With a market capitalization of $11.5 billion, the Clorox Company (CLX) is the smaller of the mega-cap consumer products companies. Clorox is more focused than competitors, only competing in three segments: cleaning products (approximately 40% of sales), household products (35%) and lifestyle (25%). The company is slightly less internationally diversified than peers with 78% of sales from the United States and international sales concentrated in two countries.
Clorox derives over a quarter of its $1.2 billion in international sales from Argentina and Venezuela. While this still only accounts for about 5.7% of total sales, price controls and currency depreciation in the two countries are a constant hurdle to profitability. Argentina depreciated its currency in January and is likely to depreciate again later this year after a technical default on its bonds last month.
This weakness was blamed for a 7% decline in profit reported in the fourth quarter against the same quarter last year. Net income fell to $1.29 per share on a 2% decrease in revenue to $1.51 billion. International sales were down 8% from the comparable quarter. Management held its earnings target for between $4.35 and $4.50 per share for the fiscal year on flat sales growth.
If Clorox lacks diversification in products and geographic reach, it more than makes up for it in brand identity. Nearly 90% of its brands are the number one or two top-sellers in their respective category. This brand identity comes through in higher prices and the company’s margins are close to those of larger peers, despite smaller economies of scale.
Sales growth increased last year but has been stagnant over the last three due to slow wage growth and slight shift to less expensive brands. Weakness in sales hit operating income over the three-year period as management focused on its marketing spend and neglected cost-cutting measures. Last year saw a new campaign for cost management and the operating margin improved.
Despite having terrific brands and a long history of profits, the company’s balance sheet worries me. Cash flow from operations and free cash flow has fallen over the three- and ten-year period. While sales have rebounded slightly, they are not likely to grow more than 2% or 3% over the long-term. Debt is an astonishing 98% of the company’s capital structure though it does not seem to be spooking the capital markets too much. Clorox has $875 million in debt due in 2015 with $575 million due in January but should be able to issue longer-dated debt to raise the funds needed. The company issues ten-year bonds for approximately 3.15%, less than a percent above the rate on the ten-year Treasury Bond.
Dividends and Growth
Clorox is included in the list of S&P 500 Dividend Aristocrats with 37 consecutive years of increasing dividends and a payment since 1968. The current yield of 3.3% is slightly above the 3.2% average over the last five years. The payout ratio of 67% is below the average of 69% over the last five years and the company should have no problem sustaining the dividend.
The company has increased the dividend by an average of 8.8% annually over the last five years and has recently increased cash returned through the buyback program. Clorox repurchased $388 million in shares over the last year, above the four-year average of $298 million annually.
Volatile growth in sales and cash flows, combined with an over-leveraged balance sheet, make me a little hesitant to say that Clorox can keep up its pace of dividend growth. While the company should still be able to increase the cash return significantly every year, they will eventually need to focus on using cash to pay down debt.
Shares of Clorox are trading for 20.3 times trailing earnings, just under the industry average of 21.8 times but above the company’s five-year average of 19.1 times.
Earnings are expected at $4.42 over the next four quarters, around the midpoint of management estimates and 3.8% higher than the previous four quarters. The company has missed expectations for earnings over the last three quarters and sales are expected flat for the coming year. It could be difficult for Clorox to meet expectations for earnings and this could weigh on the shares which are already trading for a slight premium to its price multiple.
The shares look a little undervalued on a discounted cash flows basis though only slightly. I am assuming that the company can grow the dividend payment by 7% a year over the long-term with a 3.5% terminal rate. The reliance on debt to fund the company benefits Clorox with a low cost of capital but this could increase if interest rates go up when the company needs to issue bonds.
I am conflicted on shares of Clorox. The company holds some of the top spots in products it sells and should be able to return significant cash to shareholders well into the future. The shares are a little expensive and near-term problems with international sales and slow growth in the U.S. make me hesitant to sound the all clear for buyers. The stock is not a sell if you have a position but I would wait for at least a 5% pullback to buy any more.
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