Tough Markets Doing Clorox No Favors

By Stephen D. Simpson, CFA | May 04, 2012 AAA

When the going gets tough, even the best companies find that their options are more limited. Clorox (NYSE:CLX) has proven itself time and time again, but even a company with so many category-leading products can only do so much in an environment where cost inflation is a real threat and stretched consumers limit their price leverage. While Clorox remains a top-tier personal and home care company, the valuation just doesn't demand much interest today.

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Mediocre Fiscal Third Quarter Results
Clorox reported that sales grew more than 7% in the fiscal third quarter, incorporating 6% organic growth and doing well relative to most estimates. Organic volume rose 2%, while price and mix chipped in the other 4%.

Growth was strongest in the lifestyle and cleaning categories, while household did pretty well.

Margins and profits proved less impressive. Gross margin slid almost two points on the aforementioned cost inflation, and reported operating income dropped 5%. Part of the problem here is that Clorox continues to be relatively aggressive on its promotions (much like Procter & Gamble (NYSE:PG)) and is not getting quite enough sales bang for the promotion buck.

SEE: Understanding The Income Statement

Familiar Trends in the Store
Clorox is a leading company in categories like bleach, trash bags, charcoal, water filtration, and salad dressings, but as is the case with so many companies today, that leadership is only worth so much. It's not that rivals like Procter & Gamble, Church & Dwight (NYSE:CHD), Colgate (NYSE:CL), Kraft (NYSE:KFT) or Unilever (NYSE:UL) are taking away significant share. Rather, all of the branded companies are seeing constant ongoing share growth for private label brands and a great deal more price shopping from customers.

At least water filtration is offering a little growth. Clorox continues to roll out new Brita products, and has apparently been benefiting from disruptions in the PUR business as Helen Of Troy (Nasdaq:HELE) has taken over the brand from P&G.

SEE: Earning Forecasts: A Primer

Appreciated for Its Long-Term Virtues
Analysts and investors really didn't like what they heard from the company in terms of its guidance. Still, I wouldn't be so quick to forget what has gotten Clorox to this point. Clorox has an uncanny knack for internal product development and innovation and has used that to drive growth in markets that are, for the most part, no-growth markets for most of its competition. That is the sort of internal corporate DNA that produces long-term value, and that's backed up by very solid returns on capital.

The Bottom Line
Quality isn't the issue at Clorox, but price is. I have nothing but respect for the company's innovation-driven culture (or at least the innovative results of its culture) and the company's long-term returns on capital have been simply excellent.

The problem, though, is that even mid-single-digit compound free cash flow over the next decade points to no particular undervaluation in the shares. I wouldn't tell any long-term holder of Clorox to sell today, but it's just hard to see how these shares are priced to perform for the next year or so.

SEE: DCF Analysis: Forecasting Free Cash Flows

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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