating Action

Morgan Stanley upgraded shares of Dr Pepper Snapple to Overweight from Equal Weight, while at the same time downgrading shares of Church & Dwight to Underweight from Equal Weight.

Given the fundamental and strategic factors, the firm raised its price target for Dr Pepper Snapple to $104 from $103, at the high end of its $95–105 one-year forward DCF value. Meanwhile, the firm lowered its price target for Church & Dwight to $49 from $51.

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