A Dividend Aristocrat to Buy That’s 26% Undervalued

Clorox CLX is taking a sales and profit hit to start fiscal 2024, thanks to a cybersecurity breach that drove operations temporarily offline. But we think that this issue is transitory, dividend growth will continue, and the stock is a bargain today. Morningstar chief U.S. market strategist Dave Sekera counts Clorox among his five undervalued stocks to buy for a “higher for longer” interest-rate environment; the dividend aristocrat was also among Sekera’s 10 undervalued dividend stocks for 2023. In addition, wide-moat Clorox is on Morningstar’s list of the best companies to own.

While volume growth has been hard to come by since COVID-19 prompted consumers to scour the shelves for Clorox’s products, overall sales remain well above where they were before the pandemic. However, Clorox is facing persistent and broad-based cost pressures. Beyond extracting inefficiencies to deflect these higher costs, management has also been raising prices. The company intends to spend $500 million over the next few years to bolster its digital capabilities and to look for additional productivity advancements. Clorox’s strategic playbook remains centered on bringing consumer-valued innovation to market and touting its fare in front of consumers, which we view as particularly critical against the current backdrop of elevated inflation and intense competition. We think investments in innovation and marketing should help Clorox’s products stand out on the shelf and prevent trade-down.

Key Morningstar Metrics for Clorox

• Fair Value Estimate: US$168
• Star Rating: 4 Stars
• Economic Moat Rating: Wide
• Uncertainty Rating: Medium
  
  

Economic Moat Rating

We assign Clorox a wide economic moat based on its brand intangible assets and cost advantages. Even though the company faces competition from private labels, around 80% of its U.S. sales are from brands that are number one or two in their categories. Clorox has significant market share in bleach and has historically led the field in charcoal and trash bags as well. It also leads in salad dressings (excluding mayonnaise), multipurpose cleaners, and water filtration. These leading positions make Clorox a valued partner for retailers, in our view. We also believe the company has a cost edge over its smaller competitors. In addition to scale benefits, Clorox garners cost advantages through sourcing and logistics. For example, it co-owns mines to obtain clay for its cat litter, and it procures charred wood for charcoal from mills close to its manufacturing facilities.

Read more about Clorox’s moat rating.

Fair Value Estimate for Clorox Stock

Our fair value estimate is US$168 per share. Cost pressures have been a significant drag on Clorox’s profits the past several quarters, and management still expects stepped-up costs of $200 million in fiscal 2024, on top of sizable hits the past two years. However, the company is starting to benefit from recent price hikes and efforts to unearth inefficiencies. Despite recent improvement, we think the margin rebuild could prove lumpy, and we don’t expect gross margins will close in on historical marks until fiscal 2027. For the long term, we expect around 4% annual sales growth and operating margins in the high teens, aligned with the average of fiscal 2017-21. Our valuation implies a fiscal 2024 enterprise value/adjusted EBITDA of 18. We forecast the company to spend around 10% of sales on advertising and about 2% on research and development annually, equating to about $1.1 billion in aggregate annually.

Read more about Clorox’s fair value estimate.

Risk and Uncertainty

Clorox operates in the highly competitive consumer packaged goods sector, where consumers make frequent purchases and typically face no switching costs. In several categories, Clorox’s primary competition is private-label fare, so product innovation and marketing support are essential to ensure differentiation from these lower-priced offerings. Clorox is also subject to input cost volatility and could face lasting margin erosion if it refrains from passing higher costs on to consumers. Conversely, if it seeks to maintain profits, it could be subject to deteriorating volume if consumers balk at higher prices. In addition, Clorox could be challenged if it is forced to recall products due to quality concerns.

Read more about Clorox’s risk and uncertainty.

Clorox Bulls Say

• The rising globalization of travel, and the potential for ensuing illnesses, could bolster demand for disinfectant offerings, which make up about one third of Clorox’s base.
• Investments to build out digital capabilities and streamline the operating model could boost margins beyond historical high-teens levels.
• By building out its disinfecting wipes supply chain internationally, Clorox could realize more profitable growth abroad longer term.
  
  

Clorox Bears Say

• Promotional spending has plagued Clorox in the past, and we think competitive headwinds could intensify against a bleak economic backdrop.
• Clorox’s vitamins, minerals, and supplements arm remains in the doldrums because of stepped-up competition and its own execution issues, resulting in a $445 million impairment charge.
• Private-label penetration tends to be significant in categories where Clorox plays—like bleach, charcoal, and trash bags—and volume could be hindered if consumers trade down to lower-priced products.