Rising Star Buy: Clorox

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It seems like everywhere I look in my house, I find some type of Clorox (NYSE: CLX  ) product. From the kitchen to the bathroom and everywhere in between, life needs to be cleaned, and trash taken out. So like Peter Lynch, I'm buying what I know, and adding some earnings (and cleaning) power to my portfolio.

The company
Not long ago, I took a cursory glance at Clorox as a potential dividend play; it has a well-known catalog of products and brands. Ironically, though, I think its ubiquity causes many to simply overlook it. The company has been in business for close to 100 years, generates copious cash flow, and pays a 3.1% dividend to boot.

With brands such as Glad, Hidden Valley, and Kingsford charcoal -- not to mention its namesake bleach, and cleaning products including Formula 409, Liquid-Plumr, Pine-Sol, and Green Works -- Clorox has a tremendous reach. Though demand for its products may ebb and flow somewhat with economic conditions, with a market capitalization less than $10 billion, I think the company still has tremendous growth potential.

3 reasons this'll clean up
Go with what you know: More than 80% of the company's product lineup holds either No. 1 or strong No. 2 positions in the market. With such familiar and trusted brands, consumers often opt to buy the quality they know, instead of settling for a lower-quality generic substitute.

Global presence: I love Clorox's global exposure. Its vast portfolio of products is found in more than 100 countries, with manufacturing on five continents. Last year, about 20% of revenue came from outside of the U.S., and this trend is growing.

Fat yield piggy (special thanks to Inside Value advisor Joe Magyer for that one): Since I'm looking for a dependable dividend dynamo, I'm comofrted that Clorox has paid a dividend for 38 consecutive years. Furthermore, it's raised that dividend every year since 2002; in fact, the payout is now double what it was in 2005, and I like that it's a priority.

The dirt
Producer prices: Clorox is sensitive to commodity costs to produce its products. Resin, agricultural commodities, and other raw materials -- as well as energy costs -- can hurt the bottom line. We'll need to keep an eye on operating margins to make sure they're not getting squeezed.

It's a private choice: Private-label brands do pose a threat, especially when times are tough. But when materials costs rise for one, they tend to rise for all. While some consumers trade down to private labels, many stick with the quality they know, especially when it comes to things like household products.

Customer concentration: Retail giant Wal-Mart (NYSE: WMT  ) is responsible for about 27% of Clorox's sales. That's a large number, but remember that Wal-Mart is a large company with a $187 billion market cap. Possibly the bigger concern is that the company's top five customers make up about 45% of sales. A pullback on any of these relationships could sting.

Is the price right?
I think Clorox is actually undervalued right now, amid concerns about private-label brands and higher input costs down the road. Today, the company trades for about 12.5 times normalized free cash flow; that's pretty attractive for what I consider to be a staid portfolio of brands. For comparison, competitor Colgate-Palmolive (NYSE: CL  ) trades for about 15 times free cash flow. On a discounted cash flow basis -- accounting for Clorox's near-3.5% annual revenue growth over the last decade -- I see shares being worth $80 to $84 today.

My Foolish bottom line
Given its position in the market and its globally recognized brands and products (I've personally seen their stuff in Egypt and Kazakhstan, among other places), I'm plunking down $1,000 (about 6%) of my original capital to take advantage of some serious dividend power. Drop by my discussion board and let me hear your thoughts on this addition to the portfolio. You can also follow me on Twitter.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. Click here to see all of our Rising Star analysts (and their portfolios).

Stock Advisor analyst Jason Moser owns no shares of any companies mentioned. Wal-Mart is a Motley Fool Inside Value recommendation. Wal-Mart is a Motley Fool Global Gains pick. Clorox and Wal-Mart are Motley Fool Income Investor recommendations. Motley Fool Options has recommended a diagonal call position on Wal-Mart. The Fool owns shares of Wal-Mart. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (7) | Recommend This Article (17)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 06, 2011, at 10:35 PM, sagitarius84 wrote:

    Clorox has paid uninterrupted dividends on its common stock since it was spun out of Procter and Gamble (PG) in 1968 and increased payments to common shareholders every year for 32 years. The company is a member of the elite S&P Dividend Aristocrats Index.

  • Report this Comment On April 07, 2011, at 12:28 AM, goalie37 wrote:

    Good write up.

  • Report this Comment On April 07, 2011, at 8:07 AM, lellalella wrote:

    I think Carl Icahn's recent 9% purchase has affected the stock price.

  • Report this Comment On April 07, 2011, at 9:11 AM, TMFJMo wrote:

    @goalie37: Thanks! I had fun researching and writing it. I really do appreciate the kind words.

    @sagitarius84: I love the dividend priority here and it's one of the big reasons I added it. Thanks for the info.

    @lellalella: Certainly possible. Maybe another sign that the company has some room to run.

    Thanks for the comments Fools!



  • Report this Comment On April 07, 2011, at 12:28 PM, rhuntjr wrote:

    Good call on Clorox--the market is definitely overlooking this good stock. New Constructs (an independent equity research firm whose picks consistently outperform the market) rates Clorox as a Very Attractive investment. This rating carries a lot of credence because New Constructs actually reads entire 10-Ks for over 3,000 companies to convert accounting earnings into economic earnings. CLX's rating is in the top 5% of all large cap companies in New Constructs' system.

    I took a look at the model for CLX and have a few things to add to your analysis. By the way, here's the free report on Clorox that New Constructs is currently offering on its blog:

    Another reason this'll clean up:

    -CLX has had positive economic earnings in each of the past 13 years. In other words, even after removing the cost of debt AND the cost of equity from CLX's operating profits, CLX has consistently created value for shareholders. Less than 9% of the companies that New Constructs covers have accomplished this impressive feat.

    Is the price right?:

    According to the report, CLX's current stock price implies that cash flows will fall by 13% and stay there forever. That's sounds like a pretty low hurdle for a company that has increased its economic earnings in each of the past 4 years.

    More dirt:

    Looking only at CLX's balance sheet to understand its profitability is insufficient. Remember the pooling-of-interest method of accounting for acquisitions? It allowed companies avoid recording a dime for huge premiums in all-stock acquisitions.

    Even today, this terrible accounting policy (which was outlawed in 2002) severely impedes the analysis of CLX's true profitability (thankfully New Constructs accounts for it in all models). Clorox paid a premium of about $1.4B for its acquisition of First Brands (Glad trash bags, etc) in 1999. This premium is not reflected anywhere on CLX's $4.1B balance sheet.

    A true profitability calculation must include ALL capital invested in CLX's business. An investor who ignores the total cost of the First Brand acquisition will calculate an ROIC of 15%, which is significantly higher than CLX's true ROIC of 11.7%.

    Even after accounting for its unrecorded goodwill, however, Clorox still offers a very attractive risk/reward profile.

    I highly recommend you check out New Constructs blog page about why economic earnings are a better measure of true profitability that accounting earnings. Here's the link:

  • Report this Comment On April 08, 2011, at 9:02 PM, tshk1221 wrote:

    You guys call a company with 2,000% bank debt/equity ratio a company that's worth your precious money?? The last three years' balance sheet shows a very irregular trend of stockholders' equity.Its stockholder's equity is not accumulating at all, fluctuating significantly every year. CLX makes wonderful products, but its balance sheet will deter any prudent investor's commitment. I cannot understand why Mr. Carl Icahn invested in CLX.

  • Report this Comment On April 08, 2011, at 9:14 PM, tshk1221 wrote:

    Prudent small investors,

    Don't invest your precious money in CLX now. Its price to book ratio is a whopping 15. It is time to sell it, not the time to buy it now.

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