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Tickers in this Article: ZEP, AYI, CLX, NWL, ECL
Zep, Inc. (NYSE:ZEP), a provider of chemical cleaning solutions, was spun off from Acuity Brands (NYSE:AYI) in late 2007. This means that Zep is close to completing its third full year as an independent entity. Since that time, sales and profit trends have been murky, but should start looking up once end-customer demand improves. IN PICTURES: World's Greatest Investors

Third-Quarter Sales and Profit Trends
Reported sales improved to $153 million or 24%, most of which was related to the January 2010 acquisition of Amrep, a provider of specialty chemical products for the automotive and janitorial industries. Excluding the purchase, Zep stated that it saw a sequential increase in volumes, but decline on a year-over-year basis as end-market demand remains weak. Zep sells to institutional clients, and through retail channels. Familiar consumer brands include namesake cleaner ArmorAll, which is licensed from Clorox (NYSE:CLX). Zep also licenses Rubbermaid-branded cleaners from Newell Rubbermaid (NYSE:NWL).

Gross profits improved 14% to $75.9 million, but the gross profit margin fell significantly as Amrep's focus on selling through distribution and retail channels carries lower margins. Higher interest expense and a reversal of currency benefits in last year's quarter sent operating income down 1% to $8.6 million. Higher income taxes sent net income down 3% to $5.2 million, while more shares outstanding sent earnings down 8% to 23 cents per diluted share.

Outlook and Earnings Multiple
For the full year, analysts expect sales to grow 14.1% to $571.6 million and earnings $1.01 per share, which would be well ahead of the 53 cents reported in the last fiscal year. At current levels, Zep trades at a forward P/E multiple of just below 18. This is high, but below cleaning services rival Ecolab (NYSE:ECL), which trades at closer to 20-times forward earnings.

Bottom Line
Despite the near-term profit volatility, free cash flow generation has been stable over the past three years and has averaged close to $22 million annually, or approximately $1 per share. Similar to the earnings multiple, the free cash flow multiple is currently lofty at about 18. However, growth trends should pick up as end-customer demand improves and Zep continues acquiring smaller rivals to build market share in a cleaning market that is many billions of dollars in size. (To learn more, see: Free Cash Flow: Free, But Not Always Easy.)

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