Updated on February 4th, 2019 by Josh Arnold
Consumer goods stocks are some of the most reliable dividend payers in the stock market. The Dividend Aristocrats are a group of 57 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
Each year, we review all 57 Dividend Aristocrats. The next stock in the series is consumer products manufacturer The Clorox Company (CLX).
Clorox has one of the longest streaks of dividend increases in the market as the company has raised its dividend for 41 years in a row.
This article will provide an in-depth review of Clorox’s business model, and future outlook.
Clorox started out over 100 years ago, with the debut of its namesake liquid bleach in 1913. Today, it is a global manufacturer of consumer and professional products than collectively span a wide variety of uses and customers. The company produces annual revenue in excess of $6 billion and it sells its products in more than 100 markets.
The product lineup spans multiple categories, including cleaning and household products, food, personal care, and cat litter. The Household segment includes the Glad, Kingsford, Fresh Step, and Renew Life brands. Cleaning products include Clorox, Pine-Sol, and the Clorox Commercial Solutions businesses.
Lifestyle brands include Hidden Valley, Burt’s Bees, and Brita. Lastly, the International segment sells Clorox’s brands around the world.
The strength of Clorox’s business model lies in its industry-leading brands. Consider the market share held by the following brands:
Source: Investor Presentation
Many of Clorox’s brands hold the #1 or #2 market share in their respective product categories. In fact, more than 80% of its total revenue comes from products that fit this description. This results in pricing power, and high profit margins.
For several years, Clorox had a tough time growing the top line. In fact, from 2009 to 2016, Clorox managed just 0.8% compounded revenue growth annually as it struggled with volume and pricing. However, the tables have turned and Clorox is back to some measure of top line growth.
Fiscal 2017 produced almost 4% top line growth while fiscal 2018 came in at 2.5% growth. While these aren’t huge numbers by any means, they are vast improvements over what the company had been able to do in years past.
In the most recent quarter, Clorox reported another 4% sales increase, along with gross margin expansion of 70 basis points. Higher profitability was due to price increases and cost cuts. Earnings-per-share from continuing operations declined 21% for the quarter, as the implementation of U.S. tax reform in 2018 provided a one-time benefit in the year-ago quarter.
Sales increased 6% in Cleaning, 4% in Household, and 25% in Lifestyle, partially offset by an 8% decline in International segment sales.
Looking ahead, Clorox has some levers it can pull to continue its recent growth. The company is continuously innovating with product extensions on its current lineup, such as flavors and cross-branding. It has done those things for a long time and will continue to do so in order to stay competitive. However, it is also focusing its mergers and acquisitions on companies that are: (1) fast growing, (2) focused in the US, and (3) are margin-accretive. Said another way, the company wants to boost domestic growth and margins through acquisitions.
All too often, big companies – especially ones that have a hard time growing – will go after any sort of revenue growth. Clorox, however, is taking the more prudent approach and buying companies with a better margin profile than the rest of Clorox, boosting revenue and margins simultaneously.
One such example is the relatively recent purchase of Nutranext, a leader in dietary supplements. The company manufactures a wide variety of dietary supplements and generates about $200 million in annual revenue.
Source: Investor Presentation
The company has a favorable margin profile and derives the vast majority of its sales from the US. Thus, it is a perfect fit for Clorox’ M&A strategy and should be a good purchase for the long term despite the relatively steep price paid of 3.5X sales.
Clorox is boosting margins via productivity and waste improvements each year as well, continuing to increase operating margins for many years consecutively. The company’s focus on cost savings, combined with its accretive M&A strategy, should continue to drive earnings growth for years to come.
Clorox believes it can achieve 2% to 4% top line growth in fiscal 2019 as product innovation should drive a 3% improvement, while Nutranext will add 2.5% and forex translation will cost the company 2% off of the top line.
Management further sees flat gross margins and a combination of SG&A and marketing costs to drive earnings-per-share near flat against fiscal 2018. Indeed, the midpoint of the company’s guidance at $6.30 is only slightly higher than the $6.26 produced in fiscal 2018.
Longer-term, management sees revenue growth at 3% to 5% annually and small yearly improvements in operating margins. We forecast 5% earnings-per-share gains in the coming years as Clorox should see low single-digit gains in revenue combined with small margin improvements and share buybacks.
Competitive Advantages & Recession Performance
Clorox has multiple competitive advantages. First, it holds a tremendously strong brand portfolio. As previously mentioned, Clorox products enjoy very high market share across the portfolio.
Clorox retains its high industry position in part through advertising and it spends very heavily to maintain that position. Product marketing is a necessity for consumer products manufacturers and Clorox spends 10% of its revenue on this each year.
Another advantage of Clorox’s business model is that its products are used by millions of people each day, in good economies and bad. According to the company, Clorox-branded products are in about two-thirds of U.S. households.
There will always be a certain level of demand for household cleaning products and food, even if the economy enters a downturn. This allows the company to remain profitable during recessions. Indeed, Clorox is a strong example of a defensive stock.
Clorox’s earnings-per-share through the Great Recession are shown below:
- 2007 earnings-per-share of $3.23
- 2008 earnings-per-share of $3.24 (0.3% increase)
- 2009 earnings-per-share of $3.81 (18% increase)
- 2010 earnings-per-share of $4.24 (11% increase)
As you can see, Clorox increased earnings-per-share each year throughout the recession, including double-digit earnings growth in 2009 and 2010. This demonstrates the company has a very recession-resistant business model and we like it for its high level of safety.
Valuation & Expected Returns
Clorox trades for a price-to-earnings ratio of 23.6, which is well in excess of our estimate of fair value of 19 times earnings. Indeed, as the stock is trading at 124% of fair value, we see it as overvalued. This condition has existed for a number of years but we continue to believe the valuation will drift lower over time as current growth rates simply do not support a valuation of 23+ times earnings.
A breakdown of Clorox’s historical price-to-earnings ratios can be seen in the table below:
In our view, this introduces the distinct risk of a lower valuation in the years to come, which would have significantly negative impacts on shareholder returns. Indeed, should the stock return to 19 times earnings from the current valuation of 23.6, it would produce a ~4% annual headwind to total returns.
We see total shareholder returns at just ~4% thanks in part to this, combined with the 5% forecast earnings growth and the 2.6% current yield. As a result, we see the stock as a sell at current prices despite the obvious improvements the company has made in recent years. The slate of growth in front of Clorox doesn’t support the current valuation, and we think that is enough to avoid the stock altogether at current prices.
Clorox is an ultra-reliable dividend stock. The company has a leadership position across its product markets, with potential for some measure of growth. Right now does not appear to be a good buying opportunity, as Clorox stock trades significantly above its 10-year average and at 124% of our fair value estimate.
That said, the company should be able to continue its four-decade long streak of annual dividend raises regardless of the overall economic climate. The valuation, however, is enough for us to rate the stock a sell and we think investors interested in owning it should wait for a much lower valuation.