Clorox: Cleaning The Portfolio

Summary

• Clorox has seen very strong momentum as the full year guidance implies that the biggest jump in sales might already be behind us.
• I like the operating leverage displayed and while Clorox is undeniably a long-term value creator, its valuation is sky-high.
• Following a big move higher in recent months, valuations have become far too steep from me to create a compelling risk-reward.
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Clorox (NYSE:CLX) has been one of the few and significant winners in this environment. Shares have traded around the $150 mark for years and actually traded around that level at the start of the year, although the developments surrounding the global outbreak of COVID-19 pushed shares up to a high of $200 in recent days. Despite the quality, one-time hoarding effect and potentially a continued contribution of increased hygiene consciousness, current prices reflect far too much optimism to create real appeal.

The Business

Clorox is a conglomerate which generates over $6 billion in sales from four major categories. Clorox is best known for its cleaning products which make up a third of sales including subcategories such as home care, laundry and professional products.

Household products make up 30% of sales from bags, charcoal and cat litter, among others. Lifestyle products generate a fifth of sales as the international segment adds about a sixth to total revenues. Besides the namesake brand, Clorox claims that 80% of its portfolio is comprised out of number 1 and 2 brands in their respective categories. The company deliberately focuses on leading brands in less crowded and more niche market segments such as water filtration, wipes, premium trash and bleach, as a significant portion of its products are in great demand given the circumstances.

The company seems quite proactive to the changes taking place in its marketplace as well, placing a real emphasis on data & analytics, change in retail, rising consumer expectations and focus on cost and competition.

The Numbers

Note that Clorox has a broken book year with the year ending in June of the calendar year. In August of last year, the company reported full year sales of $6.2 billion, a 1.5% increase in sales. The quality of this growth is lackluster with the acquisition of Nutranext and the divestiture of Aplicare combined adding 3% points to sales, as currencies reduced sales by 3 percentage points.

The company reported a 0.4% fall in net earnings to $820 million as earnings per share rose six cents to $6.32 per share, thanks to modest share repurchases. Despite the good intentions, organic growth is not impressive as the company guided for 2020 sales between flat and up 2% (including a 1-3% increase in organic growth) and earnings per share seen between $6.30 and $6.50 per share. The company already cut the guidance and by the second quarter, the earnings guidance has been revised to $6.10-$6.25 per share, with earnings pressure being attributed to increased promotional activity.

On the first day of May, Clorox reported very strong third quarter results with sales up 15% and earnings up 31% thanks to the hoarding effect related to the COVID-19 crisis. With volume growth of 18% being stronger than sales growth, one cannot suggest that the company is using the current crisis for its own gain. Growth is mainly firm in the main cleaning segment which reported a 32% increase in sales as the outlook is particularly interesting.

The company now sees a 4-6% increase in full year sales and earnings of $6.80 per share, plus or minus ten cents. Note that the 4-6% increase in sales works down to roughly $250-$375 million in absolute revenue growth as revenues are $151 million ahead in the first nine months of the year. That suggests about $100-$225 million in absolute revenue growth seen in the final quarter, and this comes after third quarter sales are up $232 million in absolute terms.

This suggests that despite the fact that the crisis unfolded relatively late in the quarter, the majority of the impact is seen behind us already in terms of the contribution to the results of Clorox.

Strong cash flow generation makes that the company has reduced net debt to just over $2.4 billion, which is a modest amount with trailing EBITDA totaling $1.36 billion, for a leverage ratio of 1.8 times, or probably closer to 2 times if we do not include the strong earnings contribution from this past quarter.

Too Much Optimism

Basically, I am not too impressed with Clorox, or at least the risk-reward at this point in time. The company claims to be innovative and strives for organic growth and while the company does everything to grow, a great deal is made undone by foreign exchange rate headwinds. While a close to $7 earnings per share number provides great growth this year, it seems safe to say that much of this is driven by a one-time nature. Pegging perhaps normalised earnings power generously at $6.50, shares now trade at 30 times earnings, despite the lack of structural growth for investors.

The only bright news for investors is that Clorox represents quality as long-term holders have seen great growth, as this was just a $1 stock in the early 1980s and this was actually still just a $60 stock in 2010, after which shares tripled over the past decade. This marks massive valuation multiple inflation as sales have only grown a billion over the past decade and while the company has bought back about one in every ten shares over this time period, the resulting earnings per share increase has been far less pronounced, as the run-up in the share price has caused massive valuation multiple inflation.

A great deal of this increased valuation comes from the move seen so far this year as shares have essentially rallied about $50 per share from $150 to $200 per share. Basically, earnings in the remaining two quarters of this year could boost annual earnings by nearly a dollar. Given that this is a one-time bump to earnings, the $50 move higher in response to a one-time gain looks excessive as the risk-reward does not look good, with shares anything but cheap at the start of the year already.

That is a bit too simplistic as well, yet the real question is how much the business has changed and could structurally change with consumer habits changing in a lasting manner following the crisis, on top of the current hoarding effect. Assuming a 10% increase in structural revenues and earnings, or close to the current actual sales momentum, that suggests a structural boost to earnings power of about $0.60-$0.70 per share which combined with a 25 times multiple could explain $15-$18 per share, still far not close to the $50 move higher seen since the outbreak of the crisis.

Given the discussion above, the lackluster organic growth and in my eyes modest structural impact of the disease (modest even means about 10% here), it means that I am very cautious here at these levels. Even as Clorox has been an excellent long-term steward of capital appreciation, the current risk-reward is far from compelling.

Analyst’s 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.