2023-07-05 22:04:44 ET
Summary
- The Clorox Company's shares have underperformed against the S&P 500, raising questions about its investment potential. The company's dividend yield is lower than the risk-free rate, with little growth expected.
- The $445 million write-down has caused income to plummet, but gross profit has increased by only 2.6% since 2019. This is not a "growth" company.
- The current valuation of Clorox's shares is considered unattractive for investment. I recommend avoiding.
It's been about 8 months since I wrote my cautious note about The Clorox Company ( CLX ), and in that time the shares are up about 15.75% against a gain of about 18.2% for the S&P 500. This slight underperformance has me a bit intrigued, so I thought I’d review the name today to see if it’s worth buying or not. I’ll make this determination by looking at the most recent financial performance and comparing that to the valuation. Also, since everything in investing is relative, I want to pay particular attention to the dividend, and work out the probability that it’ll grow over the coming years. If the dividend can grow, I won’t mind receiving about 210 basis points less on the yield today, but if it’s likely stuck, then there’s no point in taking on more risk and receiving less income in my view.
We’re all very busy people. I’m sure many of my dynamic and interesting readers are planning amazing vacations to exotic locations, or working out whether to take the private jet or helicopter out for a spin. For my part, I’ve got a Dungeon’s & Dragons game to plan, so time presses us all. For that reason, I write a “thesis statement” near the beginning of each of my articles to give investors the ability to get in, read my perspective, and then get out before being bogged down by a whole 1,600 word article. You’re welcome. I’m going to continue to eschew Clorox, and I would recommend doing the same. I think the reasons are fairly straightforward. The dividend yield is lower than the risk free rate, and I think there’s little reason to think the dividend will grow much from current levels. Thus, investors are paying too many units of risk while receiving too little potential return. That’s never a great idea in my view. If the shares were very cheaply priced, I may be willing to look past this relative unattractiveness on the part of the stock, but they’re not. The shares of this low grower remain premium priced. I think this will end badly, and I’d rather not be at that party when things go sideways.
Financial Snapshot
I think the most recent financial performance was “middling to bad.” While revenue budged a bit higher than it was in 2022, net income absolutely collapsed, down to a loss of $20 million. This was obviously the result of a $445 million writedown. For some reason investors treat such things as irrelevant instead of what they are: the sins of overpayment coming home to roost. That written, I would acknowledge that gross profit rose nicely, up about 9% from the year ago period. I think it’s also worth noting that although revenue is up nicely from the pre-pandemic period by 17%, gross profit has barely budged, up only about 2.6% when compared to 2019. So, I wouldn’t characterise this as a growth company by any means.
One thing I am somewhat happy about is the fact that the company seems to have managed to hold the line on debt. This is alarmingly rare at the moment in my view.
Dividend Sustainability
Now, I’ve got as much of a fascination for accrual accounting as the next semi-sane finance nerd, but I think most investors are more interested in the future. In particular, they’re interested in the extent to which a dividend can be maintained and can grow. This is obviously because dividends offer a much more predictable stream of cash flows, and that makes planning much easier for people. Additionally, the dividend is supportive of price, so if I get a sense that a dividend is going to be cut, I run from the stock. I’m therefore going to spend some time reviewing the viability of the dividend here, while trying to work out whether or not there’s potential for growth.
In order to make that determination, I look at the size and timing of future obligations, and compare those to the most likely net cash flows the company will enjoy in the future. If there’s enough room in the “future kitty”, I become sanguine about dividend growth potential. Let’s start with the obligation. I’ve plucked the following table from the latest 10-K for your enjoyment and edification, and it shows the size and timing of the company’s upcoming financial obligations. This year will be relatively heavy, with the company “on the hook” as the young people say, for $643 million in obligations. Also, 2026 will be a relatively rough year, given the need to come up with $833 million.
Against these obligations, the company has generated an average of $1.07 billion annually in cash from operations from 2017 to 2022, while spending an average of $365 million on the business. I feel obliged to remind readers of the fact that for much of the years 2020 and 2021, everyone in the world seemed to become absolutely terrified of every surface on Earth, so the cash flows to this company were abnormally high during these years. So, if we take the numbers as posted, the company generated an average of about $1.07 billion annually in Cash from Operations between 2017 and 2022. If we change the figures posted in 2020 and 2021 to the average of the previous three years, the average CFO between 2017 to 2022 drops to $919 million. I’m more comfortable using that as a “typical” average, but the reader’s free to rely upon the figures as stated. Both perspectives have some legitimacy in my view.
Anyway, we can see that the company has a good track record of generating between $545 and $635 million in excess cash over the past several years. When we compare this to the obligations, we see that the company has the capacity to meet the vast majority of its obligations from cash typically generated from operations. Thus, there’s no obligation to tap capital markets in my view. Just because the company is in a position to meet obligations doesn’t mean that there’s enough left over for dividend increases, though. I think the thought that there’ll be significant dividend increases at this point is a bit of a fantasy, so I’m going to assume limited or no dividend growth in my analysis. Remember that the payout ratio hit 121% last year, and there’s not much room to grow from current levels in my opinion.
Clorox Net Cash Flows (Clorox 2022 and 2019 10-Ks)
Clorox Financials (Clorox investor relations)
The Stock
If you read me regularly for some reason, you know that I consider the stock and the business to be two different things. For instance, the business generates revenue by selling cleaning products, while the stock is a slip of virtual paper that gets traded around the public markets. This stock represents a claim on the future revenues and profitability of the business, but you wouldn’t necessarily know that from the way the thing pops around in price. Put another way, the stock’s price movements are more volatile than most changes in the underlying business.
In my experience, this volatility is the only source of sustainable profits when it comes to buying and selling stocks. Specifically, I’m of the view that the only way to make money trading stocks is to work out the assumptions that are currently embedded in price, and trade against those assumptions when they are unreasonably optimistic or pessimistic. Paying attention to what’s known by most other investors at the present is relatively useless as current news is already “priced in.”
Additionally, I think it’s worth noting that buying cheap stocks tend to lead to higher returns. Not only are cheap stocks lower risk because they have far less to drop in price, they also offer greater potential reward, because it’s easier for the companies of these stocks to outperform low expectations.
My regulars know that I measure “cheap” in a few ways, ranging from the simple to the more complex. On the simple side, I like to look at the ratio of price to some measure of economic value, like earnings, sales, and the like. I previously eschewed Clorox because the PE was around 42, the market was paying about $2.43 for $1 of sales, and the market was paying 30.84 times free cash flow. That was egregiously expensive in my estimation.
Fast forward to the present, and here’s the lay of the land. The market is paying about 11.5% more for $1 of sales, but it’s admittedly 44% less expensive on a price to free cash flow basis. Note that I’ve excluded PE from my analysis because the massive writedown the company just took has driven earnings negative.
Since I blathered on about the dividend earlier, I should also point out that the current dividend yield is about 210 basis points below the risk free rate . When we add that fact to my view that the dividend won’t grow much from here, that’s troublesome. Investors who buy this stock today are taking on all of the risks associated with stock investing, while receiving less cash for their troubles than they would from a risk free government investment. I’m not sure how it works where you come from, but where I’m from, paying more and getting less is generally a bad idea.
Given all of the above, I think there are better uses for capital at the moment, and will continue to recommend avoiding shares of Clorox until the valuation becomes more attractive. Given that I think dividend growth will be sclerotic from here, the shares are a terrible investment in my view. The yield would have to be higher than government securities on a risk adjusted basis, and these shares are the opposite.
For further details see:
Keeping My Portfolio Clean By Avoiding Clorox