Clorox: An Acquisition Of Halyard Health Would Fit Like A Glove

| About: The Clorox (CLX)

Summary

Clorox has stated its plans to expand its professional products sales by expanding its healthcare business organically and through smaller-sized acquisitions.

Clorox offers healthcare products that include disinfectants, germicidal products, sanitizers and antiseptics, while Halyard Health offers infection protection products.

Clorox could acquire Halyard Health with proceeds from the sale of its ill-fitting food products businesses to partially fund such an acquisition.

We believe that Clorox may take over Halyard Health to further its stated purpose of expanding its professional healthcare products business.

Clorox (NYSE:CLX) is a company known for its eponymous brand of bleach. The company, however, offers market-leading products across several product categories and has an ability to develop and market innovative new products. CLX has four divisions that market, manufacture and sell products in the following divisions: 1) cleaning (including bleaches under the Clorox brand and home-care products and natural cleaning and laundry products), 2) household (including charcoal and plastic bags), 3) lifestyle (including dressings and sauces and water filtration systems and filters and natural personal care products), and 4) international (including products sold outside the U.S.). In CLX's most recent earnings report, it announced 3 percent revenue growth from the year-ago quarter due to increases across all U.S. businesses, driven by strong volume growth and the benefit of price increases. The company's revenues, however, were negatively affected by adverse currency effects and higher trade promotion spending. The company recorded $1.32 earnings per share, a 20 percent increase from the year-ago quarter due to higher sales and gross margin expansion. The company's first quarter gross margin increased due primarily to the benefits of cost savings, higher sales, which reflect strong volume growth and price increases, and favorable commodity costs.

Investors and consumers generally recognize CLX as a company that sells its flagship bleach product along with ancillary bleach-related products. The company, however, has a line of products relating to the healthcare field. In particular, CLX markets and sells healthcare products that include: 1) peroxide cleaner disinfectants, 2) germicidal bleach and related products, 3) hand sanitizers, 4) nasal antiseptic swabs, 5) hospital disinfectant and deodorizers, 6) broad spectrum disinfectant cleaners, 6) multi-surface alcohol cleaner disinfectant wipes, 7) Povidone-Iodine related products, and 8) hospital cleaner disinfectant towels with bleach. In recent years, the company has stated its plans to expand its professional products sales by expanding its healthcare business organically and through smaller-sized acquisitions. With this in mind, we believe that one such acquisition that CLX may make is for Halyard Health (NYSE:HYH), a leading provider of both surgical and infection prevention products and medical devices. We see the acquisition of HYH as a possibility given CLX's stated interest in expanding its healthcare line of products and that HYH derives much of its revenues from surgical and infection products. HYH's line of surgical and infection-related products would fit well with CLX's existing a line of germicidal, disinfectant and other antiseptic products. CLX, currently with a market capitalization of $16 billion, could clearly afford to take over HYH with its current $1.35 market capitalization.

HYH provides health and healthcare supplies and solutions worldwide. It operates in two divisions: 1) surgical and Infection Prevention ("S&IP") and 2) medical devices. The S&IP division offers sterilization wraps, surgical drapes and gowns, facial protection products, protective apparels, and medical exam gloves for the prevention of healthcare-associated infections. The medical devices division offers a portfolio of products focusing on pain management and respiratory and digestive health to enhance patient outcomes. (Readers may notice that one of the products HYH sells is medical-exam gloves and that is how "glove" became part of the title of this article.) In HYH's most recent quarter, its S&IP division recorded lower sales due to lower volumes and prices and adverse currency effects. The company's medical devices division revenues, however, increased due to higher global digestive health volume and continued volume growth in interventional pain in North America. In its first year of independence, HYH has repeatedly experienced weakness in its S&IP division while experiencing growth in its medical devices division. As a result, HYH has been working to stabilize and improve results in its S&IP while positioning itself to execute its long-term strategy of rebalancing its product portfolio to focus on its higher growth medical devices division.

There is no doubt in our mind that HYH will be taken over once the tax laws allow it to be taken over in a tax-efficient manner. Remember that a takeover of a spin-off must occur more than two years after the spin-off date for the spin-off to maintain its tax-free status. For HYH, that two-year anniversary of its spin-off and independence occurs late in 2016. As noted above, CLX has stated its intention to expand its healthcare business through internal product innovation and smaller acquisitions. An acquisition of HYH, with its $1.35 billion market capitalization, would not be a "minor" acquisition, but it would be possible given CLX's relatively larger market capitalization. We see a possible takeover of HYH by CLX given the connection between CLX's healthcare products that include disinfectants, germicidal products, sanitizers and antiseptics and the majority of HYH's infection protection products sterilization wraps, surgical drapes and gowns, facial protection products, protective apparel, and medical exam gloves. Further, we believe that CLX could buy HYH using proceeds from the sale of its ill-fitting food products businesses (as we noted in this article) to partially fund an HYH acquisition. An acquisition of HYH by CLX is not as farfetched as it sounds. Remember, Kimberly-Clark (NYSE:KMB), also a consumer products company, once owned HYH and spun it off in late 2014. There is only one caveat to our belief that CLX could takeover HYH. That caveat is that HYH's S&IP division is its weakest division and that the company is attempting to rehabilitate it while increasing its focus on its higher growth medical devices division. Would CLX want to buy a company that develops, markets and sells medical devices in addition to infection protection products? We cannot say yes or no to that question. What we can say there is a strong connection between CLX's healthcare disinfectant products and HYH's infection prevention products. If CLX passes on an attempt to takeover HYH, then we believe one or more companies in the healthcare industry will show an interest in taking over HYH.

Our view

At this point of time, if we were choose the shares of one of the two companies discussed in this article for investors to consider today we would want investors to consider HYH. To us, CLX is currently overpriced. HYH, however, does not pay a dividend and is trading near 52-week lows as the company attempts to stabilize its S&IP division while increasing its exposure to the medical devices market. For CLX, the company has been engaged in a long-term strategy to grow revenue and earnings through: 1) product category, channel and geographic expansion, 2) increased brand investment, and 3) cost reductions. In particular, CLX is growing its U.S. retail products through execution of its demand creation strategy. As noted above, the company also is planning to expand its professional products sales by expanding its healthcare business organically and through smaller-sized acquisitions. In the international market, CLX seeks to grow by focusing on its existing markets where it has significant scale and competitive advantages. CLX's forward price to earnings ratio is 24.25 based on its 2017 earnings estimates of $5.20. CLX's average price to earnings ratio in the previous 10 years is 18.70. Based on CLX's 10-year average price to earnings ratio, the shares are about 20 percent overvalued based on 2017 earnings estimates.

HYH's shares are trading near 52-week lows recently as the company's performance has underwhelmed investors. We believe, however, that the company understands the problems it faces and is working to resolve such problems. The company's underperforming surgical and infection-prevention division accounts for about 80 percent of its total sales, and, therefore, is the near-term primary focus of HYH management to revitalize this division's performance. As HYH management stabilizes and improves the performance of its largest division, management also is targeting higher growth for its medical device division through innovation and acquisitions as the division participates in a market that is experiencing higher growth.

In addition, two HYH insiders' recent purchase of the company's shares near 52-week lows underscores our belief in the company's transformative actions. We see these purchases as significant, especially for a company with a market capitalization barely above $1 billion. In particular, the CEO's (Mr. Abernathy) purchase of $310,600 of shares is indicative of his confidence in the company's intermediate and long-term plan to transform the company toward higher growth medical device products.

HYH's forward price-to-earnings ratio is about 16.00 based on earnings estimates of $1.82 for 2016. Earnings estimates have been reduced in recent months for 2016. Despite HYH's near-term weakness and its lack of a dividend payout, potential investors may want to consider a healthcare company such as HYH that is a leader in the markets it participates in as demographics and the aging of populations around the world favor companies participating in such a marketplace. With HYH's shares trading near 52-week lows, we believe that investors should follow HYH insiders and purchase the company's shares during an overall market sell off. Company insiders are sending a message to potential HYH investors that its shares are now undervalued. Further, we believe that CLX is a potential acquirer of HYH in the intermediate term. If, however, CLX fails to show interest in acquiring HYH, we believe other companies will show interest in acquiring HYH in the intermediate term.

Disclosure: I am/we are long CLX, HYH.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.