I won’t lie to you guys. It’s tough for me to find real strong values in the market right now, and I’m having to look far and wide for stocks that I feel are even fairly valued. The Shiller P/E ratio currently stands at 25.57, which is significantly above the long-term median value of 15.91. After my recent sale of shares in Lorillard Inc. (LO), I knew that while I didn’t want to sit on a bunch of cash because it’s a horrible asset for the long haul, I also didn’t want to invest in anything that didn’t offer a compelling long-term case based on fundamentals and value. What’s a dividend growth investor to do?
Easy! Stick to the plan.
My most recent purchase is with a new company, and one that I feel has much less inherent risk than Lorillard. Though the valuation is similar and the yield is a bit less with this new investment, it’s simply about managing risk while also keeping an eye on the very long term. I think that while tobacco stocks will likely continue to do well over the next 5-10 years, at some point many will likely hit a will as the secular decline in smoking rates overcomes their ability to raise prices. I simply feel this new investment has a better risk profile looking out over 30-40 years, which is my time horizon for investments.
I purchased 35 shares of The Clorox Co. (CLX) on 5/8/14 for $87.70 per share.
The Clorox Co. is a manufacturer and marketer of consumer products, including cleaning, household care, and specialty food products. They market their products in more than 100 countries worldwide. They operate in four segments: Cleaning (32% of FY 2013 revenue), Household (30%), Lifestyle (16%), and International (22%).
Some of Clorox’s brands include: Clorox, Pine-Sol, Fresh Step, Kingsford, Hidden Valley, Burt’s Bees, Glad, Brita, KC Masterpiece, Scoop Away, Tilex, Green Works, and Liquid Plumr. Nearly 90% of their brand portfolio has a #1 or #2 market share in their respective category, which is impressive.
This is a totally new investment for me, and looking forward I definitely want to have more exposure to companies that produce and market products that consumers all around the world will continue to need no matter what happens to the general economy. Companies that produce consumer staples typically sport lengthy and reliable dividend growth records, and Clorox is no exception.
Surprisingly, Clorox doesn’t have the most spectacular record of growth in the financials over the last decade. Revenue has grown from $4.324 billion in 2004 to $5.623 billion in 2013. This is a compound annual growth rate of just 2.96%. However, the company sold off their auto care business, which held brands STP and Armor All, to a private-equity firm back in 2010, which impacted revenue starting in 2011. Earnings per share have grown from $2.55 to $4.31 during this same time period, which is a CAGR of 6%. S&P Capital IQ predicts compound annual growth in EPS of 7% over the next three years.
Lately, Clorox has had trouble with growth, and most recently reported results (3Q FY 2014) shows that currency devaluation in Venezuela negatively affected EPS significantly, as EPS would have been $1.18 instead of $1.05 as reported. Volumes were also down 0.5% after currency adjustment, but up more than 1% currency-neutral. Clorox expects to increase EPS even with ongoing currency headwinds and continued product investment to drive innovation and growth.
As a dividend growth investor, however, I’m not just concerned with how well a business can grow, but also how much a company is committed to sharing that growth with shareholders via dividends and growth of those dividend payments. And on this front Clorox has been pretty strong. The company has a 37-year streak of dividend raises, and sports a 10-year dividend growth rate of 10.7%. However, the most recent raise, at 4.2% and announced just yesterday, was disappointing. I purposely bought in before the raise, anticipating a raise closer to 6% or so, but more income is never something I complain about. And with a payout ratio that currently stands at 68.2% after the new dividend is factored, a rather small raise isn’t totally surprising. And share buybacks continue to remain strong – Clorox has repurchased 40% of their outstanding shares over the last 10 years.
Clorox plans on driving growth through innovation and continued marketing of their brand name products, as well as targeted M&A. Some of their newest innovation includes products like Clorox cleaning utensils in the international market, and Burt’s Bees Brightening face care line. Overall, the international exposure is still relatively light for them, and is a huge area for growth, notwithstanding currency issues. And one has to remember that this company only has a market capitalization of $11.5 billion, which is quite small compared to some major competitors like The Procter & Gamble Company (PG) with its nearly $220 billion market cap.
Furthermore, they have what they call their “2020 Strategy” which drives the company right now. They aim to make life better everyday. And their objectives are to maximize economic profit across all categories, channels, and countries. To do so, they want to be the best at building big-share brands in economically-attractive mid-sized categories and countries. One of their methods is what they call the “3D Brand Building Model” which focuses on Desire, Decide, and Delight. Basically, the company wants to market their products effectively to create consumer desire their products and decide to purchase them at the point of purchase, and then also delight consumers through higher quality.
One concern for this company, from my perspective, is the balance sheet. They have a massive debt/equity ratio of 14.9, but that’s because the company has very little equity to speak of. They have about $1.1 billion in goodwill, which means their book value is very low. However, they have an interest coverage ratio of 9.5, which is fine. Overall, the balance sheet remains leveraged, but is not catastrophically so. Furthermore, it’s stable. Long-term debt has remained relatively unchanged over the last decade, and the company has been open about its desire to remain at this leverage level.
And there are other concerns with the company. One primary risk, in my opinion, is the fact that many of their products face heavy competition from private label products due to the fact that products like bleach and other household cleaners are basically commodities. However, their pricing power remains intact, and Clorox bleach retains a 60% market share vs. private labels at just 38%. And their Kingsford charcoal is equally impressive with a 74% market share. So while one would think consumers might choose private label products due to pricing, Clorox continues to market their value and quality proposition well, and further innovation should help. One additional risk is the fact that Wal-Mart Stores, Inc. (WMT) and its affiliates accounted for 26% of FY 2013 sales. But this is common for many companies because Wal-Mart is such a global retail juggernaut, so I’m not concerned here.
So what about the valuation? Shares are trading hands at a P/E ratio of 20.2, which is slightly higher than their five-year average of 19.1. I don’t think that premium is all that worrisome considering where the broader market is at. I valued shares using a Dividend Discount Model with a 10% discount (my anticipated return) and a 6.5% growth rate. This growth rate is between Clorox’s own 10-year EPS CAGR growth average and the projected growth rate in EPS over the next few years, but also well below Clorox’s own 10-year growth rate in dividends. Overall, considering the recent performance I think this is accurate, but Clorox could surprise in the future as currency headwinds subside. This gives me a fair value on shares of $90.07. Lowering the growth rate down to 6% gives you fair value near $80. I’d say shares are probably pretty close to fairly valued here. However, with a yield of 3.38% after the raise, I feel comfortable investing here.
This purchase adds $103.60 to my annual dividend income, based on the quarterly dividend of $0.74 per share. Factoring in the Lorillard sale and subsequent loss of dividend income from those shares, I netted a loss of $19.40 in annual dividend income from these two transactions. Not the way I’m looking to go, but I feel just a tad better about the overall long-term quality and safety of my portfolio here.
My portfolio now holds 47 positions, as this was a new investment.
I’m going to include current analyst valuation opinions below, as I use these to concentrate my reasonable valuation estimate.
*Morningstar rates CLX as a 4/5 star value, with a fair value estimate of $96.00.
*S&P Capital IQ rates CLX as a 2/5 star sell, with a fair value estimate of $57.50.
I’ll update my Freedom Fund in early June to reflect my recent addition.
Full Disclosure: Long LO, CLX, PG, WMT.
What do you think of CLX here? A fan of their brands? Think it’s fairly valued?
Thanks for reading.
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