By David Sterman
The starting gun has sounded in the consumer staples category. Billionaire activist investor Carl Icahn's widely reported bid to acquire Clorox (CLX) has led investors to focus on the broader sector, looking for other companies that may be in play. On occasion, a deal for one company can trigger a wave of takeover offers for other players.
Remember when SandRidge Energy (SD) bought Forest Energy, quickly spurring other deals such as ExxonMobil's (XOM) purchase of XTO Energy in 2009? A whole bunch of other deals followed soon after as well. In the oil services segment, Halliburton (HAL) bought Boots & Coots in 2010, leading Schlumberger (SLB) to acquire Smith International.
More recently, in the computer storage space, the first deal kicked off several more: HP (HPQ) bought 3Par; EMC (EMC) then bought Isilon, and then Dell (DELL) bought Compellent. And of course, as I mentioned back then, all of these companies were taken out at a premium, delivering some nice short-term gains to shareholders.
Still, in Clorox's case, there's no guarantee more deals will come. This is why it pays to look for the best value plays in the sector. This way, if a deal develops, the value play may solicit the highest possible premium in a takeover offer. If a deal fails to materialize, you may be left holding the bag, but you'll have downside protection.
Icahn's sense of value
It's unclear why Icahn would be willing to pay more than $10 billion to get his hands on Clorox, which owns a range of brands including Pine-Sol, Glad, Match Light, Liquid-Plumr and Brita. At this price, shares don't seem to be much of a bargain at around 19 times project profits, 2.2 times sales and 36 times free cash flow.
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Icahn is not a hands-on operator, so it's unlikely he has spotted ways to re-engineer the company to boost margins and cash flow. For that matter, Clorox's current management already seems to have the business well under control. Gross and operating profit margins hit a five-year peak in fiscal (June) 2010, so it's hard to see how these metrics can move much higher. Indeed, Clorox's board of directors has already formally rebuffed Icahn's overtures.
Perhaps Icahn simply sees Clorox as a trophy, with the opportunity to place his name atop one of the nation's most venerable enterprises (Clorox will be celebrating its 100-year anniversary in 2013). If Icahn is unable to land this trophy, then he may pursue other consumer-staple companies. For example, Church & Dwight (CHD), which owns brands such as Arm & Hammer, OxiClean and Trojan condoms, is a sort of mini version of Clorox and can be acquired for half the price.
The real values in the sector
Perhaps the real values in this sector are Newell Rubbermaid (NWL) and Energizer Holdings (ENR), both of which sport much better value metrics, though each faces its own challenges as well. Newell Rubbermaid, which makes a wide range of hardware, kitchen and office products, had been shaping up to be one of the better turnaround stories in recent years. Management redesigned a number of key products, cut costs and sharply improved the company's marketing and distribution efforts. As a result, free cash flow, which had fallen below $100 million in 2008, surged past $300 million in 2009 and 2010. This is quite impressive when you consider the lousy state of consumer spending during those years.
But even turnarounds hit speed bumps. The company recently trimmed 2011 profit guidance and noted that long-time CEO Mark Ketchum would retire. Shares subsequently took a hit, while investors realized Ketchum's replacement, Mike Polk, would do what many new CEOs do when they start a new position: Lower the bar for expectations in order to provide wiggle room to make necessary new investments in the business.
But Polk is still inheriting a company in the midst of a long-term upturn. Analysts at Merrill Lynch say Newell Rubbermaid "has a real opportunity for sustainable share gain across its U.S. portfolio, based on favorable market positions in fragmented categories, higher levels of marketing spend and more sophisticated management relative to actual competitors." They figure free cash flow will establish a base line of $350 million this year, before rising past $450 million in 2012 and $500 million in 2013. This should enable the company to reduce long-term debt from $2 billion at the end of 2010 to $1.17 billion by 2013.
As Newell Rubbermaid's free cash flow surges and debt shrinks, private-equity investors such as Icahn are bound to take note that shares trade for less than 10 times projected 2012 earnings. The fact that these earnings can be generated in a still-lousy economy points to the long-term upside for the stock when the economy finally rebounds.
Energizer Holdings also appears to be on the upswing. The maker of Energizer batteries, Eveready flashlights, Schick razors, Hawaiian Tropic sunscreen and other brands is in the midst of a major restructuring. The effort is consuming cash now, but is likely to deliver strong gains in 2012 and beyond. “We like that ENR is right-sizing the weakest half of the business (batteries) while strengthening the faster-growth and potentially higher-margin other half (personal care),” note analysts at Citigroup.
With positive sales growth prospects and quite reasonable P/E ratios, Newell Rubbermaid and Energizer Holdings appear more attractively-priced than Clorox and would make a very respectable consolation prize for Icahn should Clorox rebuff him. They'd also make a solid core holding in your portfolio, regardless of whether or not a takeover happens.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.