CLX’s strong pricing power and efficient operations have allowed it to earn extremely high returns on invested capital. This is often the sign of an economic moat, and the company’s portfolio of well-known brands is no exception.
Source: Simply Safe Dividends
Not surprisingly, CLX generates very consistent free cash flow and even targets a 10-12% free cash flow margin as part of its strategy. Throwing off reliable amounts of free cash flow keeps the dividend very safe and allows CLX to opportunistically acquire other brands that it can leverage across its distribution channels, geographies, and adjacent product categories.
Source: Simply Safe Dividends
CLX maintains about $2.1 billion in debt compared to $383 million in cash on its balance sheet, but its reliable free cash flow eliminates any financial concern. Morningstar has also assigned an “A-” credit rating to the company.
Source: Simply Safe Dividends
CLX’s dividend is very safe. It sells recession-resistant products that will be used by consumers for many years to come, its strong brands generate reliable free cash flow, and the company’s payout ratios are also very reasonable.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
CLX’s dividend growth potential is about average with a dividend Growth Score of 57. The company has increased its dividend every year since 1977 and is a member of the S&P Dividend Aristocrats Index. CLX most recently raised its dividend by 4% in 2015, and we can see that its rate of dividend growth has decelerated over the last 10 years.
Source: Simply Safe Dividends
Going forward, we would expect CLX to continue increasing its dividend at a mid-single digit rate, essentially in line with earnings growth. This would allow the company to maintain a healthy payout ratio around 60%.
Valuation
CLX trades at 26x forward earnings and offers a dividend yield of 2.4%, which is meaningfully lower than its five year average dividend yield of 3.1%.
Simply put, the stock looks expensive. To put CLX’s current earnings multiple in perspective, Carl Icahn, an activist investor, became involved with the stock during the summer of 2011. He believed the stock was cheap and ultimately bid $80 per share to acquire the company.
Icahn’s bid price represented an earnings multiple of about 18.5 (CLX ended 2011 trading at roughly 16 times forward earnings). Today, the stock’s earnings multiple is 40% higher than Icahn’s target price.
With expected sales growth between 3% and 5% per year, the company’s earnings growth seems unlikely to exceed a mid- to upper-single digit annual rate. Over the last five years, CLX’s free cash flow per share has compounded at 5.3% per year. If more of the same growth trends were to continue, the stock’s total return potential would appear to be 7-9% per year – far from a bargain.
Many investors are attracted to the stability of CLX’s cash flow and probably point to the company’s relatively small revenue base ($5.7 billion in sales) compared to giants such as P&G ($76 billion in sales). There is certainly room for growth, but building successful brands is far from a guarantee and takes a very long time. The stock’s multiple doesn’t seem to compensate for these drawbacks.
Conclusion
Clorox Co (NYSE:CLX) is a wonderful company that generates excellent free cash flow. Its brands have withstood the test of time and will likely remain core household purchases for many years to come. While private label products, relations with Walmart, and mature product categories will always remain threats, there isn’t much to dislike about CLX’s fundamentals. However, the current valuation keeps us from pulling the trigger on this blue chip dividend stock today. While the business is stable, investors living off dividends in retirement might want to look elsewhere for greater income potential.
Disclosure: None
