Shares of consumer staples icon Clorox (CLX -0.40%) are down a whopping 40% or so from the peak reached in mid 2020. That was right in the middle of the pandemic, when nobody was quite sure how to handle the illness. Consumers were cleaning everything in sight, and buying more of Clorox's cleaning products. Things are very different today, with cleaning supply demand well off its peak. But management is still upbeat about the future, and cleaning is actually a key part of the story.
The good times were great times
Consumer demand for Clorox's cleaning supplies was so intense during the early stages of the coronavirus pandemic that the company had to hire contract manufacturers to ensure it could supply retailers, its direct customers, with products. That's generally more expensive than producing products in-house, so Clorox's costs went up during this period. Because of the high demand, nobody seemed to notice or care, but this issue quickly came back to haunt the company.
Image source: Getty Images.
Indeed, as demand for cleaning products started to cool, sales in the company's health and wellness division, which is where cleaning supplies live, dropped like a rock. Worse, because of the high cost structure driven by outsourced production, profitability in this division declined materially as well. And all of this has been transpiring at roughly the same time that inflation has been a headwind throughout the consumer staples sector. Investors have been running scared from Clorox, as evidenced by its massive stock price decline.
One of the interesting things here, however, is that the rest of the company's business, which makes up around 65% of sales, has been holding up fairly well. So the cleaning business is a very big piece of the story here, but is it really all that bad?
A glass half-full
While Clorox's management has to be upbeat about the future, it hasn't been outlandishly exuberant. In fact, it has been very open that the pandemic led to a demand spike that was likely to be unsustainable. That's why it chose to outsource production, as opposed to building new factories.
At this point, with demand declining from the peak, it is exiting those outsourcing agreements. That, in turn, is helping to bring costs down and strengthen margins, which got squeezed by high production costs. While it's true that inflationary pressures on key product inputs, packaging, and distribution are also an issue, those are not unique to Clorox.
So from a big-picture perspective, Clorox is already working its way back from that unusual demand peak. That process isn't done yet, however, with management expecting early fiscal 2023 to have some tough year-over-year comparisons.
That said, there's a new normal that will emerge on the cleaning front, and at this point management appears to think it will include more cleaning than before the coronavirus pandemic. A more normal cold and flu season will also be an important determinant of the normalization process, since cleaning appears to be more impactful on those two illnesses than it is on the largely airborne spread of COVID-19.
Here's the interesting thing: Clorox continued to spend heavily on advertising during the pandemic to tout its cleaning business even though it probably didn't need to. It also used the period to expand the geographic reach of its cleaning wipes.
Basically, the company leaned into the demand in what appears to be an effort to better establish itself as a major player in the cleaning space, building off of the Clorox brand's strong image. In effect the company is betting that it comes out the other side of this unusual period with a better cleaning business than when it entered. If that proves to be true, the long-term appeal of the company will have been enhanced despite the short-term turbulence.
Paid well to wait
Although the cleaning business is garnering a lot of attention, it's important to remember that this is just one piece of a larger company. And the rest of the business is actually holding up fairly well. That said, if management played the demand surge right, it may have broadened the space in which it can compete. And that will be a net positive for the long term.
Investor negativity, meanwhile, has pushed the stock price down and the yield up toward historically high levels, suggesting that Clorox stock is trading at bargain levels today. Better yet, long-term dividend investors can collect a historically generous 3.3% dividend yield while they wait for the dust to settle in the cleaning business knowing that a lot of negative news has already been priced into the shares. If management is right on the cleaning business, there may be more opportunity here than meets the eye for those willing to think outside the box.
