Cleaning Up With Clorox

12/03/2009 1:00 pm EST


Josh Peters

Editor, Morningstar DividendInvestor

Josh Peters, editor of Morningstar DividendInvestor, and analyst Erin Swanson, say the maker of branded household products should see cash flow and dividends grow steadily.

Clorox (NYSE: CLX) is a leading player in the US household product market, holding the number-one brand in 11 of the 15 categories where it competes—including well-known brands like Clorox bleach, Kingsford charcoal, and Brita water filters.

Despite the strong brand equity that the company holds with its diverse portfolio, growth has stalled in Clorox’s liquid bleach and Glad trash bag segments. As consumers are now more reluctant to pay up for the benefit once associated with its traditional brand offerings, Clorox has been forced to look beyond its core product lines to drive sales growth.

Expanding into adjacent categories has allowed the company to capitalize on the strength of its brands while limiting the impact that [commoditized] product lines—like bleach and trash bags—can have on sales and profitability. More than half the company’s sales for its core Clorox franchise, for example, are now derived from non-bleach products, such as wipes and toilet cleaners.

Also, the firm’s launch of its Green Works line of organic cleaners (also under the Clorox banner) has allowed it to tap into the appeal of natural and organic products, and its recent purchase of Burt’s Bees puts Clorox in a solid position in the rapidly growing natural personal-care segment.

Like many consumer product firms, Clorox has been battling elevated commodity costs and a weak economic environment. As the firm seeks to charge higher prices to offset elevated input costs, we believe volume in the firm’s more commoditized categories could come under additional pressure.

But while Clorox tackles these challenges, we believe its product portfolio and expansion potential will generate high cash flows and shareholder returns. The strategy of building share in midsize categories, expanding into overseas markets, and widening the penetration of brands in its portfolio with growth potential—like Green Works and Burt’s Bees—positions the firm to prosper over the longer term.

Shareholders’ equity is negative, thanks to a decade of heavy share repurchases, but we are not concerned. Interest charges are covered comfortably by operating income, free cash flow net of dividends is quickly reducing debt, and a payout ratio of 48% strikes a healthy balance between income and internal growth.

Clorox’s free cash flow routinely exceeds reported earnings, and management has deployed this cash flow to maximum effect with prudent share buybacks. Though operating income may only grow at a pace comparable to the 3%–4% of the past decade, wise allocation of capital and minimal net reinvestment requirements lead us to anticipate dividend growth averaging 8% in the years ahead.

A current yield of 3.3% is high by Clorox’s historical standards and forms the basis for us to project annual total returns of 11%–12%.

My Dividend Buy price shakes out at $59, but I would be willing to pay into the low $60s. (It closed above $61 Wednesday—Editor.)

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