EUR 850.00 For Business Accounts Only

Morningstar | Wide-Moat Clorox Cleans Up in 2Q With Sales and Profit Improvement, but Shares Rich

The most pressing question heading into the quarter was whether Clorox would be able to raise prices to offset inflationary headwinds without incurring a sustained hit to volumes. And we believe results give credence to our contention Clorox is weathering the current challenges well. In the quarter, Clorox chalked up 3% organic sales growth and 70 basis points of expansion at the gross margin line to 43.7%. Despite higher commodity and logistics costs, which ate into gross margins to the tune of 120 and 190 basis points, respectively, efforts to implement cost-justified price increases across the vast array of its product mix (a 220-basis-point benefit) and extract excess costs (a 140-basis-point favorable impact) were a plus.

We don’t believe these higher prices are impairing its leading share position. For one, management articulated that while its raised prices in the bleach category (actions not followed yet by its next closest competitor, private label), the firm still boasted around 100 basis points of market shares gains in the quarter (a category where it already maintains 60% share). Further, the firm cited that Hidden Valley Ranch grew share for the sixteenth consecutive quarter. We think this supports our contention it has carved out a wide moat partly stemming from its entrenched retail relationships and leading brands.

Management held the line on its full-year outlook that guides for 2%-4% sales growth and EPS of $6.20-$6.40, which aligns with our 3% and $6.25 forecast, respectively. And we don’t intend to revise our $137 fair value estimate (outside of a $1-$2 bump for the time value of money) or long-term targets (nearly 4% sales growth and 150-basis-point increase in operating margins over 2018 levels to 20% by 2028). After a mid-single-digit uptick, shares strikes us as lofty, trading around a 15% premium to our valuation, but we’d point to wide-moat Colgate as a more attractive option, trading at a 10% discount to our $70 fair value estimate.

In light of intense competitive pressures (from other branded operators, lower-priced private-label fare, and smaller, niche foes), we were encouraged by management’s seeming commitment to maintain its brand by spending to differentiate its mix (which may hamper its ability to chalk up material margin expansion going forward) to support the brand intangible asset that underlies our wide economic moat rating. More specifically, our forecast calls for research, development, and marketing to approximate nearly $700 million annually over the next decade, or around 12% of sales annually--30 basis points higher than the average over the past five years.

From a capital allocation perspective, Clorox’s cash flow generation remains quite impressive, with free cash flow amounting to 12% of sales through the first six months of the fiscal year. We expect management will operate using the same playbook as it relates to deploying this cash, with its prime focus centering on bolstering shareholder returns through both dividends and share repurchases. In this vein, our forecast calls for the firm to raise its dividend at a mid-single-digit clip annually over the next 10 years (mainlining around a 60% payout ratio) while also repurchasing about 1% of sales outstanding. Beyond this, we think Clorox will opt to reinvest in the business with an eye to acquisitions; management has previously alluded to targets in the $50 million-$250 million range as ideal. However, we don’t anticipate that it will veer from its record of being an exemplary steward of shareholder capital.