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Friday, December 18, 1998

An Investment Opinion
by Warren Gump

Clorox: The Clorox, Armour All, Brita, & More Co.

Consumer products companies are some of the most enjoyable companies to invest in. Not only are you likely to be a customer, but you also understand why people buy the company's products. Most people don't get as involved in their investments as I do, but a sense of pride tingles through my body every time I pick up a can of Pepsi or a product from any other company I own. Usually you can look on a package to find out the maker of a product. Virtually all Coca-Cola (NYSE: KO) soda products have "a product of the Coca-Cola company" on their packaging, for example. Sometimes the task can be a little more difficult, however.

Prior to my incarnation as a Fool, I spent a couple of years in New York City. While certain individuals (namely the mayor) like to portray the water as being quite tasty, I loudly disagree. After a couple of days of living there, I had to break down and buy a water filter. Wandering down to Bed, Bath, & Beyond (Nasdaq: BBBY), I picked up my first Brita filter. What a revolution this turned out to be. Wonderful, fresh water was at my disposal on a regular basis. My water intake more than doubled. Unfortunately, when I looked on the package, I didn't learn the ultimate parent company. The box listed something like the Brita Products Company as the manufacturer. Checking a Quotron, I found out that company wasn't publicly traded. My (incorrect) instinct was to assume that it was privately owned.

I obviously didn't spend a large amount of time researching the subject, for a click into any of the Internet search engines would have led me straight into Clorox Co. (NYSE: CLX). That's right, Clorox is the maker of Brita filters. There's more to this company, much more. Beyond bleach, the company makes such cleaning products as Formula 409, Pine-Sol, and Soft Scrub. It also makes the Armour All brand of car maintenance products and Kingsford and Match Light charcoal products. Ever tried to stop an infestation of ants or roaches? Perhaps you used Clorox's Combat or Black Flag brands. Other brands include Fresh Step cat litter and Hidden Valley dressings. This company appears to be all over the store!

With such a panoply of products, the question is raised of whether this company has any strategic direction. While the products are diverse, they are generally either number one or two in their business. Last year, 90% of Clorox's unit volume was in products where the company held one of the top two industry positions. In addition, these are brands that can benefit from the company's primary strengths: new product development, marketing, and strong ties with retailers.

An example of the company's strength is Pine-Sol, which the company purchased in 1990. Since that time, strong marketing efforts and new product introductions such as Lemon Scented Pine-Sol have almost doubled sales. Last year, Clorox spent $56 million on research and development efforts. As to distribution clout, its strong ties are best exemplified by its relationship with Wal-Mart (NYSE: WMT), which accounts for 16% of sales.

These strategic advantages are expected to be put to the test next year when Clorox closes on its acquisition of First Brands (NYSE: FBR), the maker of Glad trash bags, STP auto protectants, and Scoop Away cat litter. First Brands had been struggling and decided it needed the strength of a larger organization. This $2 billion acquisition, the largest in Clorox's history, will enhance its role in the auto and pet products arena while adding a leading garbage and food bag brand. The companies expect to realize about $90 million in synergy from the integration of various operations.

Many consumer products companies, such as Proctor and Gamble (NYSE: PG) and Gillette (NYSE: G), have been experiencing short-term problems due to their substantial international exposure. These problems shouldn't affect Clorox as significantly because only 17% of its sales (and 7% of pretax earnings) are derived from international operations. The relatively small size of the international business doesn't mean that the company doesn't see great opportunities abroad, however. In fact, the opposite is true. Just six years ago, international sales were only 4% of revenues! These increases were generated by new product introductions and an aggressive acquisition spree (including $148 million worth last year).

The financial statements of most consumer products firms are impressive and Clorox is no exception. The company had a gross margin last year of 56.5%, up from 54.6% two years earlier. Net margins last year were a very Foolish 10.9%. Due to the nature of First Brands businesses, these figures will drop a little next year, but should still be quite attractive. The bottom-line is that this company produced over $300 million in cash from operations last year. Without a jump in accounts receivable due to acquisitions and product mix changes, this figure would have been even higher.

Of course, there is a downside to Clorox's success. Other investors figured out that it's a great company well before I did. The stock price has risen over 40% so far this year and now trades at 35x the fiscal 1999 (ends June) First Call estimate of $3.19. That's a hefty price for a company with a long-term projected growth rate of 13%. I'm a little shy to pay such a multiple, but my investing preferences lean more toward a value bent than many other Fools. Clorox has a wide array of products and looks to be poised for substantial growth in the decades ahead.

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