Source: Los Angeles Times
Clorox (CLX) has increased its dividend for nearly 40 straight years and owns some of the most well-known and recession-resistant consumer brands in the country. The company is a fraction of the size of P&G and has numerous growth opportunities to pursue over the coming years.
While the stock might not be a bargain today, it shares many characteristics with some of the holdings in our Top 20 Dividend Stocks portfolio.
Business Overview
CLX started in 1913 with five people and one product in Clorox bleach. In fact, CLX remained a one-product company for its first 56 years. Today, the company has over 7,700 employees, sells its products in more than 100 countries, and boasts a brand portfolio spanning numerous product categories including home care, laundry, charcoal, food, water filtration, cat litter, and more. Some of the company’s famous brands are Clorox, Pine-Sol, Glad, Kingsford, Hidden Valley, Brita, and Burt’s Bees.
As seen below, CLX generates about 32% of its sales from cleaning products, 32% from household products, and 17% from lifestyle products and derives 19% of its revenue from faster-growing international markets.
Source: Clorox Annual Report
Business Analysis
As a consumer products company, CLX’s primary competitive advantages are its strong portfolio of brands, shelf space with retailers, marketing expertise, and product innovation.
With the Clorox brand dating back more than 100 years, CLX has benefited from being one of the first brands in consumers’ minds for most of its key product categories. When you walk down the aisle of your favorite retailer and see CLX’s main household brands, you know they will deliver quality.
As a result, over 80% of CLX’s sales are generated from brands with a number one or number two market share position. Overall, Clorox has 23% market share and is three times the size of its next largest branded competitor. The company focuses on attaining large market shares in mid-sized categories, which also helps it avoid going head-to-head as much with giants such as P&G.
Just like we noted in our analysis of P&G, the non-food consumer products space is very sticky and generally less subject to change. According to IRI Market Advantage, 85% of American household needs are consistently filled with the same 150 items, and 60-80% of new product launches fail.
In other words, CLX maintains a durable and sticky market position, and new entrants really struggle to win over consumers who are happy with incumbents’ offerings.
To stay relevant, the company is constantly conducting consumer research to help it launch innovative products and sharpen its marketing campaigns. CLX spent $523 million on advertising (9.2% of sales) and invested $136 million on R&D (2.4% of sales) during its last fiscal year.
Smaller competitors and new entrants don’t have the financial firepower to build up their brand recognition with consumers and retailers.
CLX’s extensive distribution networks around the world are another major strength. CLX can expand the types of products under its brands or acquire new products and sell them throughout the world very efficiently. For example, the company launched the Burt’s Bees Renewal face care line last fiscal year to enter the fast-growing $24 billion anti-aging face care category. Since consumers are already very familiar with the Burt’s Bees brand, CLX can more easily grow its business in new areas.
Finally, CLX’s vertical integration and efficiency initiatives help keep its product costs very competitive. The company’s cost-savings program has delivered about $100 million or more in annual savings since 2003, and CLX operates 37 manufacturing facilities around the world.
Overall, the company expects to grow sales by 3-5% per year and improve operating margins by 25 to 50 basis points per year. With strong brands, extensive distribution channels, relevant marketing campaigns, and large and fragmented markets, CLX has plenty of opportunity ahead of it.
Key Risks
In our opinion, one of the biggest uncertainties surrounding CLX’s business is whether or not the company can continue growing at such a high level of profitability.
CLX’s operating margin hit an all-time high of 20.6% last quarter. The company has benefited from several quarters of strong market share gains, lower raw material costs, and excellent pricing power.
However, management expects “heightened competitive activity in the second half of the fiscal year” as competitors respond to CLX’s share gains.
Furthermore, Walmart accounted for 26% of CLX’s revenue last year. As we noted in our initial thesis on Walmart back in August 2015, the company is struggling to find sources of sustainable profit growth. Walmart certainly sees CLX’s 20%+ operating margin and has to wonder if it can squeeze more pricing concessions out of the company.
Private label is always a threat as well. Consumers are getting smarter about how they shop and what products they can trust. Information is more available than ever before. CLX has noted that private label products account for about 20% of the market. If more consumers trade down, demand for CLX’s higher-priced branded goods could slow.
The consumer-packaged goods industry is also a fairly mature market. With low growth rates, large incumbents can quickly find themselves treading water – some brands are growing, others are shrinking. This is what P&G is struggling with right now. While CLX is much smaller than P&G, it’s possible that some of its larger product categories eventually find themselves in similar situations, especially considering the company’s concentration in the slower-growing U.S. market (80% of revenue).
For now, CLX is showing no signs of weakness. The company continues putting up low-single digit volume growth across its entire portfolio and has done an excellent job expanding into adjacent product categories and geographies while delivering effective marketing campaigns.
Dividend Analysis
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. CLX’s long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
CLX’s dividend is about as safe as they come. The company’s dividend Safety Score is an excellent 94, suggesting that its dividend is safer than 94% of all other dividend-paying stocks in the market.
Over the last four quarters, CLX’s dividend has consumed 60% of its earnings and 61% of its free cash flow. As seen below, the company’s payout ratio has nearly doubled over the last decade, which means that CLX’s dividend was growing faster than its earnings. Going forward, dividend growth will likely be more in line with earnings growth (mid- to upper-single digits).
Source: Simply Safe Dividends
Source: Simply Safe Dividends
If CLX was very cyclical, its payout ratio would be a concern. For example, if the company’s earnings were cut in half during a recession, the company would need to dip into its cash reserves, take on debt, or issue shares to keep funding the dividend.
However, we can see that CLX’s business is remarkably stable. Sales fell by just 2% during fiscal year 2009, and its earnings actually grew. The stock also outperformed the S&P 500 by 25% during 2008. Consumers still need many of the company’s products regardless of how well the economy is doing, although some of them will be more likely to trade down to cheaper private label products.
Source: Simply Safe Dividends
CLX’s strong pricing power and efficient operations have allowed it to earn extremely high returns on invested capital. This is often the sign of an economic moat, and the company’s portfolio of well-known brands is no exception.
Source: Simply Safe Dividends
Not surprisingly, CLX generates very consistent free cash flow and even targets a 10-12% free cash flow margin as part of its strategy. Throwing off reliable amounts of free cash flow keeps the dividend very safe and allows CLX to opportunistically acquire other brands that it can leverage across its distribution channels, geographies, and adjacent product categories.
Source: Simply Safe Dividends
CLX maintains about $2.1 billion in debt compared to $383 million in cash on its balance sheet, but its reliable free cash flow eliminates any financial concern. Morningstar has also assigned an “A-” credit rating to the company.
Source: Simply Safe Dividends
CLX’s dividend is very safe. It sells recession-resistant products that will be used by consumers for many years to come, its strong brands generate reliable free cash flow, and the company’s payout ratios are also very reasonable.
Dividend Growth Score
Our 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.
CLX’s dividend growth potential is about average with a dividend Growth Score of 57. The company has increased its dividend every year since 1977 and is a member of the S&P Dividend Aristocrats Index. CLX most recently raised its dividend by 4% in 2015, and we can see that its rate of dividend growth has decelerated over the last 10 years.
Source: Simply Safe Dividends
Going forward, we would expect CLX to continue increasing its dividend at a mid-single digit rate, essentially in line with earnings growth. This would allow the company to maintain a healthy payout ratio around 60%.
Valuation
CLX trades at 26x forward earnings and offers a dividend yield of 2.4%, which is meaningfully lower than its five year average dividend yield of 3.1%.
Simply put, the stock looks expensive. To put CLX’s current earnings multiple in perspective, Carl Icahn, an activist investor, became involved with the stock during the summer of 2011. He believed the stock was cheap and ultimately bid $80 per share to acquire the company.
Icahn’s bid price represented an earnings multiple of about 18.5 (CLX ended 2011 trading at roughly 16 times forward earnings). Today, the stock’s earnings multiple is 40% higher than Icahn’s target price.
With expected sales growth between 3% and 5% per year, the company’s earnings growth seems unlikely to exceed a mid- to upper-single digit annual rate. Over the last five years, CLX’s free cash flow per share has compounded at 5.3% per year. If more of the same growth trends were to continue, the stock’s total return potential would appear to be 7-9% per year – far from a bargain.
Many investors are attracted to the stability of CLX’s cash flow and probably point to the company’s relatively small revenue base ($5.7 billion in sales) compared to giants such as P&G ($76 billion in sales). There is certainly room for growth, but building successful brands is far from a guarantee and takes a very long time. The stock’s multiple doesn’t seem to compensate for these drawbacks.
Conclusion
CLX is a wonderful company that generates excellent free cash flow. Its brands have withstood the test of time and will likely remain core household purchases for many years to come. While private label products, relations with Walmart, and mature product categories will always remain threats, there isn’t much to dislike about CLX’s fundamentals. However, the current valuation keeps us from pulling the trigger on this blue chip dividend stock today. While the business is stable, investors living off dividends in retirement might want to look elsewhere for greater income potential.
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