CLX(NYSE)

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Clorox (CLX, NYSE)

Last Updated July 15, 2000

The course of the US stock market in the nineties has been set by a combination of two strong trends; interest rates decline and returns on equity improvement. Notice that I have not mentioned rising earnings per share. While the EPS of most big corporations have been rising but not nearly as fast as the rise in the stock market and P/E ratio. Now, chinks in this armor have started to appear. Long bond yields are already up by nearly 1% and even the ever friendly Federal Reserve has decided to hike up the rates. Once again we have to decide whether to bet on the changing reality as a short term blip or a return of the old growth-inflation-recession scenario.

So far, the so called changed environment has had strange effects on the market sectors. While deep cyclicals like energy, paper and chemicals are up, the consumer staples like Coke, Procter and Gamble and The Clorox Company, the stock under review today, have all suffered. I understand that the concern is the weaker global economies where many of the branded behemoths have entered in a big way. Clorox on the other hand is much less dependent on the non-North American markets, so far the only economy with consumers who want to spend even if it is all on credit. Are we concerned about recession or inflation? We can't have both.

Clorox is a consumer products heavyweight that owns a stable of brand names on top of its namesake bleach business. Clorox is emerging from the biggest corporate acquisition in its 86-year history. Clorox's many smart acquisitions over the years are a big reason why its shares have returned an average 27.5% annually since 1980. In January, the company paid $1.96 billion in stock and debt for First Brands Corp. Here's a breakdown of the two companies' brand name products: Laundry Cleaning; Clorox bleach , Home Cleaning; Clorox, Formula 409, Liquid-Plumr, Pine-Sol, Soft Scrub, S.O.S., Tilex . Bags and Wraps; Glad trash bags and food storage bags, Gladwrap Automotive; Armor All, STP Charcoal; Kingsford, Match Light, Starter Logg, Hearth Logg Insecticides; Black Flag, Combat Cat Litter; Fresh Step, Scoop Away, Ever Clean, Jonny Cat Salad Dressings and Sauces; Hidden Valley, K.C. Masterpiece Other; Handi-Wipes, Brita water filters

The majority are either the number one or number two brands in their respective categories. With the acquisition of First Brands, it has picked up tried-and-true brands but sluggish sales growth, giving Clorox a chance to leverage its highly efficient, low-cost national retail distribution system. Since buying Pine-Sol in 1990, for instance, Clorox has effectively doubled the product's annual unit sales by adding innovative variations such as lemon-scented and even spring rain-scented versions of the cleaning agent. Prior to the First Brands merger, the company had been focusing its attention on improving the unit sales and market shares of Black Flag (acquired in 1995) and Armor All (acquired in 1996) after successfully integrating both product lines into its existing business.

During the first full quarter of combined operations, Clorox's gross profit margins came in at 53%, down only slightly from the 56% reported in the previous pre-merger quarter. And backing out merger-related charges and inventory write-offs taken during the period, net margins actually increased to 10% from 9%. For pre-merger Clorox shareholders, diluted earnings per share rose 17 percent, from 72 cents reported for the third quarter of 1998 (before restatement) to 84 cents for the current quarter, before one-time merger-related expenses. For the nine months ending March 31, 1999, and before one-time merger-related expenses incurred during the current quarter, net earnings increased 17 percent to $274.6 million from the prior year's $234.4 million; diluted earnings per share rose 17 percent to $2.29 from $1.95. Sales of $2.9 billion represented a 5 percent increase over the $2.77 billion registered in the first three quarters of fiscal year 1998.

The home cleaning business posted its best third-quarter volumes ever, on top of a double-digit growth spurt the previous year. The continued strength of two Pine Sol products introduced last fiscal year drove this brand of cleaners to a third-quarter record. Tilex Fresh Shower daily shower cleaner was the major driver behind the Tilex brand's third-quarter record. Growth of the laundry additives business was led by third-quarter record volume for Clorox liquid bleach. Clorox 2 color-safe bleach completed its eleventh consecutive quarter of growth. Clorox expects to introduce three new laundry additive products in the fourth quarter. Hidden Valley dressings and K.C. Masterpiece barbecue sauces both finished with third-quarter record volumes, propelling the company's food unit to double-digit growth. Three new flavors of Hidden Valley bottled dressings contributed to the division's growth. Armor All products also posted record shipments for the quarter. Strong volume growth in the auto protectant category, introduction of two new wax products under the Armor All label, and increased distribution in automobile supply stores fueled the growth. Cat litter volumes were up double digits. Fresh Step Scoop cat litter improved market share and posted record shipments for any quarter; Fresh Step cat litter reached a third-quarter high. In other U.S. results, Clorox registered third-quarter highs in volume of Kingsford and Match Light charcoal briquets and Kingsford lighter fluid, as the company stepped up its NASCAR promotion program. Shipments of insecticides declined slightly as consumer demand remained soft. The Brita and professional products business unit, which set a new record for third-quarter shipments, was supported by double-digit volume growth of water filters.

Clorox has a Market Capitalization of $12.6B, Price/Sales of 3.34. Four analysts rate it Strong Buy, seven Moderate Buy and three Hold.

Charts:

With an enterprise value of $13.3 billion, the company is trading at 38 times combined net income of $350 million. With analysts expecting earnings per share of $1.74 in fiscal 2000 (ends June 30) and $1.95 in 2001, the company's forward P/E ratios are 32 and 29, respectively. That looks like a fair value based on our P/E charts.

A 20% rise in EPS, if delivered will most likely give you that return as long as interest rates stay in the range as expressed on the value chart.

Following input was used to construct the Fundamental Charts;

Earnings Per Share , $1.74 (2000) Plowback 56% Return on Equity 23% Beta 0.88