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Clorox has never traded at a higher PE valuation, yet it’s still a bargain

Summary:

Clorox has focused on innovation to generate future growth;

The company shows a portfolio of premium brands providing stable cash flow;

While the PE ratio is high (23+), the company is still trading at a 10% discount.

DSR Quick Stats

Sector: Consumer Defensive

5 Year Revenue Growth: 0.51%

5 Year EPS Growth: 2.07%

5 Year Dividend Growth: 9.07%

Current Dividend Yield: 2.79%

What Makes Clorox (CLX) a Good Business?

The Clorox Company (Clorox) is a manufacturer and marketer of consumer and professional products. Basically, anything you find when you open a closet at home has a 50% chance to belong to CLX portfolio brand. The Company operates four divisions: Cleaning (Pinsol, Clorox), Household (such as bags & wraps… Glad anyone?), Lifestyle (Brita, Burts Bees) and International (to cover sales for the above three divisions outside the US of A). As you can see, their revenues are pretty well spread among the four divisions:

CLX sectors

What is even more interesting about Clorox is that 80% of their brands are #1 or #2 in their market. The size and variety of its brand portfolio enables CLX to scale their production and generate important synergy among its different brands. This is how CLX also shows a lower sales & administration cost as a percentage of sales vs their main competitors (14% compared to 21% in the industry according to a Clorox investor presentation: source)

Ratios

Price to Earnings: 25.10
Price to Free Cash Flow: 19.94
Price to Book: 46.09
Return on Equity: 291.40%

Revenue

CLX revenueRevenue Graph from Ycharts

Since 2013, CLX revenues have barely increased, this is why the 5 year growth is far from being spectacular (CAGR of 0.51%). This is mainly due to the difficult international context coupled with currency headwinds. In order to support revenue growth, CLX has put in place a massive innovation program to improve its existing products and create new ones.

The innovation program now has a 3% sales growth target for 2015 and the years to follow. This seems like solid growth for such a large and mature company.

How CLX fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve gone through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. The first four principles are directly linked to company metrics. Let’s take a closer look at them.

CLXSource: Ycharts

Principle #1: High dividend yield doesnt equal high returns

High dividend stocks systematically underperformed the market mostly because there is always a good reason why the dividend yield is so high. In general, the market requires a higher yield from company showing higher risk. Also, most companies with high dividend yield show very limited dividend growth capacity.

CLX TTMSource: Ycharts

The CLX yield has been relatively low over the past 5 years and it’s even more true ever since the stock price increased in valuation over the past 12 months. The yield is now around 2.75%. This is not a huge dividend yield, but I would rather buy shares of a company that shows strong dividend growth than a high dividend yield.

Principle#2: If there is one metric, its called dividend growth

As I just wrote, dividend growth is the mother of all solid companies held in my portfolio. The reason is simple; if a company shows strong dividend growth, it is driven by increasing sales and profits. Two very powerful factors to look at for any type of business.

CLX dividend paymentSource: CLX website

The dividend payment has more than doubled in the past 10 years. Enough said.

Principle #3: A dividend payment today is good, a dividend guaranteed for the next ten years is better

I think CLX’s dividend payment reputation is not to be discussed here. After 38 consecutive years of dividend increases, we can expect the company to continue. However, a quick look at the dividend payout ratio is always a good idea.

The company used to stick between 50% and 60% which leaves a very comfortable margin to increase it. Lately, the ratio has drifted higher than 70% and the aggressive dividend growth policy (9% over 5 years) might has to be reviewed in the long term.

Principle #4: The Foundation of dividend growth stocks lies in its business model

The Clorox business model is based on a very solid brand portfolio where most of their brands hold the #1 and #2 position in terms of market share. This makes it very hard for other competitors to enter the CLX playground.

Plus, since the company is selling consumer products, it generates constant cash flow helping the company pay ever increasing dividends while continuing to invest in the future.

What Clorox Does With its Cash?

As is the case for most consumer stocks, CLX is a real money making machine. The company focuses on free cash flow generation as demonstrated:

CLX cash flow

 

 

 

 

Last year, out of the $649 million in free cash flow, CLX paid $368 million in dividends. The company doesn’t only increase its dividend each year but also actively purchases its shares. The company bought nearly 40% of the outstanding shares over the past 10 years. This probably explains its relatively high PE ratio (over 25) but the company shows a smaller price to free cash flow evaluation (around 19).

As previously mentioned, CLX also spend and important part of its budget toward product innovation. The key to remain a leader in consumer products is to evolve continually and maintain a very strong brand portfolio. CLX has successfully done this over the years.

Investment Thesis

The reason an investor would pick CLX to be part of his portfolio is somewhat obvious: it is an ever increasing dividend stock. Clorox is part of the selective group of dividend aristocrats that has increased its dividend for at least 25 years consecutively. In 2015, they have reached their 38th consecutive year with a dividend raise.

The company is currently driving its 2020 vision focusing on 4 key strategies:

#1 Engage our people as business owners

#2 Increase our brand investment behind superior products and more multi-targeted 3D innovation

#3 Keep the base healthy and grow into profitable new categories, channels and countries

#4 Fund growth by reducing waste in our work, products and supply chain

The company goals are to support a 3-5% organic sales, improve margins by 25 to 50 bps and to generate free cash flow of 10-12% of sales.

In other words; this consumer product giant will aim at reducing their costs, improving their sales and focus on high levels of cash flow in order to increase its dividend payment for the next 100 years.

Clorox’s ability to push new products through its distribution channel should support sales in the upcoming years.

Finally, the world is highly sensitive to potential disease spreading catastrophes. We had another example with Ebola last year. Cleaning and disinfecting products have become very important and CLX is in a leadership position to benefit from this robust trend.

Risks

When you look at the CLX sales growth, you will notice there isn’t any growth among its products. Since international sales represent 20% of total sales, we can’t blame everything on currency headwinds. The problem is that Clorox bleach and charcoal products are used by consumers on a daily basis but there aren’t many ways to make consumers buy more to support higher growth.

CLX spends massively on marketing in order to promote their products and it’s working perfectly as CLX usually enjoys a price premium over its competitors without hurting its sales too much. However, this requires a constant advertising effort and the brand differentiation factor is still very slim for the consumer.

Overall, the main risk around a company like Clorox is to see sales stagnate which would push the dividend payout ratio to higher levels. The dividend payment is far from being at risk, but the payment growth might be very thin in the years to come.

The company is well aware of this situation and this is why it is focusing on improving existing products and has created a strong product pipeline for the upcoming years that should increase sales and resolve the current sales stagnation situation.

Should You Buy CLX at this Value?

CLX has recently benefitted from a strong bullish thesis pushing its valuation through higher levels. You can see in the chart below how the CLX PE ratio has risen over the past 10 years.

CLX PE ratio

Considering the previous market valuation, the PE method shows there is a lot of enthusiasm for Clorox at the moment.

Going further, I’ll use the dividend discount model to determine stock value in terms of dividend distribution. Using a 10% discount rate and a dividend growth rate of 8% for the first 10 years and then 7% after, I get the following chart:

CLX intrinsic valueSource: Dividend Toolkit calculation spreadsheet

As the stock is currently trading around $105, it seems to be trading at a 10% discount.

Final Thoughts on CLX – Buy, Hold or Sell?

Buying shares of CLX will not make you double your investment within the next two years. It is relatively stable company evolving in mature markets. However, this doesn’t mean it’s a bad investment. For its solid dividend growth history, its premium brand portfolio and the fact the company is still trading at a discount considering its dividend payment; I think CLX is a buy.

 

Disclaimer: I do not hold shares of CLX at the moment.

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3M; Low Yield; Highly Interesting

3M Company (NYSE: MMM) is a diverse conglomerate that produces a broad array of products and materials for both consumers and businesses.stock report

-Seven Year Revenue Growth Rate: 4.46%
-Seven Year EPS Growth Rate: 3.97%
-Seven Year Dividend Growth Rate: 9.85%
-Current Dividend Yield: 2.56%
-Balance Sheet Strength: Extremely Strong

Overview

3M Company (NYSE: MMM), once called the Minnesota Mining and Manufacturing Company, was founded in 1902. The company, now with 80,000 employees, produces products like Scotch tape, projector systems, Post-it notes, Tartan track, and Thinsulate. This is a conglomerate that produces products for many industries and for both personal and business use, and their manufacturing, research, and sales offices are all over the world.

Business Segments

The company is divided into five business segments:

Industrial Business
This segment provides adhesives, abrasives, filtration systems, fasteners, and specialty materials to a variety of industries. This is the largest segment, accounting for about 34% of sales.

Safety and Graphics Business
This segment provides display films, reflective materials, projection systems, and the like. This segment accounts for about 18% of sales.

Electronics and Energy
This segment provides products for electronics and energy businesses including films for LCD screens and splicing products for signal cables, and accounts for about 17% of sales. Nearly two-thirds of sales from this segment come from the Asia Pacific region.

Health Care Business
This segments provides several products in the areas of wound care, oral care, drug delivery systems, and more. This segment accounts for about 17% of sales. The bulk of sales come mainly come from the U.S. and Europe, as the products are more targeted towards developed countries.

Consumer and Office Business
This segment provides solutions for the home and office, and includes well-known products like Scotch tape. This segment accounts for about 14% of sales. The U.S. accounts for over half of sales from this segment.

Ratios

Price to Earnings: 21.21
Price to Free Cash Flow: 19.85
Price to Book: 7.3
Return on Equity: 31.72%

Revenue

MMM revenue

MMM revenue trend is very strong. Since 2012, revenue doesn’t increase at the same pace mainly because the company faces currency headwinds. The organic growth is present (4.9% in Q1 2015), but the negative impact of a strong dollar reduces sales significantly.

Earnings and Dividends

MMM earnings and dividends

Approximate historical dividend yield at beginning of each year:

MMM div history

 

 

 

 

 

The company has been paying dividends each year for the past… 98 years. We can definitely talk about a strong dividend payer here. Most importantly, the dividend increase in 2014 and 2015 are stronger than its previous years. Nonetheless, the past 7 years shows an annualized dividend growth rate near double digits (9.85%). In other words, the company is nearly doubling its dividend payment every 7 years.

How Does 3M Company Spend Its Cash?

The company generates over 5 billion per year in free cash flow. The fact MMM is selling mostly consumable products makes its cash flow base stable and predictable. This enables the company to manage growth through R&D and acquisitions while returning a good amount of money to shareholders at the same time. In 2014, MMM used $1.5 billion for capital expenditures, $1.8 billion in R&D and $1 billion in acquisitions. At the same time, it has returned $7.9 billion to shareholders via a share repurchase program and dividend payments.

Investment Thesis

3M Company is definitely more diversified than a balanced mutual fund. It is present in various consumable product areas and the bulk of its sales comes from business-to-business transactions.

Roughly 50% of its products are consumable, which implies a very high rate of repeat business year after year. Product diversification is at the center of MMM business which offers continuous growth opportunities.

The company also allocates between $1 and $2 billion per year for acquisitions providing external growth on top of what is coming out of its own R&D department. MMM also benefits from top-of-the-line technology enabling to control costs like no other company. It can easily scale any production and each innovation means higher sales volume.

It is very hard to compete against MMM due to its size and investing power. Since the company keeps investing massively in R&D and buys other innovating companies, it ensures its sustainability over time.

Risks

When an investor buys MMM, he doesn’t expect to lose 40% of its value overnight. Product and geographic diversification enables the company to post predictable and stable numbers. However, these two advantages could also be linked to some other risks.

The fact MMM produces so many different products makes high digit growth difficult to generate. It is most likely to follow closely GDP growth instead of reaching high double digit figures.

MMM has increased its sales throughout the world in the past decade. This makes the company more at risk of currency headwinds.

As you can see, these are not the biggest concerns an investor could have while buying a stock. Overall, MMM shows a very strong profile.

Conclusion and Valuation

In my opinion, MMM should be part of most conservative (or core) dividend portfolios. While you shouldn’t expect incredible growth from this company, dividend payment increases will always be there each year. In order to verify if it’s the right time to buy MMM, we will look at the company 10 year PE history along with a Dividend Discount Model calculation.

MMM PE Ratio

As you can see, the strong dividend increase in the past 5 years hasn’t been ignored by the market. The P/E ratio has continuously increased over the past 3 years.

Full Disclosure: As of this writing, I have no position in MMM. It seems the company hasn’t been highly valued as right now. Let’s use the dividend discount model to see how much the company worth according to its dividend payment ability.

MMM intrinsic value

 

 

 

 

Source: Dividend Toolkit

I’ve used a dividend growth rate of 10% for the first 10 years and reduced it to 7.5% afterward. Then, I used a discount rate of 9% since the company shows stellar numbers.

According to the DDM, the company trades at a discount of 15% or so with a fair value of $179. Strong dividend growth perspective justifies a higher P/E valuation at the moment.

Considering MMM product portfolio and the fact the company is making the bulk of its sales from consumable products in a business-to-business model, MMM seems fairly attractive at the current price. This is a “long-term-dividend-growth” stock for patient investors.

Disclaimer: I do not hold MMM in my portfolio.

 

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Wisconsin Energy; Can it Support Growth Through Acquisitions?

The company operates in mainly 2 segments: Utility (1.1M electricity customers. Power is generated via coal & natural gas) and Non-Utility (consists primarily of generating plants constructed). However, the non-utility segment generates less than 5% of WEC revenues. stock report

-Seven Year Revenue Growth Rate: 2.12%
-Seven Year EPS Growth Rate: 9.83%
-Seven Year Dividend Growth Rate: 19%
-Current Dividend Yield: 3.52%

Overview

The company benefits from a very solid business model and continuously raises its dividend. Over the past five years, the company has been relatively aggressive with its dividend growth payment showing a 5yr growth of 21.76%. Nonetheless, the payout ratio remains under 60%. The Wisconsin economy is now growing stronger, pushing WEC to new highs. All three sectors (residential, industrial and commercial customers) are consuming more energy and the forecast for the upcoming years looks promising.

Then again, it’s always the same story; WEC’s main energy source is coming from coal. Stricter regulations will definitely hit companies such as Wisconsin Energy sooner or later. This should reduce their margin as additional cost may be required to continue to run coal energy plants.

Ratios

Price to Earnings: 18.94
Price to Free Cash Flow: 28.14
Price to Book: 2.399
Return on Equity: 13.04%

Revenue

WEC revenueRevenue Graph from Ycharts

WEC declared lower than expected revenues in its most recent quarterly update (May 5th). While the company beat analysts’ estimates for earnings, revenues were hit due to a harsher winter and higher spot price for natural gas.

In order to generate future growth, WEC has entered into a deal to buy Intergrys Energy Group for $9.1 billion, including $3.3 billion in assumed debts. With this acquisition, we expect WEC to generate EPS growth between 5 and 7%. The acquisition price wasn’t cheap, but many analysts think it was the fair price to pay to insure future growth.

Earnings and Dividends

WEC earnings and div

As with many utilities, WEC’s payout ratio remains around 50-60%. Most recent dividend growth brought the ratio to slightly over 60%. As the stock price grew, the dividend yield remained stable around 3.50%.

We don’t expect such high (19%) dividend growth in the future but the recent acquisition should keep the future increase around 7-8%.

How Does WEC Spend Its Cash?

Between important dividend payouts and its recent acquisition, Wisconsin Energy uses most of its cash flow. The company was able to control cost efficiently reducing its operating expenses by 19% last quarter. Some analysts fear return on investment on the recent acquisition might not be as good and represents a regulation risk over the long haul. WEC must always use part of its cash to maintain its investment and make sure they keep up with new regulations.

Investment Thesis

The investor looking for a steady dividend payment will be interested in WEC. The fact that WEC is operating in a monopoly in Wisconsin confirms a minimum level of cash flow annually, leading to a solid dividend distribution.

The company is well managed and focused on distributing an important part of their profits to investors. Cost control seems to be at the center of their attention at the moment.

Risks

Relation with regulators is the main source of uncertainty for a utility such as WEC. If their relations with regulators turn sour, WEC will lose their ability to increase rates as they wish. This would put pressure on their margins and limit profitability.

Borrowing inflation might also be a concern in the future. At the moment, utilities benefit from low rates on both sides; companies can borrow money at a very cheap rate for their investment and many income seeking investors moved their money towards this sector. With interest rate on the edge of rising, WEC may not be that interesting in the future from a stock price growth perspective. However, the dividend payment is sustainable and should continue to increase over time.

Conclusion and Valuation

Looking at the past 10 years of PE history, we can see how lower earnings affected the recent PE ratio.

WEC PE Ratio

The stock seems currently overpriced compared to its valuation history. Let’s use the dividend discount model to see how the company is priced considering its dividend.

WEC intrinsic valueSource: Dividend Toolkit Excel Spreadsheet

I’ve used a 9% discount rate since utilities are evolving in a very stable portfolio. I’ve used a 7% dividend growth for the first 10 years and drop it down to 5% to make sure it’s sustainable. Past growth was impressive but I don’t expect the company to continue boosting its dividend as it has before. Their most recent acquisition will help WEC to keep increasing their dividend by 7% for a few years, and should reduce their growth to 5% to reflect the new economic environment (higher interest rates, slower consumption growth).

Nonetheless, the company seems to trade at a 10% discount. The stock lost almost 9% since the beginning of the year, it’s like saying it was fairly valued at the beginning of the year and it may become an interesting play for dividend growth investors.

Full Disclosure: As of this writing, I WEC is part of our DSR Portfolios.

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