When Wall Street decides on a story, it sometimes has a hard time seeing when things change for the worse -- or, in the case of Clorox (CLX 0.60%), for the better. Right now, it seems like Clorox can't do anything right -- at least, if you read Wall Street research -- even though management is doing exactly what it said it would do.
Here's why investors should be happier with the company than Wall Street wants them to be.
Ups and downs
Clorox was performing extraordinarily well during the early days of the pandemic. The main driver was the increased use of cleaning supplies as consumers tried to avoid getting sick. The spike in demand led the consumer staples giant to bring in contract manufacturers so it could catch up. That increased costs, but allowed Clorox to keep shelves full and bolstered earnings.
Image source: Getty Images.
When that unusual spike in demand waned, however, sales for cleaning products fell and the contract-manufacturing deals it signed weighed on margins. At the same time, inflation has been raging, pushing up costs throughout the rest of the business and further crimping profits.
This all came to a head in the second quarter of its fiscal 2022 when Clorox reported that its gross margin contracted a massive 12.4 percentage points. There's no way to sugar-coat that: It was a terrible quarter, and the stock fell sharply on the news.
And yet, while cleaning supplies were weak, sales throughout the rest of the company were flat to higher. Moreover, management made it clear that it was going to take the steps necessary to get margins moving in the right direction again. That includes raising prices, ending contract-manufacturing deals that were no longer needed, and cutting costs where it could.
Still not happy
When Clorox reported fiscal third-quarter earnings, D.A. Davidson quickly lowered its price target for the stock while Wells Fargo (WFC 2.73%) upped its price target, but maintained the shares at underweight. The vast majority of Wall Street has the stock at what amounts to a hold or worse. But the third-quarter results were actually pretty solid and, more important, show that management is following through.
For example, gross margin in the third quarter fell 7.6 percentage points year over year. On a stand-alone basis, that's not good, but when you compare it to the fiscal second quarter, it's a vast improvement. Driving the narrowing trend was a mixture of price increases and cost-cutting. Inflation -- in the form of rising manufacturing, logistics, and commodity costs -- were an issue, but they are issues for all of Clorox's competitors right now. The company basically did what it promised and achieved the results it expected, namely improved gross margins.
On top of that, sales were up in all but one of its businesses. The lone weak spot remained health and wellness, which is where Clorox's cleaning products reside. Sales in that business were down 3% year over year, which was a vast improvement from the 21% decline in the second quarter. Given the backdrop and unusual pandemic issues, Clorox appears to be holding up pretty well.
That, however, clearly isn't enough for Wall Street. In fact, even after bouncing back in a flight-to-safety trade, Clorox's dividend yield is still at the high side of its historical range at around 2.9%. That suggests the shares are worth a closer look for value-oriented income investors since Clorox is a Dividend Aristocrat working on a 45-year streak of payout increases.
The big takeaway here, however, is that nothing goes up or down in a straight line, so fixing the margin issue will simply take time. If you can think long term and wait patiently for the incremental improvements management has hinted at, you can own a great company even though Wall Street no longer loves it quite as much as it did.
Time arbitrage
One of the biggest advantages that smaller investors have is the ability to buy and hold without someone else watching over their shoulders. With nothing to prove to anyone, individuals are free to invest in out-of-favor companies like Clorox that are still well-run and have wonderful businesses.
In fact, you might even find it pleasing to sit back and collect a historically generous yield while you wait for the better days that are, frankly, already starting to show up in the company's results -- whether or not Wall Street is willing to give the company any credit for the improvement.
