2023-03-20 12:00:44 ET
Summary
- Clorox’s price increases and cost-cutting should help it deliver margin growth.
- However, sales trends are mixed, with price increases getting offset by declining volume and FX headwinds.
- Valuation is expensive.
Investment Thesis
The Clorox Company's ( CLX ) revenue outlook is mixed, with price increases helping sales, while adverse FX and volume decline due to moderating demand post-pandemic and lower consumer confidence in an inflationary environment adversely impacting it. Margins are much lower than pre-pandemic levels and should improve thanks to price increases and cost-saving initiatives. However, much of this margin improvement seems to be already priced in at the current levels, with the stock trading at a higher valuation than its historical averages. Hence, I have a neutral rating on the stock.
Revenue Analysis and Outlook
I previously covered Clorox in December and talked about how the normalization of demand for its cleaning and disinfectant products and supply chain disruptions are impacting the company's sales. The company is raising prices to offset some of the sales slowdowns and cover inflationary costs, but it is further impacting its sales volume. The company has reported its Q2 2023 results since my previous coverage, and similar dynamics were seen there as well. The company's revenue increased 1% YoY in Q2 2023, with 4% organic sales growth offsetting 3% of the FX headwind. However, more of this increase in organic sales growth was due to a significant price increase, which provided a 14% boost to sales. The volume, on the other hand, was down 10%.
Additionally, sales growth in the quarter was further bolstered by the pull-forward of sales in Q2 due to a shift in the timing of merchandising activity and an unexpected early start to the cold and flu season, which typically occurs in January and February, coinciding with Clorox's Q3.
Looking ahead, I believe demand moderation, volume decline, and unfavorable foreign exchange rates should continue to pose significant headwinds for the company's sales growth in the near term.
As mentioned previously, demand for CLX's cleaning products is moderating as the vaccinated population is less concerned about catching infections and is not prioritizing cleaning needs as much as they were during the pandemic. While cleaning products are daily essentials, stocking up or buying these products on a regular basis is no longer at the top of consumer shopping lists, and this is expected to have a continued adverse impact on CLX's sales growth in the upcoming quarters.
In addition, the sales in Q3 2023 are likely to be negatively impacted by the pull-forward of sales into Q2 due to the early start of the cold and flu season and the shift in the timing of merchandising activity.
Furthermore, CLX's premium pricing and price gap versus its peers are expected to result in additional revenue headwinds. The company's significant pricing increases over the last year are expected to result in additional volume declines. In an inflationary environment where consumer confidence has decreased significantly, CLX's high pricing could prompt consumers to trade down to other brands or private labels, leading to further volume declines and negatively impacting sales growth in the near term.
Offsetting this volume decline is double-digit price increases, and management has guided for 2% to 3% organic growth in Q3 FY2023, helped by price increases. This is slightly lower than the second quarter's 4% organic growth rate. For the full year, management has guided for flat to 3% organic growth, but the total sales growth should be closer to flat as there are forex headwinds. Overall revenue outlook remains mixed in the near term, with CLX sales benefitting from price increases but seeing volume decline and market share loss versus low-price peers.
Margin Outlook
CLX's gross margin has significantly declined from pre-pandemic levels due to higher commodity, manufacturing, and logistics costs and higher digital investments. However, in the second quarter of fiscal 2023, the significant Y/Y price increases (a benefit of 680 bps Y/Y) and cost savings (a benefit of 170 bps Y/Y) more than offset the impact of inflationary costs. This resulted in gross margin improvement, increasing 320 bps YoY to 36.2%.
While the company continues to experience cost increases in most of its commodities, such as soybean oil , liner board , and chemicals , and expects $400 million of total inflation in this fiscal year, pricing actions should be able to offset it to a good extent. The company has also launched cost-saving initiatives at the beginning of fiscal 2023, aiming to reduce costs by $75-$100 million through reducing headcounts and decentralizing decision-making. These initiatives should allow the company to respond quickly to changing consumer behaviors and improve productivity.
The company's current margins are meaningfully below pre-pandemic levels, considering gross margins were 43.9% in FY2019 and adjusted operating margin was 18% in FY2019. Management is focusing on increasing them back to pre-COVID levels. The company's pricing increases and cost-cutting initiatives are bearing fruit, and I believe margins should continue to improve sequentially from here, given we are at meaningfully low levels compared to the company's historical margin levels. So I am optimistic about margin improvement prospects.
Valuation and Conclusion
Clorox is currently trading at 36.44x the FY 2023 consensus EPS estimate of $4.23, which is above its historical 5-year average forward P/E of 27.51x. I find it pricey, given the company's mixed revenue growth outlook. One of the reasons investors might be giving such a premium multiple for the company is their expectations of a swift margin recovery next year, which should result in meaningful EPS growth. But even if we look at the company's P/E valuation on the FY2024 consensus EPS estimate of $5.36, it comes to around 28.71x, which again is a slight premium to its 5-year average forward P/E. I believe most of the margin recovery prospects are already getting priced in at this level. Hence, it is best to remain on the sidelines, and I have a neutral rating on the stock.
For further details see:
Clorox: Good Margin Improvement But Mixed Revenue Outlook And Expensive Valuations