Clorox Is Heading Lower In The Next Year

| About: The Clorox (CLX)

Summary

Clorox is a strong consumer staple company with important competitive advantages.

But the stock is currently trading as if it were a growth company.

Economic weakness will challenge the firm's product differentiation strategy.

Clorox is overvalued relative to peers and its own historical metrics.

With the US economy showing new signs of weakness every week, many investors are contemplating shifting their assets to more defensive stocks such as consumer staples. There are a number of companies with strong underlying fundamentals to be found in this space, but at current market prices, most of them are not attractive candidates for investment. An example of such a company is Clorox (NYSE:CLX), a leading manufacturer of household, grocery, and personal care products. While the firm possesses important competitive advantages that keep earnings relatively stable, the stock trades at a valuation above what is justified.

Clorox's diverse portfolio of leading brands, which includes names such as Clorox, Glad, and Kingsford, gives the firm an economic moat. According to Morningstar, "more than 80% of the company's products hold the number-one or -two spot in the aisle". CLX has 30% share of the US trash bag market, 70% share in charcoal, 20% in salad dressing, and 60% in water filtration. This brand equity and product breadth makes CLX an integral part of the retail supply chain and gives the firm bargaining leverage. And, because retailers are often hesitant to partner with less proven suppliers where the risk of costly stocking-related problems is higher, CLX's market position is difficult to surmount. But with the economy slowing and possibly heading for recession, CLX's product differentiation strategy will not be as formidable. Competition from cheaper private label products has intensified, and a number of cost-effective alternatives are now available in most of the company's core product categories such as bleach, charcoal, and trash bags. This has led to a slowdown in volume growth and increased discounting for Clorox, and these trends will only magnify if the US enters a slowdown and customers switch to cheaper alternatives.

Nobody purchases defensive stocks with the expectation of spectacular earnings growth. But Clorox is currently priced as if it were a growth company. CLX has averaged annual sales growth of just 1.6% over the past five years, which is equivalent to the peer-group average. In a mature industry such as household products, companies must grow either through price increases or market share gains, as the market is more-or-less fully served. Historically, CLX has achieved modest sales growth through inflation, but the company needs to spend heavily on marketing and innovation to achieve incremental top-line growth. Management is targeting annual sales growth of 3% over the forecast period, driven by innovation initiatives that management believes will further differentiate the company's products and win customers from rivals. Given CLX's historical sales growth, and the fact that the competitive environment is more intense now than it was in earlier years, we think this is too optimistic. We project sales growth of just 1-2% in 2016.

CLX trades at a forward P/E of 25.4 and a P/CF of 21, compared to an average of 22.1 and 18.5, respectively, for the peer group (Figure 1). The stock has ascended almost 10% since the middle of April and is now priced just below its 52-week high. CLX's latest quarter beat analyst expectations on the top and bottom lines, but the company didn't do anything spectacular. The company's ability to beat earnings over the past few quarters is largely thanks to low oil prices, as resins make up a significant portion of CLX's input. But commodities are beginning to rebound and their gradual recovery will prevent CLX from expanding margins every year, which is what the market seems to expect. The company already earns higher margins than peers on average, which includes some larger players, and we see limited margin upside potential for CLX. Based on Yahoo Finance's average EPS estimate of $4.95 and a P/E of 24, Clorox is overvalued by 11% relative to our fair price target of $118.80.

Figure 1: Comps Analysis

Company

Sales Growth %

Operating Margin %

Forward P/E

P/CF

Clorox

1.6

17.4

25.4

21

Proctor & Gamble

-0.7

17.2

20.8

15.6

Church & Dwight

5.6

19.4

26.1

20.8

Colgate-Palmolive

0.6

20.6

23.5

23

Kimberly-Clark

-1.2

12.2

20.1

16.8

Unilever

3.8

14.1

19.8

16.5

Average

1.6

16.7

22.1

18.5

Click to enlarge

Note: Sales growth is a 5-year average; operating margin is a 5-year median. Data provided by Morningstar

Not only is Clorox overvalued relative to its peers, the company is also expensive based on its historical metrics. CLX's P/E is more than 12% above its five-year average of 23, and we think the use of 24 in our model is conservative. The stock could easily fall farther in the next year, especially if we enter an economic downturn, which looks increasingly likely. While we do believe that investors should begin to overweight defensive stocks before more bad data comes out, there are better options than Clorox.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.