Clorox (CLX): An Industry Leader With 40 Straight Years of Dividend Growth

Dividend aristocrats, S&P 500 companies with 25+ years of consecutive dividend growth, can make a great starting point in the search high-quality income investments.

 

Among the dividend aristocrats, consumer products conglomerates are one of the most popular choices, thanks to their recession resistant business models and low volatility.

 

Warren Buffett owns a number of consumer products companies in his dividend portfolio here, too.

 

With 40 straight years of dividend growth, including 9.6% annual payout growth over the past 30 years, and a number of iconic brands, let’s take a look to see if Clorox (CLX) still represents one of the best long-term investment options.

 

 

Business Overview

Founded in 1913 in Oakland, California, Clorox is today a dominant leader in global consumer goods, selling dozens of well-known brands in over 100 countries including: its namesake bleach and cleaning products, Pine-Sol cleaners, Liquid-Plumr clog removers, Poett home care products, Fresh Step cat litter, Glad bags, wraps and container products, Kingsford charcoal, RenewLife digestive health products, Hidden Valley dressings and sauces, Brita water-filtration products and Burt’s Bees natural personal care products.

 

It operates four divisions, each one marked by brands that either hold the number one or number two market share position in their respective industries.

 

 

Approximately 83% of sales come from the U.S., with the rest being derived from its international business, which is focused on faster growing emerging markets.

 

Business Analysis

The key to Clorox’s competitive advantage is its large, diversified portfolio of leading brands, which have extremely high penetration rates in most U.S. homes.

 

 

More importantly, Clorox has been highly successful over time in growing its portfolio by acquiring new brands that fit well into its corporate culture and business model, one focused on only owning grade-A products with dominant market share positions.

 

 

There are two primary reasons why this strategy works so well. First, the consumer non-food sector is highly sticky and generally price inelastic. Specifically, that means that 85% of American household purchases are the same 150 products, with a preference for well-known and trusted brands like Clorox.

 

In fact, a study by IRI Market Advantage indicates that 60% to 80% of new product launches in this industry fail, showing that consumer brand loyalty in this industry is particularly high, resulting in highly consistent sales growth and stable and growing margins over time.

 

This fuels steady increases in earnings and free cash flow (FCF), which generally grow faster than revenue.

 

 

In fact, thanks to Clorox’s quality management team, which has been able to extract ever larger economies of scale from its worldwide supply chain and manufacturing base, Clorox enjoys some of the best profitability in its industry.

 

 Clorox Q1 2017 Return On Invested Capital

Clorox Trailing 12 Month Margins and Returns On Shareholder Capital

 

These impressive returns on capital are a testament to management’s long-term strategy, which involves investing heavily (12% of sales in 2016 on advertising and R&D) into more profitable niche products, such as cleaners, bags, and charcoal.

 

The key to Clorox’s success is that it’s been able to differentiate its products from lower cost private label (i.e. generic) brands through simple yet value-adding propositions that have proven to be a hit with consumers.

 

 

This continued popularity with consumers further helps to maintain the company’s moat because it’s a highly prized supplier for some of the country’s largest retailers, including Wal-Mart (WMT) and Costco (COST). As a result, Clorox often receives the best shelf positioning, further insulating it from its rivals products.

 

In other words, Clorox’s exemplary management team has its capital allocation priorities straight, with most of its cash flow dedicated to growing its brand portfolio, building brand equity, and strengthening the firm’s competitive advantage over time, while also rewarding dividend investors with steady payout increases, made possible by a fiscally responsible (i.e. not overly levered) balance sheet.

 

 

This is part of the company’s 2020 growth plan, which calls for a multi-pronged approach to further cutting costs, through economies of scale, while investing in its strongest, fastest growing, and highest margin brands.

 

 

That includes continued strong growth in emerging markets, especially Latin America, where Clorox has found success in steadily winning market share and achieving the same kinds of competitive advantages as in its core U.S. market.

 

 

Meanwhile, through disciplined cost controls, Clorox still has plenty of opportunities to boost its already impressive profitability further.

 

 

All told, Clorox’s 2020 strategic plan should be able to continue generating moderately strong but consistent growth in its top line while improving its profitability.

 

 

Key Risks

Clorox faces several key risks that investors need to keep in mind.

 

The first is that, while it currently enjoys a very strong moat thanks to its world famous brands with leading market share positions, Clorox, like all consumer brand companies, could see its market share eroded by the growing popularity of private label (i.e. store brands) competition.

 

To help minimize this risk of shifting consumer tastes, Clorox has been highly aggressive in spending a growing share of its advertising on digital media to target younger consumers such as Millennials and generation Y.

 

 

However, it’s important to remember that, while Clorox is a well-known blue chip company, it’s still relatively small compared to mega rivals such as Procter & Gamble (PG), Kimberly-Clark (KMB), and Unilever (UL), all of whom have much larger annual sales than Clorox.

• Clorox TTM sales: $5.9 billion
• Kimberly-Clark: $18.2 billion
• Unilever: $54.2 billion
• Procter & Gamble: $65.1 billion

And since all of its major rivals are basically adopting similar long-term strategies to win and maintain market share and pricing power, this means that Clorox may be forced to increase its R&D and advertising spending in the future, which could threaten its planned margin expansion.

 

Another threat to that plan is the fact that Clorox depends on cyclical commodity markets for its manufacturing inputs, such as resin, diesel, sodium hypochlorite, corrugated cardboard, trucking prices, and agricultural products.

 

While the company has a hedging strategy in place to minimize its overall margin volatility, at the end of the day, there is only so much it can do. In other words, at some point Clorox’s ability to grow its margins, and thus leverage slow but steady top line growth into earnings and FCF growth, could stall.

 

That’s especially true given that it remains highly reliant on key customers to operate its sales channels.

 

For example, sales to Wal-Mart represented 27% of Clorox’s revenue in 2016. As Wal-Mart attempts to compete with upstart Amazon (AMZN) on price, it could squeeze suppliers like Clorox in terms of wholesale prices, further making margin expansion harder to come by.

 

Finally, don’t forget that while its international markets represent potentially stronger growth opportunities, that also acts as a double edged sword.

 

That’s because faster international growth will mean greater exposure to volatile currency fluctuations.

 

The reason this is important is because Clorox’s foreign sales are in local currency, which need to be converted back to U.S. dollars for accounting and dividend payment purposes. Thus a stronger U.S. dollar can not only hurt its sales (because its product become more expensive overseas) but also result in slower earnings and cash flow growth.

 

Clorox’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Clorox has a Dividend Safety Score of 97, indicating it has one of the market’s most secure and dependable payouts. That’s not surprising given that Clorox has been steadily increasing its dividend every year since 1977.

 

 

There are three main reasons why Clorox has been able to pay such a steady dividend over the years.

 

First, because of its business model, demand for most of Clorox’s products is recession resistant since people need to purchase cleaning supplies even during economic downturns. The company’s sales fell by just 2% during fiscal year 2009, and its earnings actually grew. With resilient cash flow generation, Clorox’s dividend is better protected.

 

Second, management has been disciplined in maintaining a very safe EPS and FCF payout ratio, ensuring a strong safety buffer that protects the payout during times of unexpected earnings or cash flow declines.

 

 

While Clorox’s payout ratio has been rising somewhat over time, it’s important to note that even when taking into account buybacks, management has wisely maintained a total capital return payout ratio (i.e. dividends + buybacks/FCF) of under 100% in recent years. That’s in contrast to many rivals who have funded buybacks with cheap debt.

 

 

And speaking of debt, this is the third component of Clorox’s rock solid dividend security. Specifically that means a strong balance sheet, with a low level of net debt relative to its strong free cash flow.

 

 

In fact, while Clorox has a slightly higher than average debt load relative to its peers on certain metrics, such as debt/capital, its high and stable free cash flow stream means that it has a very high interest coverage ratio and continues to enjoy a strong, investment-grade credit rating.

 

 

In other words, Clorox continues to have plentiful access to cheap debt with which to fund its growth ambitions, including future brand acquisitions, while still maintaining a highly safe and steadily growing dividend.

 

Clorox’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Clorox has a Dividend Growth Score of 51, indicating that its future dividend is likely to grow at a similar pace to the S&P 500’s 20-year median growth rate of 5.7%. That isn’t a surprise given that its payout growth rate has slowed in recent years.

 

 

For example, the most recent dividend increase just announced was 5%. Going forward, Clorox’s payout ratios don’t have much room for further expansion, which means that future dividend increases will likely track its EPS and FCF per share growth closely.

 

Since Clorox should be able to generate 3% to 5% long-term sales growth, when combined with margin expansion and continued share buybacks, the company’s bottom line could grow by 5% to 7% a year for the foreseeable future, and its dividend along with it.

 

Valuation

Over the past year Clorox has underperformed the S&P 500 by about 10%. However, that doesn’t necessarily mean its shares are an attractive buy at this time.

 

For example, CLX’s forward P/E ratio of 23.8 is not only higher than the S&P 500’s 17.7, but also greater than its industry median of 20.2 and the company’s historical norm of 19.2.

 

Meanwhile, the stock’s dividend yield is 2.5%. While that’s slightly above the S&P 500’s 1.9% yield and the industry median of 1.9%, it’s below Clorox’s 13-year median yield of 3.0%. In fact, over the past 22 years Clorox has offered a better yield nearly 40% of the time.

 

Which basically means that shares appear to be currently overvalued. At a more normal valuation multiple, Clorox’s stock appears to offer long-term total annual total return potential of 7.5% to 9.5% (2.5% yield + 5% to 7% annual earnings growth).

 

While that may not be a terrible return potential, it is still weaker than Clorox’s 12.8% annual total return over the past 20 years, as well as much lower than certain faster growing dividend aristocrats and kings.

 

Conclusion

While Clorox isn’t right for everyone, due to its average payout growth prospects and low current yield (making it unappealing for retirees seeking high dividend stocks), it does represent one of the best managed, fastest growing, and most profitable blue chip names in the defensive consumer products industry.

 

And with a solid growth plan in place, Clorox should not only continue offering steady and growing dividends in the future, but it is almost certain to join the ranks of an even more elite group of companies, the dividend kings, in 2027.

 

However, at today’s seemingly overvalued share price, Clorox is probably better off left on one’s watchlist at this time.