Cleaning Up With Clorox (CLX)

By Stephen Brown | April 24, 2007 AAA

Few companies qualify as widow-and-orphan stocks. Those that do share a common attribute: they own or are strong, persistent consumer brands. Companies such as Proctor & Gamble (NYSE: PG), Coca-Cola (NYSE: KO), Altria Group (NYSE: MO) and MacDonald's (NYSE: MCD) qualify.

Arguably on the cusp of window-and-orphan status is Clorox (NYSE: CLX), whose major brands include its eponymous bleach, Formula 409, Liquid-Plumr, Pine-Sol, Tilex, S.O.S., Brita, Hidden Valley Ranch, Glad, Kingsford, Armor All and STP.

Though its products are staples in many households, Clorox has, nevertheless, been a volatile performer in recent years.

In part, the volatility is due to the seasonal nature of a few of its products, like Kingsford, but more so because of energy and raw-material costs. On that front, Clorox absorbed $170 million of these costs in 2006 alone.

Calmer Waters Ahead
But Clorox appears to be steadying its operations and getting a handle on costs, at least if recent numbers are any indication.

Revenue for the second quarter of 2007 grew 3.5% to $1.10 billion, operating margins improved 115 basis points to 17.5%, and income from continuing operations rose 9.6% to $91 million over the year-ago quarter.

For the remainder of the year, revenue is expected to increase 4%, reflecting volume growth driven by new product introductions, price increases and the acquisition of Colgate-Palmolive's (NYSE: CL) bleach businesses in Canada and Latin America. Meanwhile, earnings per share should increase in the $3.20 to $3.28 range, 12.5% higher than 2006's EPS of $2.89.

Reducing Risk
In consumer products, competition from private-label brands and retailer leverage, from mega-chain stores such as Wal-Mart (NYSE: WMT), is always a concern, but I believe it's one that's overdone at times. The popularity of leading brands contributes to increased pricing-power and stronger cash flow for industry leaders, often at the expense of generic competitors -- which are usually inferior anyway (for proof, drink a store-brand cola).

Of greater concern to Clorox investors is financial risk. In November 2004, the company completed a complicated exchange of its ownership interest in a subsidiary for approximately 61.4 million of its shares held by Germany's Henkel KGaA. The exchange included Clorox's existing insecticides and Soft Scrub cleaner businesses, its 20% interest in the Henkel Iberica, S.A. joint venture, and approximately $2.1 billion in cash.

The $2.1 billion in cash forced Clorox to load up on debt, which ballooned to 128% of total capitalization and turned owner's equity negative.

Fortunately, Clorox's prodigious cash-generating ability has enabled it to readily service and amortize the debt ($600 million has been amortized to date). On that front, the company netted $122 million in operating cash flow in the second quarter of 2007, which was sufficient to not only handle the debt, but to fund the company's share repurchase program and its dividend obligation -- recently hiked 7% to $1.24 per share.

Room to Move
Clorox is currently trading at 21-times its 2007 EPS estimate, which is in line with its average P/E ratio over the past five years. My 12-month price target is $72, and is based on a blended P/E and DCF analysis, which includes a 10% discount rate, 8% average annual EPS growth over the next three years and 5% annual EPS growth in perpetuity.

My analysis could be conservative. Further out, I think Clorox's potential is even greater, especially after the debt is reduced to normal capitalization levels (25%-30% of total capitalization) and more cash is allocated for investment and product development. Once its financial house is in order, Clorox could indeed achieve widow-and-orphan status.

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