The Clorox Company (CLX 2.70%) may not sound as interesting as some aggressive growth stocks, but its safe, strong cash flow shouldn't be ignored either.
In the past 6 months the bleach manufacturer has only produced returns of 2.86%. This market price stagnation could make some investors doubt about the intrinsic value of the company. But how valuable is Clorox? Is it really safe to invest in this bleach manufacturer? The following reasons suggest Clorox may be the perfect choice for the risk-adverse investor.
Well recognized, strong brand
Quality is a crucial factor when deciding the brand of the cleaning product we buy. Nobody is more aware of this than Clorox. In one hundred years, the company has positioned itself as a manufacturer of top-quality cleaning products, from its bleach to Glad garbage bags, Kingsford charcoal and Brita water filters. Each of these brands is itself well positioned in its respective segment.
Source: Clorox Investor Relations
The truth is that constant improvements in quality over one century have made Clorox brand a must-have in most households, and consequently the company has managed to build lifetime loyalty bonds among its consumers. For example, according to the latest earnings call presentation slides, as nearly as 90% of its portfolio holds the number-one or number-two spot. Furthermore, management has shown a strong commitment to allocate consistent advertisement spending to reinforce its brand strength. In the past 6 years, about 9% of total yearly sales has been used for advertisement.
The brand strength of Clorox has made Matt Koppenheffer identify Clorox as one of Warren Buffett's next big buys, which makes a lot of sense if you consider his preference for high-quality, stable companies.
Solid Fundamentals
Clorox's brand strength is reflected in the company's excellent fundamentals. First, Clorox has been able to keep consistent top-line revenue growth rates for the past 6 years. Even in 2008, when households were extremely price sensitive, Clorox grew in terms of revenue, while keeping prices well above generics.
Source: Clorox Investor Relations
Notice that between 2003 and 2012, annual revenue grew from $4.14 billion to $5.57 billion. This implies an average yearly growth rate barely above 3%, which could be regarded as too low to be attractive.
However, it is important to keep in mind the current scale of operations of the company (Clorox is three times the size of the next branded competitor in terms of market share) and the fact that growth, although slow, was very consistent, before judging Clorox's growth rates.
Profitability is also strong. In the latest quarter, adjusted gross margins jumped 130 basis points to 44%. Most of this was due to the firm's cost-saving efforts. And measures like using a Chlorine-free supply chain, packaging reduction and plant consolidation are set to add 2% to efficiency every year.
Amazing dividend
Clorox's dividend yield is well above the Standard & Poor's 500 average (2%), offering around 3.4% in annual payouts. As a matter of fact, Clorox has increased its dividend every single year since 1977, and a recent increase of roughly 11% was announced in May this year.
Even better, dividends are not the only way management is using to return value to shareholders. Over the last 9 years, management has used cash to repurchase as many as 40% of outstanding shares. Considering the long track of commitment to increase returns to shareholders, I also expect the usage of cash in the future to continue being shareholder-friendly.
Great value
Clorox has a very strong free cash flow (10% to 12% of sales) and return on invested capital percentage (23%, the peer average is roughly 15%).
As a result, Clorox fair estimate must be quite high.
The sell-side has conservative estimates. According to Yahoo Finance, the median price target is $86. Morningstar, on the other hand, is quite bullish, with a $92 fair value estimate.
Competitors aren't a serious problem
Church & Dwight Co (CHD 0.80%) and Zep (NYSE: ZEP) represent a strong fast-growing middle-sized and a stagnant small-sized competitor respectively.
Like Clorox, Church & Dwight takes brand strength seriously. More than 80% of its revenue comes from 8 so-called power brands: Arm & Hammer, Orajel, Oxiclean, Nair, Spin Brush, Xtra, First Response, and Trojan. The brands address diverse segments and are very strong in the U.S. but, unlike Clorox, their international presence is still quite limited. In fiscal year 2012, only 20% of sales came from abroad. The upside is that Church & Dwight has far more room for growth.
Unlike Clorox, the company has strong exposure not only to household products but also to the personal care segment. The upside to this is that its portfolio mix is more diversified. The downside is that with an $8.3 billion market cap, the company may have too few resources to compete optimally in every segment, specially against some major personal care giants like Procter & Gamble.
Church & Dwight is currently trading at a 23.2x price-to-earnings ratio, above Clorox.
On the other hand, Zep is only in the business of providing cleaning and maintenance chemicals to commercial, industrial and consumer customers. This market alone is said to be worth $75 billion globally (according to the company presentation slides). Unfortunately, without accounting for the effect of acquisitions, Zep is experiencing no organic growth. The company has predicted a mild revenue contraction for the first 3 quarters of 2014. The company is also quite leveraged, with a debt-to-equity ratio of 1.33.
Zep is trading at a 15.8x price-to-earnings ratio, below Clorox.
Final foolish thoughts
It's hard to imagine a world without Clorox. The brand is simply too strong to be ignored. Furthermore, excellent fundamentals, a commitment to actively return value to shareholders via dividend increases and share repurchases, 10-12% of sales converted to free cash flow and one of the highest ROICs in the industry make Clorox a strong and safe investment opportunity.
Competitors do exist, but they do not represent a major risk. Most competitors have a wider field of action, operating in various segments. This is a disadvantage, because they can devote less resources to compete against Clorox. Taking these factors under consideration, Clorox may be a great choice for investors willing to reduce volatility in their portfolios.
