Heaven Scent or Bleach Bum?

by Brian Graney (TMFPanic)

ALEXANDRIA, VA (May 19, 1999) -- One of the companies on the Drip Port's watchlist is The Clorox Co. (NYSE: CLX), a consumer products heavyweight that owns a stable of brandnames on top of its namesake bleach business. Jeff and I are attracted to large brand name consumer product companies like Clorox as potential long-term investments since many of these firms boast market-beating past performance records, sport industry leadership positions in popular product areas we feel we understand, and offer bright future prospects. Combine those attributes with a no fee DRP plan and Clorox seems like a strong candidate for this portfolio right off the bat.

This is a great time for investors new to Clorox to familiarize themselves with the company, which is emerging from the biggest corporate acquisition in its 86-year history. Not shy to break out the wallet when it sees an opportunity, Clorox's many smart acquisitions over the years are a big reason why its shares have returned an average 27.5% annually since 1980. In January, the company paid $1.96 billion in stock and debt for First Brands Corp. Never heard of it? Here's a breakdown of the two companies' brand name products:

Laundry Cleaning
Clorox bleach

Home Cleaning
Clorox, Formula 409, Liquid-Plumr, Pine-Sol, Soft Scrub, S.O.S., Tilex

Bags and Wraps
Glad trash bags and food storage bags, Gladwrap

Armor All, STP

Kingsford, Match Light, StarterLogg, HearthLogg

Black Flag, Combat

Cat Litter
Fresh Step, Scoop Away, Ever Clean, Jonny Cat

Salad Dressings and Sauces
Hidden Valley, K.C. Masterpiece

Handi-Wipes, Brita water filters

Throw in some milk and eggs, and Clorox could outfit a small corner grocery store all by itself. While the company's offerings may seem a haphazard collection of products at first glance, the diversity makes sense upon learning that the vast majority are either the number one or number two brands in their respective categories. In fact, as fellow Fool Warren Gump pointed out in an article about the company last year, 90% of Clorox's fiscal 1998 unit volume was in product areas where the company held either the number one or the number two spot in the market. This makes Clorox not only a market leader, but a multi-market leader.

The acquisition of First Brands seems like a classic strategic move for Clorox, which has ventured down many new supermarket aisles this decade thanks to several well-timed deals. Most of the brands it has picked up have had tried-and-true images but sluggish sales growth, giving Clorox a chance to leverage its highly efficient, low-cost national retail distribution system and perform some turnaround tricks.

Since buying Pine-Sol in 1990, for instance, Clorox has effectively doubled the product's annual unit sales by adding innovative variations such as lemon-scented and even spring rain-scented versions of the cleaning agent. (How they managed to get the spring rain scent into the bottle, we have no idea.) Prior to the First Brands merger, the company had been focusing its attention on improving the unit sales and market shares of Black Flag (acquired in 1995) and Armor All (acquired in 1996) after successfully integrating both product lines into its existing business.

The ultimate success or failure of individual turnaround stories, like the ultimate success or failure of individual stock investments, can only be measured properly after a period of years rather than mere months. Even so, early indications suggest that Clorox is doing a pretty good job of bringing First Brands into the fold.

During the first full quarter of combined operations, Clorox's gross profit margins came in at 53%, down only slightly from the 56% reported in the previous pre-merger quarter. And backing out merger-related charges and inventory write-offs taken during the period, net margins actually increased to 10% from 9%. It's dangerous to read too much into one quarter's worth of performance, of course, but the initial results are encouraging and worth noting.

Meanwhile, the company's strong performance over the years has not gone unnoted by the market, leading to a current valuation brighter than a bleached white dress shirt. With an enterprise value of $13.3 billion, the company is trading at 3.4 times combined fiscal 1998 revenues of $3.95 billion and 38 times combined net income of $350 million. With analysts expecting earnings per share of $3.19 in fiscal 1999 (ends June 30) and $3.71 in 2000, the company's forward P/E ratios are 33 and 29, respectively. That seems steep for a company that is only expected to grow earnings by 13% to 15% over the next few years.

As dollar-cost averagers, though, we could possibly work around Clorox's rich valuation. With sufficient insight into the firm's business prospects and enough confidence in its future profitability, we would be more willing to consider a long-term commitment. We are a long way from that point, however, especially considering how much of the company's near-term performance depends on the successful integration and enhancement of the First Brands businesses. We will keep an eye on things, and as we learn more about Clorox we'll share it right here free of charge, in typical Foolish fashion.

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