Clean Up Time for Clorox

Clorox's new guidance disappointed investors and Fitch, but CLX is buying back its shares on the down-slide.

(Stocks in article: NYSE: CLX, NYSE: CHD, NYSE: PG, NYSE: KMB, NYSE: CL)

Clorox Company (NYSE: CLX) reported a disappointing fourth quarter, with revenues coming in flat compared to last year's quarter if you exclude the contribution of a recent acquisition. The company still managed to expand margins, but EPS came in at the low end of expectations. Adding insult to injury, CLX declared that increased anticipated charges would require it to cut its forecast for fiscal year 2008 (Jun). A few days later, Fitch Ratings cuts its credit rating on Clorox based on the company’s plan to repurchase shares, which Fitch expects would likely be funded by debt that would leave Clorox operating at a riskier debt-to-capital ratio.

Clorox, well known for its household name in bleach, sells many other familiar products including Glad plastic bags and wraps, Liquid-Plumr, Tilex, Pine-Sol, Armor All, Kingsford brand charcoal and other products. Clorox is definitely another one of those consumer staples ideas sector strategists favor in times of market peril. But, Clorox has problems of its own right now, as it described in its fourth quarter report. Competition and higher commodity input prices are limiting CLX’s prospects.

In its fiscal Q4, total net sales inched 1.9% higher, but according to management, when excluding the impact of recently acquired bleach businesses in Canada and Latin America, sales were flat. CLX has three reportable segments: its Households Group (45% of FY 06 sales); Specialty Group (41%); and International segment (14%).

Sales at Clorox’s Households segment fell 2.0% in Q4, as volume slipped due to competitive pressure and poor weather. During its conference call, management specifically noted tough competition vying against its disinfecting wipes product. The company also noted that poor weather in April hurt auto-care product sales.

Sales from CLX’s Specialty Group rose 1.0%, on strong demand for Glad products that came on the heels of heavy promotional efforts, and due to improved kitty litter sales. Still, one of the coldest Aprils in recent history apparently led to a sharp drop-off in backyard barbecuing, affecting charcoal sales.

International efforts continue to prove a logical expansion route for Clorox, as the company’s foreign focused segment experienced 21% quarterly sales growth this past quarter. However, a closer look reveals that about twelve percentage points of that growth came from newly acquired business and favorable foreign exchange rates.

Clorox impressively squeezed 50 basis points of gross margin expansion, despite the revenue softness. Ongoing cost cutting initiatives and price increases outweighed higher trade-promotion spending, increased logistics costs and higher agricultural commodity costs. Even so, things were not all that good. Even with an improved tax rate and the repurchase of one million shares, if you exclude the $0.16 of charges to last year’s quarter, Clorox actually earned a penny less than last year’s reporting period.

As if the company’s revenue disappointment was not enough, it’s guidance drove the shares 4% lower through August 21st from the day before reporting earnings. Considering its “safe haven” appeal, that’s poor performance when compared to the 1.3% correction of the S&P 500 Index from August 1st through the 21st.

Clorox had already forecast charges of about 6-8 cents per diluted share for the consolidation of its home-care manufacturing network, but the company expanded its charge expectations another 15-17 cents. Management decided to forestall certain new venture investments and to consolidate its international supply chain. Because of these moves, Clorox reduced its FY 08 (Jun) EPS guidance to a range of $3.27 to $3.46, from previous guidance for $3.44 to $3.61.

So, Clorox has some cleaning up to do in order to restore an impression of reliability to safe-haven seeking investors. As far as valuation goes, CLX compares well to its Consumer Staple peers, in the Greek’s view. On a P/E basis, it’s likely being penalized for its forecast setback and growth stall. As far as dividend yield goes, CLX offers a payout about as rich as any of its peers.

Company --------------- Ticker ---------- P/E ttm ----- Div Yld
Clorox ------------------ NYSE: CLX ---- 18.4 ---------- 2.7%
Church & Dwight ----- NYSE: CHD ---- 21.2 ---------- 0.7%
Proctor & Gamble ---- NYSE: PG ------ 21.2 ---------- 2.2%
Kimberly-Clark ------- NYSE: KMB --- 18.2 ----------- 3.0%
Colgate-Palmolive ---- NYSE: CL ------ 22 ------------ 2.2%

In our view, CLX has strong brands and grand opportunity to grow internationally. These are probably the two most important components of the formula for the company’s future success. The tragic loss of its CEO in its recent past may have played a role in the company’s recent slippage, but we anticipate management will reassess its strategy and tool-set moving forward. They have already laid out their "Centennial Strategy", which is gearing CLX to seek double-digit annual percentage growth of economic profit. Economic wha you must be asking… That’s the profit a company makes over and above the cost of assets used in earning those profits. We think this is the right mindset and strategy for this type of company (read large), and CLX’s valuation seems to offer opportunity to move toward its historical mean value (21.5X P/E over last four years). This is another occurrence we view common among companies of this type (read mature).

So, as long as the company can get a handle on commodity cost pressures and competition, we would expect safe haven capital flow and mean revision to help CLX’s performance going forward. We think its share repurchases should help it toward that end as well. So in our contrairian viewpoint, CLX has appeal.

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