Clorox – Relatively Overvalued And Headwinds Put Dividend At Risk (NYSE:CLX)

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Investment Thesis

In this article, we argue that The Clorox Company (NYSE:CLX) is not a good buy at today’s levels. CLX is overvalued relative to peers and faces the risk of cutting its dividend in case management is not able to improve margins. As a result, potential shareholders should avoid investing in CLX as we believe the downside risks are greater than any potential upside for now.

Introduction

Over 2023 the market has climbed the wall of worry having exceptional results and 2024 looks to be a good year so far. At the same time, we see a lot of uncertainty around the macroeconomic environment including inflation and rates as well as geopolitical risks. In such times, consumer staples are a good place to park your money due to the safety they can provide. Today we are looking into Clorox. Year-to-date return for CLX is 9.7% and 1-year return is 10.9% against an S&P500 year-to-date return of 4.0% and 1-year return of 19.9%.

Latest quarterly results – Q2 2024

CLX is a multinational consumer goods company focused on manufacturing and selling various household and professional health and wellness products including very well-known brands including Liquid-Plumr, Chux and Ayudin. The company is well established in both consumer and professional products and has a global presence. The company is present and sells products in more than 100+ markets, has operations in 25 countries and 80% of its portfolio ranks number 1 or number 2 in market share. CLX focuses on health and wellness through its cleaning and disinfectant products which became prominent during the COVID-19 pandemic. The company is now navigating a post pandemic market and is facing a few challenges.

CLX recently reported Q2 2024 results with the stock rising in after hours. Here we summarise the most important takeaways from the call. Overall CLX showed good results as net sales increased c.16% as volumes improved, gross margin improved by 7.5 percentile points as a result of better pricing and cost savings leading to adjusted earnings per share of $2.16 increasing by 120% compared to a year ago. The earnings per share (EPS) guidance for fiscal year 2024 is between $3.06 and $3.26 and adjusted EPS is expected to be between $5.3 and $5.5. EPS upper bound outlook compared to fiscal year 2023 is an increase of c.170% compared to the fiscal year 2023 EPS of $1.2. The leadership also highlighted the progress made in recovering from the cyberattack that the company suffered in August which impacted their operations. The cyberattack is believed to have impacted more firms and led to significant disruptions impacting sales due to processing delays, margins due to additional costs incurred from cyberattack consulting fees and future spending to safeguard the firm from similar issues. Lastly, management confirmed their focus on improving margins over the coming years.

Fundamentals

Let’s have a closer look at CLX’s fundamentals over the last decade. The company has been growing revenue per share over the last 10 years with an average growth of 3.5% per year whilst the company has struggled to grow revenues per share meaningfully over the last two years as they grew a total of 2.3% in absolute terms. In addition, EPS grew steadily until the pandemic however, after the pandemic EPS significantly declined and is yet to recover. EPS declined by 12.0% on average over the last 10 years going from $4.3 EPS to $1.2 as of fiscal year 2023. Looking at adjusted EPS over the last 3 years which excludes non-recurring or unusual items the drop is less significant as adjusted EPS went from $7.3 in 2021 to $5.1 in 2023. This is driven by the investments in digital capabilities and enhancement but most significantly from the impairment charges in CLX’s vitamins, minerals and supplements business.

As communicated by management in the last quarterly call EPS will start to grow again as long as they achieve their targets but will remain well below the EPS achieved in 2013. We believe management will struggle to turn to meaningful EPS growth due to a persistently higher inflation environment squeezing consumer spending further and hence limiting their pricing power and because supply chains will become more expensive due to geopolitical risks and higher costs on raw materials raising their cost basis even higher.

Over the last decade, free cash flow per share increased by 5.4% per year on average, going from $4.5 per share to $7.5 per share, with fiscal year recovering from the fiscal year 2022 lows of $4.4 free cash flow per share. Given the management’s focus on improving margins and continuous revenue growth, free cash flow per share should continue to grow albeit at low rates as we have seen over the last decade. Management is looking to improve margins by increasing prices, reducing costs and optimising supply chains. We believe these goals are going to prove more difficult than anticipated due to the same reasons we described above. Higher inflation means the company will have less pricing power and higher cost basis will be driven by geopolitical risks and higher raw material basis.

The net debt per share has increased from $18.5 to $20.9 since 2012. That is a total increase of c.34% over the last 10 years or an average of 3.0% per year. It is worth noting that the net debt per share has declined since fiscal year 2022 from $23.7 to $20.8. If management wants to make CLX a more resilient company then we expect them to focus on deleveraging the company further, especially given the higher interest rate environment that we are in. In a low interest rate environment, we see debt as a useful tool to fuel growth or share buybacks however, this comes at a greater risk when interest rates are higher and the company faces additional challenges such as more consumer budgeting that we are facing now.

Lastly, as we can see below management had a good share buyback record until fiscal year 2022. In fiscal year 2023, diluted shares outstanding increased marginally. Over the last decade shares outstanding decreased by 6.6% or an average 0.7% year on year which is an additional form of shareholder return on top of the 3.0% dividend that the company is currently paying.

The CLX fundamental story showcases that the company is facing some challenges currently however, it seems that they are working towards reversing the post pandemic trends. As management communicated in the Q2 24 report they do expect the environment to remain challenging due to consumer spending and the fact that consumers remain under pressure showcasing value-seeking behaviours. In our opinion, consumers will remain sensitive to prices and will seek value over brands as their disposable incomes are further squeezed due to higher inflation and hence costs, hence management’s task will prove more challenging.

Dividend and relative valuations

CLX offers an above-average forward dividend yield of 3.0% and the company has been an established dividend payer increasing its dividend by 6.0% per year over the last 10 years. However, the dividend payout ratio is not sustainable since 2021 and if EPS does not grow we see the dividend as being in danger of being cut. The payout ratio climbed to 391% in 2023. This means if fundamentals do not improve CLX will be forced to cut the dividend or worse issue shares or debt to continue paying the dividend. Improving margins will help however, it is too early to say that management will achieve its goals to improve margins. The company has many well-known brands that can lead to some pricing power but at the same time, consumers are under pressure given the increased inflation and lower savings that we have seen over the recent years.

Looking at CLX’s relative valuation against main competitors CLX is overvalued.

Click to enlarge

Source: Seeking Alpha

We believe CLX is relatively overvalued when compared to its peers. On a forward price-to-earnings and forward price-to-cashflow multiples CLX is overvalued. For example, The Procter & Gamble Company (PG) has a lower price to earnings and lower price to cash flow multiples whilst having a very similar return on total capital returns with CLX. Colgate-Palmolive Company (CL) has lower price-to-earnings and price-to-cashflow multiples whilst also having a higher return on total capital. Lastly, Henkel AG & Co. (OTCPK:HENOY) has lower multiples but lower returns on total capital as well. Looking at its peers we believe that there are better places to put your money as price multiples are high for CLX.

Overall, CLX is relatively overvalued and as we can see from the chart below the multiples have been expanding over the last three years. In our opinion, given the relative overvaluation, headwinds and increased net debt levels price multiples will decline over the coming years which will be a headwind for the stock price. Management’s focus on improving margins will lead to better company fundamentals but shareholders should not expect to benefit from margin expansion over the next few years as price multiples might decline leading to below-average returns.

Lastly, when comparing the forward price-to-earnings multiple between, CLX, CL, and PG on the chart below we can see that CLX is overvalued relative to its peers. Reverting to a forward price-to-earnings multiple of 24x would imply a 15% drop in CLX’s price today. Given CLX’s elevated price multiple if management does not deliver, there is a greater downside risk relative to CL or PG. We believe management will struggle to achieve their profitability goals and as a result, we believe this risk can materialise.

Risks

The major risk that we see with CLX is the macroeconomic conditions that impact consumer spending habits. CLX has a lot of well-known brands however, when consumers have less disposable income their choices are not as impacted by brands but rather prices and value for money. For example, the recent high inflation levels that we have seen have led to consumers using their savings. In addition, personal saving rates in the U.S. have significantly decreased compared to pre-2020 levels. This means that consumers are becoming more price sensitive due to less savings and lower disposable income whilst management is working to expand margins. This will be a fundamental challenge for management as consumers are faced with more crucial challenges including 30-year fixed mortgage rates that are currently sitting at 6.6% which is significantly higher than the 2021 lows of 2.7% eating away at their disposable income. Hence, management is facing a headwind as they might not be able to pass higher prices to consumers all whilst supplies will become more expensive due to higher inflation making margin expansion a challenge.

On the contrary, there is also the risk that the Fed will backtrack on its recent statements of rates being higher for longer which will then be in favour of CLX. The Federal Open Market Committee maintained policy rates constant in the most recent meeting for the 4th consecutive time. The market is expecting a number of rate cuts in 2024 however, the Fed has signalled that the battle over inflation is not over yet. As a result and since the Fed has backtracked on previous guidance there is the possibility that the Fed will cut rates more in 2024 which will be a positive catalyst for CLX. Lower rates will lead to lower mortgage rates which will then lead to higher consumer disposable income making CLX’s position on price increases less sensitive for consumers. For now, there is a divergence between the market vs the Fed’s view on rate cuts, and if the Fed cuts more or deeper than the market expects this will be a positive for CLX.

Conclusion

In our opinion, CLX is overvalued relative to peers and there is a great risk that management will not be able to improve margins. CLX’s fundamentals seem to be improving but we need to see more to increase our confidence that management will manage to turn this around on time. If they fail to improve margins price multiples will decline and the dividends are also at risk which will lead to poor shareholder returns. We continue to monitor CLX and look for stronger signs that fundamentals are finally improving.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.