The Clorox Company

Household products

NYSE symbol CLX

The Short Version

Despite its iconic brands and nearly recession-proof bleach business, the Clorox Company is priced too highly to qualify as an investment, and the company’s long-term debt poses risks that do not make the company an attractive buy right now. The company may have too much diversity in its subsidiaries and will have to spend a substantial amount of effort to really maintain its current business model. Stable cash-flows and a seemingly safe dividend mean the company is not a sell, but I cannot consider buying the company until it drops below $70/share. Even then, it will require another careful analysis and a reduction in debt and brand diversity. Clorox goes on my watch list, not my buy list.

The Long Version

I had my latest idea for an analysis while cleaning my bathroom (yes, I do know how to clean a bathroom). After spraying down the entire shower with Clorox foaming bleach, and thanking God that I live in a world with foaming cleaner, I looked at the bottle in my hand and noticed “subsidiary of The Clorox Company.” It had never really hit me that Clorox was a company before that moment. I was due for a new analysis so I went to the internet (after rinsing the bleach off of everything), and found out that Clorox is a fairly diverse public company, currently valued at about $10 billion. How about that? I figured since I was a regular consumer, I might as well look into being a regular owner of the company as well. I packed up my laptop, hit the nearest Caribou Coffee (still a favorite) and started getting excited about cleaning products. Hear that, Mom? I learned about cleaning supplies! As always, I started with a qualitative analysis – what’s The Clorox Company all about anyway?

Qualitative

At first blush, there is a lot to like about The Clorox Company. They have brand recognition in a field that, candidly, I hadn’t associated with branding. Just like Kleenex has become synonymous with facial tissue (Puffs is trying to change that), Clorox has become a word for bleach. As I was typing this article, my word processor recognized “Clorox” as a word. When shopping for apartment supplies, even a poor bachelor with limited cleaning interest (like me) knows to reach for the Clorox bottle. Their foaming bathroom cleaner is a high-quality product that makes life easier for everyone, and their famous Clorox wipes are a popular product that has quickly become a “need” for american households. Even many of their non-bleach brands are dominant in their fields. Quick – name the first brand of wood cleaner you can think of! If you said “Pine-sol,” you proved my point – it’s owned by The Clorox Company!

There are parts of The Clorox Company that I find very attractive as an investor, particularly when it comes to their laundry and home care divisions. It doesn’t matter how good or bad the economy is, people will have to clean their bathrooms and will have to do their laundry, and while there are products that compete with bleach, there aren’t really any bleaches that compete with Clorox. In its niche, Clorox has a virtual monopoly on a necessary product. The only thing better for a long-term investment than a product line that people will always need and use, is a virtual monopoly on that product line.

However, upon looking through the company’s portfolio of brands, at least 45% of the company is vulnerable to economic cycles and competition. Clorox owns a diverse group of brands, including Kingsford, Glad, and Burt’s Bees. All of these companies are extremely vulnerable in the marketplace. If things are not good in America, we can easily stop having cookouts (not good for Kingsford), buy the non-name brand plastic wrap (bad news for Glad), and cut down on the expensive lip balm, or at least buy the cheap version (bummer for Burt’s). Not to mention all of the competition these kinds of brands face in good times. Burt’s Bees fights tough battles in the cosmetics market against dozens of companies, Glad has to compete against Saran and Ziploc, and Kingsford not only has to compete against other charcoals (a crowded field already), but also has to compete against the cheaper, cleaner, and more convenient alternative of propane. This doesn’t even touch on brands like Hidden Valley and Brita (both owned by Clorox). The point is that only 1/3 of the Clorox company enjoys the safe, recession-proof, brand dominance that makes the company so attractive at first glance. Not a deal-breaker, but not a great sign either.

This leads into another qualitative concern I have of the company – the number and diversity of its brands. Clorox owns a large number of subsidiaries in various industries from cleaning products to plastics to cosmetics. Some of these brands, particularly in the cleaning sector, make a lot of sense for the company’s portfolio. It isn’t a far jump from bleach cleaning products to wood cleaning products (like Pine-sol). However, it surprised me to see that the company owns Burt’s Bees (they were bought out in 2005) and Hidden Valley dressings. What is a cleaning company doing in the cosmetics sector? I get that Burt’s Bees is another common product found in many homes, but if that is your only thread to connect everything, then where does it end? Sinks? Furnaces? Mattresses? All of these things are found in every home, but fall far outside of the Clorox core business model of cleaning supplies. And more bothersome – why does a bleach company own a salad dressing company? Maybe I’m crazy, but what do making bleach and making food products have in common? I get why the company owns Formula 409 (tile cleaner), but I can’t understand why the company owns a charcoal company. This is another qualitative red flag. Any company that strays too far from its core business model ends up exposing itself to all kinds of operational and market risks that it does not understand.

Reading through the company’s annual report, I caught a line that struck me as very odd. In his letter to shareholders, the CEO said “[a]fter a thorough assessment, we made the strategic decision not to expand in certain emerging markets such as India and China at this time. These markets require large capital investments, and we currently believe there are better investment choices to drive economic profit growth and create value for our stockholders.” As a possible long-term investor, this bothered me a great deal. I am no economist, but I think it is safe to say that China and India are here to stay. They are two of the largest and fastest growing economies in the world, and together they have 2.2 billion possible consumers. Why shouldn’t a company looking for long-term returns jump at the chance to get 2.2 billion new customers? Ok, most of the people in those countries do not have the disposable income to buy bleach right now, but both countries have a growing middle class, and even if only 1% of that population qualify as potential customers, that still translates to 22 million people. That’s a lot of untapped potential. I would understand if the company said something about export law, concerns about dealing with Chinese or Indian trademark laws, or even expressed hesitation to enter China given that the country is still technically communist and may repossess/confiscate any investments that Clorox makes there at any time. However, the company pointed to the cash outlay it would require as its reason for not making the leap. Unless I’m missing something, that large cash outlay looks like it would be cash well spent. Management’s job is to take good risks with the company’s money, and this looks like a mistake on the management’s part.

Still looking through the stockholder information website for Clorox, I found some very interesting good news; on January 28th, the Clorox company was named on the 2013 Global 100 Most Sustainable Corporations in the World List by Corporate Knights. This is big news for investors. The list is not just made up of companies that make an effort to be ecologically sustainably; the companies on this list have to be financially stable enough to survive as well. Clorox has done a great job of making their products and production as ecologically friendly as possible, while never losing sight of the end goal: making money for shareholders for years to come. The company has reduced water and energy consumption, and many of its subsidiaries have started to release eco-friendly product lines. While I’m not thrilled with the number and breadth of Clorox’s subsidiaries, at least they are all doing good business, and making an effort to do good for the planet. As the environment becomes a more important issue for consumers and companies, Clorox should be in a position to benefit.

There are both pros and cons for this company. I like their core business model, and many of their brands. The company’s management is clearly interested in returning value to shareholders, and doing so in the best way possible for employees, owners, and consumers alike. Green initiatives and employee engagement (now at 88%) at the company are both great signs. On the other hand, the company has too many irons in too many fires, and it is hard for me to ignore that fact. Additionally, I can’t say I’m thrilled about the way the company has been investing its cash. Management used cash to buy back a large numbers of shares from investors, and purchased a cosmetics company. Why didn’t the management focus on reducing debt and establishing product lines in China and India? I realize these are expensive up front, but I have to believe that lowering debt will help with cash flow, and that 2.2 billion people in the two fastest growing economies in the world will generate some demand for bleach. It is a shame that Clorox was afraid to spend money on these potential opportunities. Overall, I could go either way on Clorox qualitatively, but I have to give it a thumbs-down. None of the problems I have are deal-breakers, but all together, they make me too uncomfortable to take the jump. The most important thing to remember when picking investments: never be afraid to walk away, there are plenty of great opportunities out there, so don’t be afraid to miss one.

All of that said, the numbers are just as important as the qualitative analysis. If shares of the company are cheap enough, maybe it could be a good investment anyway. Time to read the accounting mumbo-jumbo and see if Clorox is still worth buying.

Quantitative

A look at the qualitative picture that the company paints has a lot of attractive elements. Fundamentally, the purpose of any business in any field is to make money for the owners, and Clorox has consistently done exactly that. Over the past six years, the company has had a diluted EPS of at least $2.23 per share. That includes the catastrophic year of 2008, when the credit crisis threw most companies into chaos. That year, when many seemingly unshakable institutions were collapsing, Clorox managed to report diluted EPS of $3.24, and they raised their dividend. Stability like that is certainly attractive in a business. I’ll go into more detail about earnings analysis a bit later, but the fact that the company has kept earning money through some crazy years is a fantastic sign for a potential investor.

I can definitely see the appeal that the company’s stock has – Clorox (CLX on the New York Stock Exchange) currently has a healthy dividend yield of 3.17% – not a bad return for your money. For the many stock investors who are interested in dividends as a means of income, this makes the stock very attractive to own. More importantly, that number appears to be stable and protected. One of the most important factors for dividends is dividend security. A company that offers a dividend yield of 20% is only a good investment if the company makes enough money to actually pay that dividend. Fortunately for Clorox investors, the company makes enough to generously cover the dividend. Currently, the company pays $2.56 per share every year (quarterly dividends of $.64). With the exception of 2011, the company has made more than enough to cover that amount in every year since 2006. Even in the down year of 2011, the company had a diluted EPS of $2.23, and thanks to several lucrative years, had more than enough cash to cover the difference of $.33 per share. The company hasn’t stopped there, the company has raised its annual dividend every year since 2006, showing a real commitment to returning profits to investors, and if business keeps moving in the same direction, that pattern will not change. The management at Clorox clearly understand that the company is owned by the shareholders, and they have made great efforts to make sure that shareholders get a return on their investments.

Part of the effort to return value to shareholders has been a substantial buyback plan over the last 8 years. In their most recent annual report, the company pointed out that they have bought back nearly 40% of outstanding shares. This is a pretty bold statement of confidence on the part of the management, and once dividends are included, it means the company has returned about $5 billion in shareholder value since 2005. Not too shabby! When a company raises its dividend consistently, it is a sign that the company is doing well, and is able to make more money for its investors every year. Companies that buy back shares from investors are essentially making a claim that the stock is undervalued, and should perform well over the long-term. Clorox has done a lot to make investors happy over the last several years. However, neither dividend raises nor share repurchases on their own are sufficient to call the stock a good buy; the company must also have a stable financial position, and that is where Clorox starts to run into trouble.

One upsetting fact about the company’s finances became clear as I looked though several old balance sheets – the company has way too much long-term debt. Currently, taking the accounting statements at face-value, Clorox has assets valued at $4.36 billion, and liabilities totaling $4.49 billion, leaving the shareholders with negative book value. According to the books, each share of the company has a negative value of about $1. This is largely caused by the company’s long-term debt, which is currently $1.57 billion, much of which is coming due in the next few years. Additionally, the company has had at least $300 million in short-term debt in each of the last 5 years, which is over 7.5% of the company’s asset value. It is very hard to make money if you consistently have to borrow that much cash for short-term needs. That doesn’t even count the impact of long-term debt and other liabilities on the company’s financial situation.

Another way to look at debt is to look at how much debt the company has relative to assets. The company has $2.72 billion in total debt (both long and short-term), or 62.4% of its asset value. When you remove $1.75 billion of goodwill that the company carries on its balance sheet as an asset, that ratio jumps to 104%, which is dangerously high. Debt levels this high leave the company vulnerable. If things start to go wrong and the company’s earning power is shaken, this debt will quickly destroy the real value that the company has for shareholders. The company’s debt has to be paid before dividends are paid out or earnings are declared, so if the company fails to earn enough to cover both dividends and interest, the shareholders lose their precious dividend. This makes me question the management’s decisions to raise dividends and buy back so much stock over the last several years. Why not take that money and reduce the company’s debt? Sure it isn’t as sexy as sending fat checks to the owners, but eliminating debt helps to reduce risk and increase cash flow for long-term investors. Additionally, had the company focussed on reducing debt over the last five years, it might have had the financial flexibility to lay out the large amount of cash needed to enter China and India. Perhaps this was why management didn’t like the cash level needed to make that move.

Another worrisome factor is the company’s negative book value. While book value alone is not a perfect indicator of the company’s true worth, it helps gauge the risk associated with owning the company. I touched on this earlier, and even without carefully looking through the accounting statements to eliminate assets with no real value, the company has a book value of negative $1 per share. Once you adjust for assets like goodwill, which rarely translates into real money in a liquidation, that number changes to negative $14.21 per share. Yikes! Granted, if you buy a stock, you can never lose more money than you paid, so the real value of the stock cannot be a negative number, but the stock has a long way to go before it looks like a safe investment from an asset point of view. I know this is an oversimplification of the issue, but the basic idea is that there is a lot of risk associated with the stock. Not a good sign for an investment.

Finally, a look at the company’s earnings is important for a thorough analysis. Looking through the last five years, the company has managed to keep earnings relatively stable, and has had an average diluted EPS of $3.524. Using a price-to-earnings ratio (P/E) of 20, the highest average P/E I ever use for an investment, that means CLX has a maximum investment value of $70.48. This number doesn’t factor in things like extraordinary earnings and discontinued operations, but for the sake of an initial estimation, it helps to set a rough idea of the maximum that you can safely pay for a stock. At last check the company was trading at $80.74 per share. Even before you account for any accounting magic that might have inflated earnings over the last five years, the company appears to be too expensive to be considered an investment.

Given all this information, I have to give Clorox a qualitative thumbs down. It is too highly valued to be an investment, and as a speculative stock, it doesn’t cut it. A good speculation is one that has a shot to make a big price move, and the management at Clorox has shown that they are not interested in big changes like, say, investing in China and India. This doesn’t mean that I would short the stock, the company does have solid earning power. If I owned the stock already, I’m not sure I would sell it either – the bleach business isn’t going anywhere. However, it isn’t worth buying.

Conclusion

There certainly is a lot to like about Clorox as a company. The company fills several consumer needs, makes high quality products, has engaged employees, and focusses on returning money to investors, all of which are good things. However, the risks created by the company’s debt, the recent management decisions, and the seemingly scattered portfolio of brands, all make me worry about the company at its current price. It isn’t that any one of my worries about Clorox is a deal breaker. After all, there are always things to worry about. That said, all of my concerns put together are a deal-breaker for me. That’s not to say that the stock will go down, or that anyone who thinks it is a good buy is wrong. All I am saying is that I won’t buy the stock. There are plenty of opportunities out there, and there is no reason to take a chance on a stock I’m not sure about when there are plenty of wonderful opportunities out there. After all, the most important skill is knowing when to walk away.

– The Filosopher in Phinance

Disclosure – I have no financial interest in CLX, and no plans to change that in the future.