2023-12-01 09:00:00 ET
Summary
- Clorox is a leading consumer goods and household products manufacturer with a diverse portfolio of popular brands.
- The company holds a significant market share in various categories, including bleach, charcoal, trash bags, salad dressings, and multi purpose cleaners.
- Clorox has faced challenges in terms of margins and profitability due to increased input costs, but is implementing cost-cutting measures and product innovation to address these issues.
Investment Thesis
The Clorox Company ( CLX ) stands as one of the world's leading consumer goods and household products manufacturers. They are the creators and owners of numerous household brand items, including Clorox wipes and bleach, Burt's Bees brand, Glad trash bags, Hidden Valley Ranch dressings and seasonings, Kingsford charcoal, Brida, and many more.
Their products reach over 25 countries, and an impressive 80% of their portfolio holds either the #1 or #2 market share position in their respective categories. In fact, Clorox claims that 9 out of 10 U.S. homes have at least one of their products.
Morningstar analysts reveal that CLX commands a remarkable 70% market share in the bleach market, half of the charcoal market, and a third of the trash bag market. They also lead the way in salad dressings, multipurpose cleaners, and water filtration.
If it wasn't already clear, Clorox's durable competitive advantage (MOAT) stems from its extensive and diversified product offerings.
While Clorox boasts a strong product portfolio, it's not all sunshine and roses. The stock has been facing challenges, and its year-to-date (YTD) performance is essentially flat. In fact, the stock has experienced negative returns over one, three, and even five-year time horizons.
A key reason for the stock's struggles is the contraction in margins and profitability. Rising input costs and price undercutting by private labels have eroded Clorox's premium brand pricing. However, Clorox has recognized these concerns and the stagnant growth, prompting the launch of the "ignite" initiative. This initiative aims to slash costs, enhance supply chains, and introduce groundbreaking new products to the market.
CEO Linda Rendle, whom I hold in high regard, reaffirmed the company's unwavering commitment to its long-term strategies:
- Product Innovation: The activation of our plans on consumer-centric innovation remains on track. Investment in bigger, stickier innovation platforms focused on value superiority is core to how we drive growth, and we continue to expect launches across all our major brands this fiscal year.
- Brand Investments: We continue to build our brands and execute merchandising plans supported by ongoing investment in advertising and sales promotion to drive consumers to our portfolio of trusted brands.
- Cost Savings: We will also continue to lean into our hallmark cost-savings program, building off the record savings achieved last year and the strong performance in this past quarter.
- Transformation: We are also advancing our digital transformation and streamlined operating model to create a more consumer-obsessed, faster and leaner company to support our objectives of driving greater productivity and growth.
Despite CLX's recent struggles, I believe the stock still holds promising opportunities. After a turbulent September and October, the market has experienced a resurgence. CLX has rebounded 20% from its 52-week low and YTD low of $115 on November 1st. However, given the recent surge and the diminished risk-to-reward ratio, I am compelled to maintain a "hold" rating on the stock at current levels.
Management is taking decisive steps to revitalize and enhance operations. They are optimizing supply chains, implementing cost-cutting measures, introducing innovative product offerings, and even unveiling a new direct-to-consumer option through Clorox.com .
Overall, I view Clorox, a near-dividend king, as a compelling long-term value play for investment portfolios. The company's strong brand recognition, diversified product portfolio, and strategic initiatives position it well for sustainable growth and shareholder value creation.
Fundamentals
Overall, Clorox's cash flow and balance sheet are improving, gradually.
Three key aspects to consider when analyzing CLX are:
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CLX currently carries a debt burden of $3.2 Billion , a similar level to that of 2020. I anticipate debt reduction to below $3 billion within the next 2-3 years.
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CLX generates $795 million in free cash flow ((FCF)), translating to an FCF-to-net revenue margin of 12.6%. Management' target range is 11%-13%. This $795 million in FCF equates to an FCF yield of 4.5%, which is relatively strong compared to competitors, enabling CLX to reinvest in the company.
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CLX has reduced its share count by approximately 3% over the past five years. However, since mid-2021, Clorox's share count has increased by nearly 2 million shares, representing just over a 1% rise.
Investors are eagerly awaiting even incremental improvements. Management is finally gaining a grasp of the situation and initiating a turnaround. With a consumer staple like Clorox that provides everyday household essentials, investors prioritize pricing power and cash flow, both of which are at the forefront of Clorox's focus.
Improved cash flow and earnings are paramount for all investors. CLX maintains a robust dividend yield of nearly 3.5%, or $4.50 per share, and has consistently increased its dividend for 47 consecutive years. However, due to past missteps and lost profits, the payout ratio is gradually creeping up. Investors will closely monitor management's enhanced focus on efficiency and cost-cutting measures to determine the extent of potential savings.
The final aspect of Clorox's fundamentals to consider is its margins. As mentioned earlier, the company has faced significant margin pressures due to rising input costs from inflation and customer price undercutting. The chart below illustrates the contraction of operating and net income margins, which has contributed to the stock's underperformance.
Clorox is actively addressing these issues and has set an annual goal of improving adjusted EBIT margin by 25-50 basis points each year. Despite recent margin contractions, Clorox still maintains near or above sector median margin levels, excluding the exceptional net income dip experienced this past year due to a cyber attack .
Given CLX's history of above-average sector margins, let's now delve into valuations and price targets.
Valuations and Price Targets
Clorox currently trades at a 31x 2024 price-to-earnings (P/E) ratio and a 24x 2025 P/E ratio. Historically, CLX has averaged a 29x 5-year P/E, while the sector median is only 17.3x. Considering CLX's dominant market share in its respective categories and historically superior margins, it's reasonable for it to trade at a premium to its peers.
While the stock appeared undervalued in early November, its current valuation seems more aligned with fair value. The P/E chart clearly illustrates this recent shift.
Management and analysts anticipate mid- to high-single-digit sales and EPS contractions for CLX in 2024. Therefore, using 2025 estimates for calculations is more prudent. Employing Clorox's historical valuations for P/E and enterprise value to sales (EV/S), along with analyst estimates for revenue growth and EPS, I constructed a next twelve months (NTM) price target table with bull, base, and bear scenarios.
However, it's important to note that a lackluster fiscal year 2024 could lead to stock stagnation or underperformance for the year. On the other hand, better-than-expected results, indicating a less severe slowdown than anticipated, would undoubtedly drive the stock higher, potentially back towards the $160s and the 52-week high of $178.
My price target scenarios are presented below:
CLX NTM Price Target Scenarios (Author Calculations Based On Analysts Estimates From Data On Koyfin)
As you can see, my base case fair value for CLX suggests a slight discount (6.7%) to its current trading price. Using my bull and bear case scenarios, I calculate a 2.2x risk-to-reward (R:R) ratio at current levels. I generally seek a minimum R:R of 3x when initiating a position in a stock.
Prior to November, CLX presented an attractive opportunity: a cheap valuation for a great company with exceptional products. While the company remains strong with an impressive and expanding product portfolio, its valuation has lost some of its former appeal.
For value investors, I recommend implementing a dollar-cost averaging (DCA) strategy, gradually accumulating shares over the next three months or so. Consider purchasing a few shares each week or with each paycheck. Establishing a long-term position under $145 allows you to benefit from the company's nearly 3.5% dividend yield.
Clorox is a top-tier consumer staple company and should undoubtedly be considered when constructing a diversified value portfolio.
Risk
To succeed in the market, one must embrace risk. We've already discussed CLX's valuation risk to some extent, so I'll refrain from repeating it here. However, long-term investors should consider a few key risks before establishing a position in CLX.
Firstly, the company's stock exhibits cyclicality, as we've witnessed in recent years.
Consumer staples are typically considered defensive, right?
Yet, as consumer spending contracts, consumers tend to forego premium brands in favor of cheaper knock-offs from Walmart ( WMT ) or Dollar Tree ( DLTR ).
Not only does the shift in consumer spending habits pose a risk, but Clorox also faces intense competition from discount retailers and private-label companies offering competitive products. Increased competition generally drives margins down over time, and private labels, unlike publicly traded companies, don't face the pressure to please shareholders. This allows them to lower prices without worrying about profit levels or shareholder dividends.
Finally, input cost volatility significantly impacts earnings and the stock's performance. This is another scenario that has impacted CLX's earnings in recent years. Higher input costs typically lead to higher prices for consumers, which drives them towards lower-priced private-label brands.
Conversely, lower input costs allow CLX to enjoy margin growth, flexibility, and enhanced pricing power.
Conclusion
After careful consideration, I believe that for risk-averse long-term value investors, a small position in Clorox is a sound choice. They have established a formidable product portfolio that dominates households across kitchens and homes. The company's balance sheet and cash flow are exhibiting signs of improvement, and I, as an analyst, will continue to monitor these developments closely.
With near-dividend king status, respectable cash flow figures, and management's unwavering commitment to pursuing their objectives, cost-cutting measures, and product innovation, I anticipate that investors will find holding CLX over the next five years to be a more rewarding experience than the past five.
Adopt a gradual approach to building your position in CLX, as better prices may emerge in the future. However, remember that investing in and owning CLX is a long-term endeavor. Clorox offers significant value and is proactively exploring avenues to expand its product offerings and enhance profitability.
For further details see:
Clorox: One Of The Best Household Product Portfolios