Overview
"The first thing I'm going to do as president is I am going to Clorox the Oval Office."
- Sen. Kirsten Gillibrand
It was last week during the Democratic presidential primary debate in Detroit that presidential candidate Sen. Kirsten Gillibrand made the above statement that incorporated the word "Clorox" (CLX). In no time, the remark sparked reactions on social media.
The power of "verbification" of a brand or product name is widely applauded by marketers. The verb status signals a large scale of recognition and use of the product as well as builds a significant barrier to entry. The brand always sits on the top of people's minds in the category, just like "Google" (GOOG)(GOOGL) in terms of online search, which even has an official entry as a verb in the Oxford English Dictionary -- "Don't hold your breath waiting for that to happen to Bing," Peter Thiel and Blake Masters wrote in their book, "Zero to One: Notes on Startups, or How to Build the Future."
Despite the short history of being a verbified brand (compared to Google), Clorox has put consistent effort and focus on building, enhancing and acquiring top brands. More than 80% of the company's sales are generated from brands that hold the No.1 or No. 2 market share positions in their categories.
Founded in Oakland, California, as a "bleach startup," Clorox Co. is now a leading multinational manufacturer and marketer of a diversified portfolio of consumer and professional products, including bags and wraps, cat litter, water filtration and even dietary supplements.
Economic moat
If you live in the U.S., as you can see below, major brands (by revenue) owned by Clorox are so well recognized that you cannot even think of any peer in the category -- for example, Glad food wrap, Brita water filters and of course, Clorox bleach.
Source: Investor Presentation, February 2019
Management wisely chooses mid-sized categories (see the breakdown below) to focus on in order to avoid competitors, gain the lion's share of the market and maximize profits (versus costs and invested capital), which offers another sustainable competitive edge.
Source: Investor Presentation, February 2019
Innovation, which is deeply embedded in the corporate culture at Clorox, should further strengthen the brands' leadership positions and widen the economic moat as a result. Recent examples include Fresh Step Clean Paws cat litter, Burt’s Bees cosmetics and a reinvention of Clorox bleach by adding the power of Cloromax, which reduces the adhesion of soil to surfaces and makes whites brighter and last longer. The company also built upon the previous successful introduction of the Clorox Scentiva experiential scent cleaners platform by expanding into new product categories and fragrances.
Financial performance
Earlier this month, Clorox released its fiscal-year 2019 results:
- Sales increased 1%.
- Gross margin was up 20 basis points to 43.9%.
- Diluted earnings per share rose 1%.
Fiscal-year 2019 was not a good year by any standard for the company, primarily due to rising material and labor costs as well as foreign currency headwinds. As a long-term investor, I regard both factors as temporary.
Beyond the recent quarters, Clorox has been a consistent performer with a low-single digit CAGR in revenue and high-single digit earnings per share CAGR (see below) over recent years.
Source: Investor Presentation, February 2019.
Compared to its peers, Clorox has clearly been the outperformer in terms of return on invested capital and margins (see below).
Source: Fourth-quarter 2019 results
Source: Fourth-quarter 2019 results
Source: Fourth-quarter 2019 results
Over the longer-term history, the business steadily increased its free cash flow per share, maintained consistently high margins and improved its return on invested capital over time (see below), indicating a wide economic moat protecting the healthy and profitable growth.
Source: GuruFocus data as of Aug. 7, 2019
Source: GuruFocus data as of Aug. 7, 2019
Source: GuruFocus data as of Aug. 7, 2019
Source: GuruFocus data as of Aug. 7, 2019
Long-term prospects
For fiscal-year 2020, Clorox management projects 0-2% sales growth or 1-3% organic growth. For the mid-run, analysts estimate a 2.7% CAGR in earnings per share, according to SimplyWallSt, for the next three to five years.
Source: SimplyWallSt data as of Aug. 6, 2019
Innovation should continue to play a key role here in driving long-term growth.
Source: Investor Presentation February 2019
Also, investments in e-commerce and other digital initiatives and assets should position the company well for sustainable profitability into the future.
Source: Investor Presentation February 2019
Source: Investor Presentation February 2019
For the long run, it would be reasonable to expect a 5% CAGR for Clorox, primarily driven by product innovation, investments in white spaces and research and development, and international expansion.
Management
Benno Dorer was named CEO of the company in 2014 and appointed chairman of the board two years later.
Prior to his current role, Dorer served in numerous senior management roles with the company, including executive vice president and chief operating officer for cleaning, international and corporate strategy, senior vice president for the Cleaning division and Canada, and vice president and general manager for the Cleaning division.
Before joining Clorox in 2005, he worked for 14 years at Procter & Gamble (PG), where he led the marketing for the Glad Products joint venture and worked in various other marketing positions across a range of categories and countries, including laundry, home care, beauty care and paper products, in the U.S. and worldwide.
The average tenure of the board is 4.1 years, while the average tenure among senior managers is only 1.6 years, which raises a red flag. Five out of the 10 current executives have been place for less than two years, including Chief Financial Officer Kevin Jacobsen and Executive Vice President of Cleaning Linda Rendle.
Another red flag comes from the insider trading activity for the past 12 months: four sales and no buys (see below).
Source: SimplyWallSt data as of Aug. 7, 2019
Valuation
The valuation of Clorox following the 2008 to 2009 Financial Crisis gradually increased, as see below. Both price to free cash flow and enterprise value to EBIT ratios are close to their respective 10-year highs.
Source: GuruFocus data as of Aug. 7, 2019
Source: GuruFocus data as of Aug. 7, 2019
With a free cash flow yield below 4% and long-term growth rate of 5%, I have to stay neutral on the shares even in light of the superior return on invested capital and wide economic moat built around a portfolio of top-notch brands. As a value- and quality-focused investor who seeks wonderful businesses at attractive prices, I would wait patiently till the free cash flow yield exceeds 5% at least.
Summary
Clorox appears to be a promising candidate for long-term buy-and-hold investors, thanks to its well-known and purpose-driven brands. The stock price, however, looks a bit expensive in terms of the business fundamentals, and therefore, investors may want to keep Clorox on their watch list and wait for pullbacks.
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