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Clorox: A Simple Business That Is Highly Expensive!
Posted by: Riddhi Kharkia (IP Logged)
Date: July 10, 2014 09:25AM
How would the idea of going on an adventure without any safety equipment whatsoever sound to you? Many would call it completely absurd. While investing in stock markets is not completely an adventure, it is definitely an activity that entails some risk and calls for some safety measures. It is always prudent to have some safe investments in your portfolio that allow you to trade with confidence and satisfaction. The Clorox Company (CLX) is one such safe stock that carries on a pretty simple business and generates healthy returns.
Simplicity is this business’s best feature
One of Peter Lynch’s investment principles is to invest in an idea that can be illustrated with crayons. Clorox more than fulfils this parameter with a comprehensible business model. It manufactures various consumer products for daily sanitation and hygiene, the demand for which is relatively inelastic. Such inelasticity shields the business from major revenue swings during periods of recession. Its flagship bleach product enjoys a favourable reputation across the globe, ensuring a sustainable revenue stream. Recently, the company launched a concentrated version of its famous bleach, and this new product is gaining traction in the consumer market.
Competition has affected results
For the past few years, Clorox has been operating with a gross margin of over 40% by following a disciplined expense management system. In the most recent quarter, the company's gross margin declined by 30 basis points to 41.8% of sales. As was pointed out by the management, the market share of Clorox decreased by 0.3 points as compared to the last quarter, highlighting the intense competition in the industry.
The sales for the third quarter decreased by 2% (including the impact of negative foreign currencies). The only segment that showed promising growth for the company was the household segment wherein volume grew by 5% and sales grew 4% driven by the growth in its Kingsford and Glad products. Turning now to the cash position, Clorox has generated year-to-date free cash flow of $346 million which compares with $352 million generated in the same period last year. It is still a comfortable cash position for the company and with the management focusing sharply on reducing costs using innovation and planning, it can be safely presumed that Clorox will exit fiscal 2014 in accordance with expectations around cash.
Is Clorox a value generator?
As per the Q3 earnings call, Clorox repurchased about 1.5 million shares of common stock at a cost of about $130 million Also, the management has committed to channel any funds lying unused in M&A environment to fuel dividends and share repurchases.
Since the recession of 2008, U.S. markets have been experiencing higher level of volatility. During such times, it is prudent to invest in stocks that create reasonable value for shareholders. Clorox is a valuable company in that regard as it has created impressive value for its shareholders via its dividend policy. It declared a total dividend of $2.48 per share in 2012, an increase of 188% from the $0.86 per share that it offered in 2002. The company has consistently kept its dividend pay-out ratio below fifty percent in order to build up cash for capital expenses. Recently, the company has been piling cash in order to finance its bolt-on acquisitions.
A leader in consumer products, Procter & Gamble (PG) offers an array of packaged goods. At the beginning of 2013, it sold out a portion of its bleach business to its counterpart in the Italian joint venture that it has operated with the Angelini group. The company cited its concern in terms of market reach for its bleach products as a reason for the divestiture. Like Clorox, Procter & Gamble has also maintained a healthy dividend policy and it trades at a lower price-to-earnings (forward) multiple than Clorox. Apart from a reasonable valuation, it also possesses strong financials. Its current debt-to-equity ratio stands at 0.48, which is quite impressive considering the fact that it operates in multiple categories and also returns a sizable amount of cash to its shareholders.
In contrast, Colgate-Palmolive (CL) carries an expensive price tag at a forward multiple of around 21x and a PEG ratio standing at 3.32. One of the company’s biggest strengths is research and development which enables it to launch new products on a consistent basis. In fact, Colgate-Palmolive has seen double the growth of Clorox in terms of revenue over the past decade owing to its innovative practices and plethora of products. In terms of future outlook as well, Colgate-Palmolive is better positioned to offer future sales growth of around 3% and an EPS growth of around 10.90 %. In contrast, the future estimates for Clorox with regard to earnings growth stand at a petty 3.95%.
As I mentioned in the beginning, Clorox is not an adventurous stock with wide swings or complicated developments. The company is a leader when it comes to creating shareholder value. Market analysts have recently criticized Clorox’s valuation and in certain sense, I believe that it is slightly overvalued at the current price level. The company has a price-to-book value ratio of around 223, a scary number when compared to industry peers. Even though the company has been performing well in the household segment, other business units especially laundry services have remained stagnant over the past quarters
While Clorox might be a worthy stock for your portfolio any day, it is not advisable to take a new position in the company right now. In my opinion, a quarter’s wait is worthwhile as the company attempts to implement its strategies around innovation, cost-cuts and pricing reforms.
Stocks Discussed: CLX, PG, CL,