2023-10-28 09:00:00 ET
Summary
- Clorox is a leading provider of cleaning products in the United States.
- High inflation and decreased demand have put pressure on the company's top and bottom lines.
- The latest preliminary results suggest that the worst is not yet over.
- Despite the attractive valuation, I assign a HOLD due to headwinds.
Investment Thesis
Clorox ( CLX ) is perhaps the most well-known cleaning product in the United States. The company owns products with high penetration rates, such as trash bags, bleach, cleaning wipes, etc. Sales peaked during the pandemic due to a spike in demand for cleaning products. However, high inflation and diminishing demand have caused the firm's sales and margins to compress over the past two years. The historic gross margin is 43%-44%; as of the latest quarter, that figure was down to 39.32%.
Clorox's moat is derived from its intangible assets. In 2022, CLX was the third-leading home care brand in the U.S., with 70% in the bleach market. I think it's safe to say that every American has used or is familiar with Clorox products, given that 80% of its sales are from the U.S. Now, let me explain the other part of my thesis. Why assign a HOLD if the company is undervalued, has a great brand, and products with a high penetration rate?
Well, margins and revenue aren't the only figures that have taken a hit lately. It's also the firm's return on invested capital, which is one of the main things I look at in companies. Over the past decade, CLX's ROIC has been stable around the high twenties, but as of the last two years, it has taken a significant hit. The decline started soon after a new CEO was appointed .
Additionally, as the company increases prices to try and combat inflation, this could result in customers switching to other cleaning products. I believe it's highly unlikely that consumers will switch from CLX, but it's possible. Inflationary times are when companies' brands are really put to the test, whether consumers find value in your products or not.
On October 4th, CLX released preliminary results of first-quarter earnings, which caused the stock to drop by 5% the following day. The company said it expects Q1 24 revenue to decrease by 28% to 23% from the year-ago quarter, ADJ EPS of -$0.40 to $0.00, and gross margin to be down from the year-ago quarter compared to the company's prior expectations for gross margin to be up.
Business Summary
Since its divestiture from P&G in 1969, Clorox has grown into a $15 billion company, generating more than $7.2 billion in annual sales (FY2023). The company offers consumers a wide set of products, such as trash bags, cleaning supplies, cat litter, and more, in more than 25 countries. The firm drives revenue from four main segments, as you can see below.
Cleaning product sales to retail make up about 30% of its domestic and roughly 40% of its international sales. Walmart is CLX's largest customer, accounting for 26% of annual sales. Clorox's five largest customers accounted for nearly half of the company's consolidated net sales for FY 2023. As I said, CLX's competitive advantage is mainly derived from its brands.
The company has also been operating for more than 100 years, Being such a veteran Clorox has been able to capture a big part of the market for itself. The company has roughly 70% of the market share in the bleach market.
Valuation
CLX's stock is down by ~14% YTD at the time of this writing ($122.80). The company is trading at a forward PE of 26.55x the FY24 consensus of $4.63 and 20.29x the FY2025 consensus of $6.05. On a trailing free cash flow basis, the stock yields over 5.1% relative to its enterprise value.
My base scenario includes revenue growing by 3.6% from FY 2024-2032, driven by price increases and moderate demand. I have a gross margin expanding by 16 bps annually over the same period as inflation cools down and price hikes start to show up in the financials. I used a WACC of 7.00%, a growth rate of 2.00%, and an EV/EBITDA multiple of 14.50x. I picked a growth rate lower than GDP because the industry in which CLX operates doesn't offer much growth potential. As for the multiple, it is a discount to the FWD multiple and TTM.
Other assumptions include an S&A margin of 17%, an advertising margin of 10%, an R&D margin of 2%, and a tax rate of 20%. These assumptions are based on historic figures. I arrived at a value per share of $132 using the perpetuity growth method and $141.32 using the exit multiple method. Taking the average of both methods, I arrived at a value per share of ~$137, translating into a 10% return from the price of this writing.
My downside scenario includes revenue growing by 2.6% from FY 2024-2032, driven by price increases and moderate demand. I have a gross margin expanding by 10 bps annually over the same period as inflation cools down and price hikes start to show up in the financials. I used a WACC of 7.00%, a growth rate of 1.50%, and an EV/EBITDA multiple of 13.50x.
Other assumptions include an S&A margin of 17.5%, an advertising margin of 10.5%, an R&D margin of 2.5%, and a tax rate of 22%. These assumptions are based on historical figures. I arrived at a value per share of $104.11 using the perpetuity growth method and $123.21 using the exit multiple method. Taking the average of both methods, I arrived at a value per share of ~$132, translating into an 8% downside from the price of this writing.
Risks
The company's biggest headwind is inflationary pressure, which has slightly eaten into its margins. According to the latest preliminary results, the company's gross margin is still struggling, so the pain is not yet over. This pressure isn't only in the U.S.; CLX also operates in Argentina, with record inflation levels of more than 100%. Other risks include competition and debt (a net debt/EBITDA ratio of 2.00x).
Takeaway
In conclusion, Clorox is a business with a strong moat, but the company faces headwinds such as inflation that have put pressure on its bottom line. Despite the attractive valuation, I would stay away from the company for now, but I will keep it on my watchlist, and should things start to improve, I will upgrade my rating. Until then, I assign a HOLD.
For further details see:
Clorox: Undervalued But Too Many Red Flags