Clorox Stock: A Normalization Was Needed (NYSE:CLX)

Spraying disinfection on surface.

Guido Mieth/DigitalVision via Getty Images

Clorox (NYSE:CLX) is a company that I’ve had my eye on for years. There’s a lot to like about the business, for starters it’s a consumer staple offering its customers every day items that they use in and around their household. From their namesake Clorox brand of cleaning solutions to Kingsford charcoal, to the all-purpose cleaner 409, Scoop Away cat litter and many other brands.

Clorox Brands CAGNY Presentation

Clorox Brands CAGNY Presentation (CAGNY 2022 Presentation)

Source

Clorox was a huge beneficiary of the pandemic as consumers sought out their array of cleaning and disinfectant products. The share price got pushed up to extremely lofty levels unless you had an expectation that the pandemic would materially change the mindset of consumers. Personally, I didn’t think we would see a sustained shift in demand and Clorox’s share price, and business have fallen back in line.

Clorox’s business has changed over time with 41% of FY 2021 sales coming from the health & wellness segment, 27% from household, 16% from lifestyle, and 16% from international.

Clorox’s share price has retreated nearly 40% since their peak in Q3 2020 which made me want to take another look at this high quality business.

Dividend History

While a lengthy dividend growth history is no guarantee that it will continue in the future, I do believe that conservative investors are well-served by using it as a starting off point for finding potential investments.

Clorox Dividend History

Clorox Dividend History (Clorox Investor Relations)

According to the CCC list, Clorox is a Dividend Champion with 45 consecutive years of dividend growth. That streak of annual dividend increases dates back to the mid-1970s and covers just about every kind of economic and geopolitical calamity imaginable.

Dating back to 1986 Clorox’s year over year dividend growth has ranged from 2.4% to 22.4% with an average of 9.7% and a median of 8.9%.

Over that same time there’s been 31 rolling 5-year periods with annualized dividend growth ranging from 5.8% to 15.6% with an average of 9.3% and a median of 8.6%.

There’s also been 26 rolling 10-year periods with Clorox’s annualized dividend growth spanning from 7.0% to 11.6% with an average and median of 9.3%.

The rolling 1-, 3-, 5- and 10-year annualized dividend growth rates from Clorox since 1986 can be found in the following table.

Year Annual Dividend 1 Year 3 Year 5 Year 10 Year
1986 $0.1850
1987 $0.2125 14.86%
1988 $0.2500 17.65%
1989 $0.2975 19.00% 17.16%
1990 $0.3475 16.81% 17.81%
1991 $0.3825 10.07% 15.23% 15.64%
1992 $0.4125 7.84% 11.51% 14.19%
1993 $0.4425 7.27% 8.39% 12.10%
1994 $0.4650 5.08% 6.73% 9.34%
1995 $0.5050 8.60% 6.98% 7.76%
1996 $0.5550 9.90% 7.84% 7.73% 11.61%
1997 $0.6100 9.91% 9.47% 8.14% 11.12%
1998 $0.6800 11.48% 10.43% 8.97% 10.52%
1999 $0.7600 11.76% 11.05% 10.32% 9.83%
2000 $0.8200 7.89% 10.36% 10.18% 8.96%
2001 $0.8400 2.44% 7.30% 8.64% 8.18%
2002 $0.8600 2.38% 4.21% 7.11% 7.62%
2003 $0.9800 13.95% 6.12% 7.58% 8.28%
2004 $1.0800 10.20% 8.74% 7.28% 8.79%
2005 $1.1200 3.70% 9.20% 6.43% 8.29%
2006 $1.1600 3.57% 5.78% 6.67% 7.65%
2007 $1.4200 22.41% 9.55% 10.55% 8.82%
2008 $1.7200 21.13% 15.37% 11.91% 9.72%
2009 $1.9200 11.63% 18.29% 12.20% 9.71%
2010 $2.1000 9.38% 13.93% 13.40% 9.86%
2011 $2.3000 9.52% 10.17% 14.67% 10.60%
2012 $2.4800 7.83% 8.91% 11.80% 11.17%
2013 $2.7000 8.87% 8.74% 9.44% 10.67%
2014 $2.9000 7.41% 8.03% 8.60% 10.38%
2015 $3.0200 4.14% 6.79% 7.54% 10.43%
2016 $3.1400 3.97% 5.16% 6.42% 10.47%
2017 $3.2800 4.46% 4.19% 5.75% 8.73%
2018 $3.7200 13.41% 7.20% 6.62% 8.02%
2019 $4.0400 8.60% 8.76% 6.86% 7.72%
2020 $4.3400 7.43% 9.78% 7.52% 7.53%
2021 $4.5400 4.61% 6.87% 7.65% 7.04%

Source: Author; Data Source: Clorox Investor Relations

The dividend payout ratio is a quick, useful measure of the safety of a dividend that lets you know how much of the business’ profits or cash flow is used on the dividend payment. The more stable and predictable the underlying business the higher a payout ratio can run and still be deemed safe.

CLX Dividend Payout Ratios

CLX Dividend Payout Ratios (CLX SEC filings)

While Clorox’s payout ratio runs on the higher side it is still pretty safe given the stability of the business. The 10-year average net income payout ratio is 61.9% with the 5-year average at 61.7%. Similarly, Clorox’s average free cash flow payout ratios are 59.3% and 57.0%.

Quantitative Quality

As an investor that looks to own a stake in a business for a period measured in several years, if not longer, the quality of a business is very important. A high quality business will be able to continue to improve itself over time and work through temporary issues. I track several financial metrics over time to see how a business has performed and to get comfortable with the quality of the business.

CLX Revenue Profits and Cash Flow

CLX Revenue Profits and Cash Flow (CLX SEC filings)

Clorox isn’t exactly a rapid grower as they operate in fairly mature markets. Over the last decade Clorox has seen its revenues improve 34.3% in total or roughly 3.3% annualized. Gross profit growth has tracked with revenue growth increasing 38.8% in total or 3.7% annualized.

Operating profits rose 35.7% or 3.4% annualized with operating cash flow showing big outperformance increasing 108.5% or 8.5% annualized. Similarly, free cash flow improved 125.0% in total or 9.4% annualized.

For mature businesses such as Clorox, I expect to see stable or rising margins over time as they are able to flex the strength of their business.

CLX Margins

CLX Margins (CLX SEC filings)

Clorox has shown steady gross margins during the last decade with a 10-year average of 43.7% and a 5-year average of 44.3%. Free cash flow margins have been improving over that time and Clorox benefitted greatly from the pandemic as their cleaning products were in great demand. The 10-year average free cash flow margin for Clorox is 12.1% with the 5-year average at 13.6%.

Similarly, I examine how efficient the business uses its assets and capital to generate free cash flow. I want to see a free cash flow return on invested capital of at least 10% that is at least stable and preferably trending higher over time.

CLX Free Cash Flow Returns

CLX Free Cash Flow Returns (CLX SEC filings)

As the dominant player in its sub-industries, Clorox maintains very strong free cash flow returns. The 10-year average free cash flow ROA for Clorox is 15.0% with the 5-year average at 16.1%. Likewise, Clorox’s free cash flow ROICs are very strong with averages of 25.1% and 26.1%, respectively.

To understand how Clorox uses its free cash flow I calculate three variations of the metric, defined below:

  1. Free Cash Flow, FCF: Operating cash flow less capital expenditures
  2. Free Cash Flow after Dividend, FCFaD: FCF less total cash dividend payments
  3. Free Cash Flow after Dividend and Buybacks, FCFaDB: FCFaD less net cash used repurchasing shares

CLX Free Cash Flows

CLX Free Cash Flows (CLX SEC filings)

Over the last decade Clorox has generated $7.4B in FCF and returned $4.2B to shareholders via dividends. That puts the 10-year cumulative FCFaD at $3.2B. Clorox has also spent a net total of $2.3 B repurchasing shares which has the cumulative FCFaDB at $0.9B.

Share repurchases can be a great way for management teams to return excess cash to shareholders if there’s not productive or attractive internal or external re-investment opportunities. Buybacks, if done at reasonable valuations, can boost returns for remaining shareholders by increasing the per share value of the business.

CLX Shares Outstanding

CLX Shares Outstanding (CLX SEC filings)

Surprisingly Clorox has not typically utilized buybacks to return additional cash to shareholders. Over the last decade Clorox’s shares outstanding are down just 3.8% or ~0.4% annualized. The bulk of the reduction came during FY 2019 and FY 2020 which saw declines of 1.4% and 1.6%, respectively.

Additionally I want to see how a company’s capital structure has evolved over time by looking at the debt-to-capitalization ratio. With my potential equity investment being the lowest rung of the capital structure ladder, it’s important that the debt levels do not appear overly burdensome.

CLX Debt to Capitalization

CLX Debt to Capitalization (CLX SEC filings)

During the last decade, Clorox’s debt-to-capitalization ratio has been improving although it is still at elevated levels. The 10-year average debt-to-capitalization for Clorox is 88% with the 5-year average at 81%.

The net debt ratios are another measure of the leverage that the business carries by examining the net debt versus some measure of profits or cash flow.

CLX Debt Ratios

CLX Debt Ratios (CLX SEC filings)

Clorox’s net debt ratios have been fairly stable over time. The 10-year average net debt-to-EBITDA, net debt-to-operating income, and net debt-to-FCF ratios are 1.8x, 2.1x, and 3.2x. Additionally the 5-year averages are 1.8x, 2.0x, and 2.8x, respectively. Clorox’s interest coverage ratio has also been improving during that time as their cost of debt has fallen.

While Clorox’s capital structure is largely debt backed, the debt that is carried on the balance sheet is well covered by the profits of the underlying business. Arguably, Clorox could lever up further given the predictability of their business.

Valuation

When valuing potential investments I use multiple valuation methods to attempt to value the business from varying perspectives. The valuation methods that I utilize are a reverse discounted cash flow analysis, dividend yield theory, and a minimum acceptable rate of return analysis.

Analysts expect Clorox to report FY 2022 EPS of $4.11 with FY 2023 rebounding to $5.39. Analysts also expect Clorox to be able to grow EPS at 6.0% annually for the next 5 years and I then assumed that Clorox would be able to maintain 3.0% EPS growth for the following 5 years. Dividends are assumed to target a payout ratio of 65%.

Over the last decade, Clorox has traded for ~16x to ~30x TTM EPS. For the MARR analysis I’ll examine exit multiples spanning that range.

Chart
Data by YCharts

The following table shows the potential internal rates of return that an investment in Clorox could generate provided the assumptions above are reasonable estimates of the future. Returns assume that dividends are taken in cash and paid along the timeline that Clorox has traditionally followed. It’s assumed that shares are purchased at $146.66, Wednesday’s closing price.

IRR
P/E Level 5 Year 10 Year
30 11.9% 8.6%
25 7.7% 6.7%
22.5 5.4% 5.7%
20 2.8% 4.6%
17.5 0.1% 3.3%
15 -3.1% 1.9%

Source: Author

Additionally I use the MARR analysis framework to work backwards in order to determine what price I could pay today in order to generate the returns that I desire from my investments. I typically aim for at least 10% returns and for Clorox I’ll also examine 8% and 12% return targets.

Purchase Price Targets
10% Return Target 12% Return Target 8% Return Target
P/E Level 5 Year 10 Year 5 Year 10 Year 5 Year 10 Year
30 $159 $132 $147 $114 $171 $154
25 $135 $115 $126 $100 $146 $134
22.5 $123 $107 $115 $93 $133 $124
20 $112 $98 $104 $86 $120 $114
17.5 $100 $90 $93 $79 $107 $104
15 $88 $81 $82 $71 $95 $93

Source: Author

Dividend yield theory is a valuation method based on reversion to the mean and operates under the idea that market participants will value a business around a normal dividend yield level. It’s best suited for stable companies that have a rich history of paying dividends. For Clorox I’ll use the 5-year average forward dividend yield as a proxy for fair value.

Clorox Dividend Yield Theory

Clorox Dividend Yield Theory (CLX Investor Relations & Google Finance)

Clorox shares currently offer a forward dividend yield of 3.16% compared to the 5-year average forward yield of 2.61%.

A reverse discounted cash flow analysis can be used to decipher what the current price of a business implies about the necessary growth and margins that a business must be able to produce in order to generate the necessary cash flows. In other words it’s a way to see what you have to believe about a business in order for it to be worth the current market price.

I use a simplified DCF model based on revenue growth, an initial free cash flow margin of 11.0% that improves to 14.0% during the forecast period. The terminal growth rate is estimated at 3.0%.

With a 10% discount rate, Clorox needs to grow revenues 9.9% annually through the end of FY 2031 in order to generate the necessary free cash flows. Lowering the discount rate to 8% reduces the required revenue growth to 4.4% over that same timeframe.

Conclusion

Clorox is a fantastic business in the consumer staple sector. At this stage of its business life Clorox definitely falls into one with a legacy moat with a firmly entrenched, recognizable, and trusted brand. That’s allowed them to consistently earn >10% free cash flow margins with free cash flow ROICs greater in the low 20% area.

Unfortunately, they haven’t been able to expand much into other markets with sales just coming in at just over 3% annually over that last decade. That’s still adequate; however, it’s not exactly exciting especially given that Clorox typically trades at a premium valuation given the strength and durability of its business.

In my opinion Clorox was very clearly overearning in FY 2020 and FY 2021 thanks to the heightened awareness for their cleaning products brought about by the global pandemic. My general idea surrounding Clorox over that time was that shares appeared very overvalued and carried a lot of risk as demand would eventually normalize.

Dividend yield theory suggests a fair value range for Clorox between $162 and $197 which at a share price in the mid-$140’s means it’s quite undervalued. Meanwhile the MARR analysis when targeting 10% annualized returns five years out with a terminal multiple between 17.5x and 22.5x puts fair value range between $100 and $123. Although with an 8% IRR target the fair value range rises to $107 to $133.

The reverse DCF also suggests that 10% returns are not very likely as the required revenue growth and/or margin expansion is not likely to come to fruition. However, 8% returns do appear achievable although Clorox appears to be fully valued at best. Share repurchases could potentially help juice the per share returns although Clorox has not consistently repurchased shares in any meaningful way.

A cause for concern is where is Clorox’s dividend increase? Clorox has typically increased their dividend beginning with fiscal Q1, calendar Q3, payment with the declaration typically announced in mid to late May although in 2021 the declaration was moved into early June. However, we now sit in early July and there’s still no dividend declaration as of today.

I believe that Clorox will raise their dividend even if it takes 5 or 6 quarters from the prior increase. However, the lack of announcement implies that management remains cautious on the shorter-term outlook for the business.

Clorox has been hit with a 1-2 punch of negativity in falling demand as the pandemic, or at least concern for it, has waned in conjunction with inflation squeezing their margins.

Clorox’s share price has been a one-way train down since peaking at nearly $240 per share in August 2020. That’s nearly a 40% drawdown for a very stable business. Irrational exuberance pushed Clorox’s market valuation to incredibly expensive heights.

That being said, Clorox is looking much better after the pullback. I believe Clorox is still on the expensive side; although, it’s now around levels that are justifiable. Especially in conjunction with the nearly 3.2% starting dividend yield. Clorox hasn’t offered a starting yield that high since 2012.

I’m fairly confident that Clorox the business won’t be going anywhere anytime soon. The share price has finally reverted back into the realm of reasonable and while over the near-term Clorox could very well underwhelm. However, given its track record and stability, pandemic not-withstanding, I believe that Clorox will eventually work through the margin pressures and resume their slow grind higher over time.

With nearly a decade high starting yield and margin relief potentially on the horizon, dividend growth investors and those with a long-term mindset, myself included, can consider buying Clorox. Although personally I’d like to purchase shares on any further dip into the low $130s given my expectation for a slow, baseline growth rate of the business.

Be the first to comment

Leave a Reply

Your email address will not be published.


*