2023-08-15 05:07:13 ET
Summary
- Clorox has pricing power and inelastic demand for its cleaning and household products.
- Sales growth has a minimal impact on the company's stock, but improving margins drive it higher.
- Clorox's ability to raise prices and protect margins makes the stock undervalued.
Clorox (CLX) is a $20 billion market cap, global consumer goods company that specializes in the production and marketing of various cleaning and household products.
During the major part of the last decade, CLX stock price kept pace with S&P 500 (SPX). When Covid hit early 2020, CLX massively outperformed, with cleaning products obviously being a beneficiary of the largest pandemic since the Spanish flu.
This massive outperformance was based on actual improvements to fundamentals. CLX sales growth was 18% during 2020 compared to -1.5% during 2019 and the operating margin went from 18% to slightly above 20%. However, as consumers pulled back on purchases and cost headwinds in commodities and logistics weighed on margins, CLX stock collapsed and during two sessions in 2022, the stock went below $125 per share.
Comeback and pricing power
As CLX fundamentals have started to improve its stock has bounced back. LTM sales growth was at the latest earnings release almost 5% and the operating margin has improved from a trough of 8% during 2022 to an LTM figure of 13.4%. Make note that Pre-Covid (2018-2019) CLX operating margin fluctuated in the 17.8%-18.4% range. So obviously there is still room for considerable improvement.
CLX products exhibit pricing power or inelastic demand, i.e. their products are a necessity for everyday life. So when the company experiences negative price shocks to their cost base (like inflation to labour, commodities and logistics) they are able to raise their own prices towards the consumer without losing the equivalent in value from lower volume. This is why I think it's more likely that CLX is on a margin improvement path than the opposite.
From the latest earnings release gross profit margin is improving, albeit inflation in commodities, labour and logistics is still an issue, my view is that over time these factors will normalise and fade away. Since the best cure for high commodity prices is high commodity prices. Basically, when supply constraints in the commodity space push prices up, suppliers relatively quickly can and will increase production, of course, there is some lag to this process, why an investor needs some patience.
Valuation
For a slow-growing business like CLX, the focus is usually on margin improvement and operational excellence, it's hard to innovate with a material effect on your financials in the kinds of product categories they compete in.
This is why I believe sales growth not to be a major impact on future stock appreciation, although given LTM sales trend, and comparing this with management guidance of 0-2% the stock might receive a bump due to management lowballing sales guidance.
However, the main factor for possible future revaluation of CLX expectations and significant price appreciation possibility in its stock price is margin improvement. For management, it's much easier to improve margins than achieve sales growth, it's much easier to control your costs and mitigate such issues than lure in more customers to buy your products.
Running a diverse range of assumptions in a Discounted Cash-flow model, the stock appears really cheap. Assuming 2% nominal sales growth for the foreseeable future and that the operating margin stabilizes around current levels, the stock has at least a 50% upside. On the downside, if margins were to collapse and the company achieves no sales growth I calculate a 20% fall from the current level.
For further details see:
Despite Earnings Rally, Expectations On Clorox Are Low