The Clorox Company (CLX) announced the sale of their auto care business yesterday in an all cash transaction with gross proceeds of approximately $780 million. Clorox announced that they anticipate using the net proceeds from the sale to repurchase shares of Clorox common stock over the remainder of this current fiscal year. They indicated that the goal of this transaction was to reshape their portfolio to better align it to exploit key consumer megatrends such as health and wellness and sustainability.
With this transaction, Clorox Company is divesting itself of all of their global auto care business which includes the market-leading brands Armor All and STP. Avista Capital Partners, the buyer, will acquire two auto care manufacturing facilities in addition to worldwide rights to distribute all of Clorox's global auto care brands. Clorox anticipates the transaction will be dilutive to earnings in the range $.26 - $.25 this fiscal year ending June 30, 2011. This transaction is subject to regulatory and other customary approval and is expected to close by calendar year-end.
The following slide from their most recent investor presentation puts the impact of this transaction on their global business in perspective. The slide clearly illustrates that the auto care business, although a high margin business with solid brands, is not a great fit with their health and wellness products. The slide also provides a clear summary of their four business segments.
click to enlarge
Consistent Operating Results
The Clorox Company has one of the most consistent operating records of any company you might examine. A consistent record of increasing earnings at an above-average growth rate is an attribute that we covet in a company. The ability to generate a strong and consistent growth rate speaks volumes about the sustainability and reliability of the underlying business. Few companies can match the record that Clorox Company has achieved.
One of the great advantages of our EDMP, Inc. F.A.S.T. Graphs™ is the ability to provide a visual representation of a company's operating results virtually instantaneously. Additionally, these powerful “tools to think with” allow the researcher to generate important calculations almost effortlessly. One very important calculation is the determination of how well a company is maintaining growth. Our tool helps us answer the question: Is the company's growth accelerating, decelerating or staying the same?
Figures 1 through 4 below look at the Clorox Company graphically from the perspective of earnings growth and dividend income only. Each graph covers a shorter and more recent time frame. Figure 1 below measures Clorox Company’s earnings growth rate since calendar year 1992, which is as far back as our data allows us to go. The green shaded area graphs earnings-per-share, the light blue shaded area depicts the dividends paid out of those earnings (dividends are stacked on top for visual perspective).
The orange line with white triangles depicts the company's intrinsic value based on a widely accepted formula for valuing a business. The fair value price earnings ratio based on an intrinsic value formula is listed to the right in orange ink. One of the key components of the value formula is the earnings per share growth rate, this earnings growth rate number is listed to the right in green ink. Figure 1 shows that Clorox Company has consistently grown earnings at an annual rate of 10.5% since 1992. The calculated fair value P/E ratio for Clorox is 17.5 (orange line with white triangles).
We are keeping price out of the equation for a specific and we feel important reason. Most investors only see price movement, and therefore, lack a clear perspective of the success of the business. Figures 1 – 4 below focuses on the business results and plot earnings only - no price. Figure 5 brings price into the equation where recognition of valuation can be visually seen and determined.
Figure 1 Clorox Company 20yr. Earnings History
Figure 2 below looks at Clorox Company since calendar year 1997. Here we begin to see the consistency that has been previously written about. The fair value price earnings ratio of 17.5 remains the same as it did in Figure 1, the earnings growth of 10.2% remains consistent with the longer period measured in Figure 1.
Figure 2 Clorox Company 15yr. Earnings History
Figure 3 below looks at Clorox Company since calendar year 2001, which we all know was a recessionary year. The shorter time frame includes not only the recession of 2001 but also the great recession of 2008. Both recessions are shaded in red in Figure 3. Note that the growth rate has slowed down to 9%, however, considering the two recessions both the growth rate and the price earnings ratio remained remarkably consistent.
Figure 3 Clorox Company 11yr. Earnings History
Finally, Figure 4 below looks at Clorox Company since calendar year 2007. The earnings per share growth rate of 9.2% is a slight acceleration over Figure 3 indicating a possible return to its long-term growth rate of 10% or better. Once again, the calculated fair value P/E ratio of 17.4 - 17.5 is virtually identical over all 4 graphs. By shortening the time frame that is being measured with each graph we’re able to determine whether the company’s growth is accelerating, decelerating or staying the same. In this example of Clorox Company, growth of earnings is remarkably consistent notwithstanding two recessions.
Figure 4 Clorox Company 5yr. Earnings History
Figure 5 below adds monthly closing stock price to the equation and simultaneously illustrates the strong correlation between price, earnings and dividends. Since 1992, Clorox’s stock price has tracked earnings on a trend line basis. When on occasion the stock price deviated from its earnings justified level (the orange line with white triangles) in short order, stock price reverted to the mean. Importantly, most of the deviations of stock price from earnings indicated overvaluation since 1992. Clorox's stock price has only been undervalued or below its earnings justified level since the great recession of 2008.
Figure 5 Clorox Company 20yr. EPS Growth Correlated to Price
Figure 6 below calculates the performance associated with Figure 5. The annual rate of return of 10.4% that Clorox shareholders enjoyed is consistent with a 10.5% earnings growth the company achieved. Add in dividends paid and it is quite clear that Clorox’s buy-and-hold shareholders have been well rewarded for their loyalty. Not only have they seen their share price appreciate along with earnings, but the dividends have also increased every year. Clorox shareholders outperformed the S&P 500 in both capital appreciation and dividend income.
Figure 6 Clorox Company 20yr. Dividend & Price Performance History
Debt to Capital Ratio
One negative regarding Clorox is their highly leveraged balance sheet with over $2.1 billion of long-term debt. On the other hand, their prodigious generation of cash flow has allowed them to reduce their debt to capital ratio over the last couple of quarters. The company has indicated that they would use some of their approximately $600 million per year of free cash flow to reduce debt. Also, interest coverage of more than seven times, mitigates much of their debt risk in our opinion.
We believe that a reduction in debt would create the necessary flexibility for Clorox to fund acquisitions, re-purchase shares and continue to pay and increase future dividend income. The company has the cash flow generation capability to accomplish this. Evidence of this fact is found in their 33 consecutive years of increasing their dividend.
Thesis for Growth
We believe that The Clorox Company’s focus on health and wellness products is a terrific strategic objective. Although the auto care business was a good high-margin business with highly recognized brands, it did rest outside the health and wellness theme. Their Green Works® product line, along with the acquisition of Burt's Bees in 2007 illustrates a commitment to the burgeoning green revolution. The Clorox Company's tagline "we make everyday life better, every day" is more than mere hyperbole; instead it's a proven successful business strategy.
The Clorox Company's brands are well-positioned with consumers all over the world and across all their distribution channels. Over 80% of their brand portfolio holds the position of number one or a strong number two across all categories. The company has a robust pipeline of products that emphasize cost savings designed to offset any future commodity inflation. Therefore, we believe the company's recent success improving margins is sustainable.
The Clorox Company has proven itself to be very efficient in their use of capital. The company has a long history of consistently high cash flow averaging 10% to 12% of net sales. The Clorox Company's management is committed to what they refer to as their "Centennial Strategy" with stated goals of 3% to 5% sales growth, double-digit economic growth and the continuation of free cash flow equaling 10% to 12% of sales. We believe their objective of maximizing economic profit across all categories, customers and countries is achievable under this strategy.
Figure 7 below calculates the consensus five-year estimated earnings growth for the Clorox Company based on the consensus of leading analysts reporting to FirstCall. The estimated five-year future growth rate of 10% indicates more of the same for this proven consistent generator of double-digit earnings growth. Assuming these estimates prove true, then the Clorox Company appears very attractively valued today at 14 ½ times earnings. Furthermore, their current entry-level dividend yield of 3.3% is higher than historic norms, further indicating attractive valuation.
Figure 7 Clorox Company 5yr. consensus earnings forecast
The Clorox Company is a leading multinational corporation with a well-positioned stable of leading brands. Over 88% of the Clorox brand portfolio commands leading market share status. 70% of their brand portfolio is ranked number one and 18% of their brand portfolio is ranked a strong number two. Even though the Clorox Company currently has a high debt to capital ratio, their long legacy of generating high cash flow mitigates the risk. We are confident that the Clorox Company should be able to continue paying and raising their dividend with ample cash flow left over to make acquisitions and continue buying back shares.
Therefore, we believe that prospective investors seeking current income from dividends with the opportunity for those dividends to grow should take a closer look at the Clorox Company. As can be seen from Figure 6 above, it has only been since calendar year 2008 that Clorox could be bought at such a low valuation. Since Clorox is expected to continue to grow in the future as it has in the past, this could be a great opportunity to build a position in his blue-chip stalwart.
Disclosure: Long CLX at the time of writing.