Clorox Company (CLX) Dividend Stock Analysis 2013

-Seven Year Average Revenue Growth Rate: 2.8% Dividend Stock Report
-Seven Year Average EPS Growth Rate: 5.7%
-Seven Year Average Dividend Growth Rate: 12.2%
-Current Dividend Yield: 3.43%
-Balance Sheet Strength: Leveraged, Stable

The company appears to be a reasonable buy in the low $80’s for an estimated 9-10% rate of return going forward.

Overview

Clorox (NYSE: CLX) is a leading consumer products company and a solid dividend payer. It was founded almost 100 years ago in 1913, and currently has a market capitalization of over $9 billion. At one point during the 20th century, Clorox was purchased by Procter and Gamble, but due to concerns over a lack of competition, Procter and Gamble sold Clorox and it is again a stand-alone company.

The company is divided into four business segments: Cleaning, Household, Lifestyle, and International.

Cleaning
The cleaning segment provides 32% of company revenue, and includes brands such as Clorox, Liquid Plumber, 409, Tilex, and Pine-Sol.

Household
The household segment provides 30% of revenue and includes brands such as Glad, Kingsford, Match Light, Fresh Step, and Scoop Away.

Lifestyle
The lifestyle segment provides only 16% of revenue and includes Burt’s Bees, Hidden Valley, Brita, and Masterpiece.

International
The international segment provides the remaining 22% of revenue, and includes some international brands as well as some of the domestic brands like Clorox.

Valuation Metrics

Price to Earnings: 19
Price to Free Cash Flow: 19
Price to Book: 74

Revenue

Clorox Revenue
(Chart Source: DividendMonk.com)

Revenue grew at a low average rate of only 2.8% per year over this period. The company did, however, sell its auto care business for three quarters of a billion dollars, which impacted revenue.

Earnings and Dividends

Clorox Dividends
(Chart Source: DividendMonk.com)

EPS growth was modest at 5.7% per year on average. The dividend growth rate was high at over 12.2%. To maintain a steady payout ratio, Clorox will have to have some combination of EPS growth rate acceleration and dividend growth rate reduction. The current dividend yield is 3.43% and Clorox has increased its dividend every year since the 1970’s.

Approximate Historical Dividend Yield at Beginning of Each Year:

Year Yield
Current 3.43%
2013 3.45%
2012 3.60%
2011 3.47%
2010 3.26%
2009 3.26%
2008 2.52%
2007 1.81%
2006 1.90%

 

Clorox has expanded its payout ratio from 40% to 60% over this period, which along with changes in valuation has resulted in a higher dividend yield over time.

How Does Clorox Spend Its Cash?

Clorox enjoys strong free cash flow generation, and brought in nearly $1,500 million in free cash flow during the combined fiscal years of 2011, 2012, and 2013. During that time period, the company brought in another $650 million in cash from its net acquisition activity (with the cash coming from the divestiture of their auto care segment). Over this same period, the company spent $950 million on dividends and $1,000 million on share buybacks.

Balance Sheet

The debt/equity ratio is very high, because Clorox has practically no equity. Assets minus liabilities leaves essentially zero. The company has about $1.1 billion in goodwill, so the tangible book value is negative.

The debt/income ratio, on the other hand, is fair at 4x. Most importantly, the interest coverage ratio is 8x, so the company’s operating income can pay the debt interest 8 times over.

Overall, it’s a leveraged but stable balance sheet. The company has stated in investor presentations its intention to maintain the current leverage.

Investment Thesis

The company manages a medium-sized portfolio of top brands that for the most part are the #1 or #2 brands in their categories. Some brands such as the Clorox and Kingsford brands dominate their industries with market shares that are multiple times the size of the next largest competitor.

The company aims for 3-5% organic sales growth per year going forward, with the U.S. retail segment having 2-3% growth (representing most of the company), the international segment having 5-7% annual growth (representing less than a quarter of the company), and the U.S. professional segment having 10-15% annual growth (representing only a small portion of the company).

Much of the sales growth, or about 3% per year, comes from product innovation. The product innovation varies, but generally targets one of the 4 “megatrends” that Clorox describes: Health and Wellness, Sustainability, Affordability, and Multicultural (primarily the U.S. Hispanic market). For the professional segment, Clorox is looking to expand into health care applications, to develop and sell new products for that industry.

Risks

Many products such as bleach and charcoal are commodities with no significant differentiation between brands, and yet Clorox enjoys a price premium and leading market share. The lead is maintained by years of marketing and brand recognition rather than clear product superiority. This can have difficult-to-predict consequences on pricing power over the long-term, especially since the company reports a goal of slowly increasing profit margins as part of its overall growth strategy.

A full quarter of revenue is derived from a single retailer: Wal-Mart. This gives Wal-Mart leverage in price negotiations.

Conclusion and Valuation

The company has strong brands, decent diversification, and a long history of consecutive annual dividend growth stretching back to the 1970’s. My 2012 analysis on the company was lukewarm, but after a solid fiscal year and rising stock prices overall, I believe the attractiveness of Clorox as a stock has improved compared to the overall market.

If the company can achieve 3-5% organic sales growth, and continues to buy back 1-3% of its shares each year, then that’s about 4-8% EPS growth assuming constant net margins, which specifically excludes their goal of gradual margin improvement.

Based on the Dividend Discount Model (DDM) with a 10% discount rate (the target rate of return), if the company grows the dividend by an average of 7% per year for the long term, then the fair price is over $90, compared to the current stock price of only about $83. Alternatively, if the dividend growth rate ends up only being 6.5%, that makes the current price in the low $80’s about fair.

In a fairly poor scenario, even if only a 5.7% long-term EPS/dividend growth rate is achieved (chosen to match the previous 7-year average EPS growth), then the current price in the low $80’s can still offer a 9% long-term rate of return, based on the DDM again.

Overall, the company appears to be a fairly stable bet. Most of the returns should come from maintaining pricing against inflation, moderate product innovation, dividends, and buying back shares. The valuation is neither entirely unreasonable nor unusually appealing, but compared to the fairly high valuation of the market currently, it may make a good choice for a stock with a decent dividend yield (3.43%) and consistent dividend growth history.

Full Disclosure: As of this writing, I have no position in CLX, though it is on my watch list for possible purchase.
You can see my dividend portfolio here.

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Five Dividend Stocks Buying Back Their Own Shares

Top Dividend StocksWhen management of a company is looking to make good use of incoming capital for shareholders, there are various options.

If they have a good expansion opportunity, or believe stronger advertising can provide good returns, then the money may be beneficially reinvested for organic growth. Organic growth is often the best use of capital, but there’s a limit to how quickly a large company can grow in a given amount of time.

Alternatively, if there is a complementary business that management believes is appropriately priced and will strengthen their company, they can make an acquisition. The downside is that, in many industries, acquisitions are often over-priced empire-building activities rather than truly beneficial to shareholders.

And of course, if a company has a weak balance sheet, some incoming capital can be used to pay off debt and add additional liquidity to the balance sheet.

In addition, there are two more direct ways to give money back to shareholders. The most direct way is to pay a dividend, where a company sends a portion of the profits to shareholders, ideally on a regular basis.

Alternatively, or in addition to dividends, company management might want to use some incoming profits to buy back shares of the company, and thus decrease the number of shares outstanding, and therefore increased the percent ownership of each share. All else being equal, share buybacks boost EPS, and are functionally similar to reinvested dividends, but are treated better than dividends under current tax law. The downside to buybacks is that a lot of companies buy back shares when they are expensive and hold tightly onto their money when times are tough, with the end results being similar to a nervous investor that avoids investing in market bottoms and happily invested in market tops.

There are some companies that pay regular growing dividends, and then use any extra cash flow after that and other options, to buy back some shares. The dividend yield and share buyback yield, put together, are the shareholder yield, which gives the investor a decent idea of what rate of return can be expected merely from taking existing profits and giving them back to shareholders, on top of all other growth prospects.

One of the criticisms about the sustainability of capitalism is that it requires constant growth to function, but that’s only partially true. You can get substantial returns from a company that isn’t growing. When a stock is at the right valuation, then a significant number of share buybacks along with dividends can produce a 10% rate of return even when the company is not growing at all, or only growing due to keeping pricing up to pace with inflation. A good example of that is Chubb Corporation (CB), which has no revenue growth, but has boosted EPS, dividends, book value, and the stock price, over the long term.

This is a non-exhaustive list of five more select companies that are both paying dividends and regularly buying back shares.

Becton Dickinson (BDX)

Becton Dickinson is a global medical device company, producing a variety of medical, diagnostic, and bioscience products, with significantly more than half of company revenue coming from outside of the United States.

The company has over four decades of consecutive annual dividend growth, but due to a modest payout ratio and the recent surge in stock price for 2013, the dividend yield is fairly low at only 2%. Much of the capital goes to buybacks, however. In the past nine years, they’ve bought back nearly 25% of the company’s market cap. Recently, the company has bought back over 7% of its market cap in each of two years, but that has largely been due to taking advantage of low interest rates to increase the corporate leverage. More sustainably over the long-term, the company buys back perhaps 3% of its stock per year, while paying a 2-3% dividend yield, and combining that cash return with solid revenue growth.

I view the current valuation of BDX to be reasonable, if not exactly appealing, compared to many other potential investments on the market currently. A full analysis from earlier this year is available here.

Lowe’s Companies (LOW)

I haven’t published a report on Lowe’s in a few years, primarily due to the low dividend yield of only 1.5% (despite five decades of consecutive annual dividend growth). It’s a good mention in a share buyback list, however, since it couples the dividend with serious regular stock buybacks. The company bought back 30% of its market cap in under 8 years, reducing the share count considerably from over 1.6 billion to well under 1.2 billion. The company offers a decent 5% shareholder yield overall, along with solid core growth.

Overall, I’d classify this home improvement retailer as being a bit pricey at the current time after the 2013 run-up.

J.M. Smucker Co. (SJM)

Smuckers, the maker of Jams and Jelly, is an interesting example. Over the past decade, they went on an acquisition-spree buying brands like Folgers coffee and Jif peanut butter to turn Smuckers into a larger, diversified food company. To afford all of this, the company regularly issued new shares, growing the number of outstanding shares in the process. Over the 2005-2010 period alone, the company doubled its number of shares outstanding. The strategy paid off, as per-share metrics had very strong growth and roughly quintupling the investment of their investors over the most recent 12 year period.

Now, the company is using substantial buybacks and decreasing its share count. The current dividend yield is about 2.16%, with another 2-3% buyback yield. I do feel, however, that the valuation is a bit ahead of itself, and it would be better to watch this one for a while.

Target Corporation (TGT)

It’s tough to dig any sort of moat in retail, which is a low margin and hyper-competitive industry. Being a “middle of the road” retailer, avoiding the bargain or luxury extremes, is a particularly dangerous place to be. Target has found a niche at the high end of the budget space- typically a classier shopping experience than Wal-Mart and membership chains, but still with rather low prices. The company’s four and a half decade streak of consecutive annual dividend increases is evidence of the success of this strategy so far, and the current dividend yield is 2.68%.

Target also buys back shares, having bought back nearly 30% of its market cap in the past decade. The company often purchases up to 5% of its market cap in a single year, although it can vary year to year. I view the company as reasonably valued, but with large retail competitors, bulk membership competitors, and disruptive online competitors, I’d like to see a bigger margin of safety.

Texas Instruments (TXN)

Texas Instruments is the largest producer of analog chips in the world. Their products tend to have long life-cycles and high margins, and they supplement those strengths with a particular focus on their large sales team. The headwind for the company is that they’ve been exiting some commodity product lines to focus in their core analog area, and as can expected this decision has impacted revenue.

The company wasn’t much of a dividend payer until the last few years, where it has quickly grown its dividend to a current yield of 2.89%; fairly high for the tech industry. The company bought back 35% of its market cap in the past decade, and continues to buy back ~4% of its shares each year.

Full Disclosure: As of this writing, I am long CB, BDX, and SJM.
You can see my dividend portfolio here.

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McCormick and Company: Decent Stock But No Margin of Safety

-Seven Year Average Revenue Growth Rate: 6.4% Dividend Stock Report
-Seven Year Average EPS Growth Rate: 10%
-Seven Year Average Dividend Growth Rate: 10%
-Current Dividend Yield: 1.87%
-Balance Sheet Strength: Strong, Stable

At the current price of around $73, McCormick appears poised to offer reasonable long-term returns, but the lack of a margin of safety and the low current yield reduce the attractiveness of the stock unless or until the earnings multiple contracts a bit.

Overview

McCormick and Company (NYSE: MKC) is a 120+ year old spice and herb business. They produce and sell spices, herbs, and seasonings the world-over to both consumers and businesses. The company grows both organically, and through acquisitions, and sources product material from 40 countries and sells its products in over 110 countries.

The company is involved in multiple industries and areas, with 41% of their revenue coming from their “Americas Consumer” segment, 28% of revenue coming from their “Americas Industrial” segment, 14% from “EMEA Consumer”, 7% from “EMEA Industrial”, 5% from “Asia Pacific Consumer” and 5% from “Asia Pacific Industrial”.

Examples of industrial customers include Pepsico, McDonald’s, General Mills, Yum! Brands, Subway, Kraft Foods, Wendy’s, and Sysco.

Consumer brands include McCormick, Old Bay Seasoning, Lawry’s, Simply Asia, and many others. In addition to owning by-far the dominant market position in branded spices and herbs (more than twice as large as nearest competitors), McCormick is also a leading provider of private label spices and herbs.

Valuation Metrics

Price to Earnings: 24
Price to Free Cash Flow: 29
Price to Book: 5.5

Revenue

McCormick Revenue
(Chart Source: DividendMonk.com)

McCormick grew revenue by an average of 6.4% per year over this period, which is impressive. Notably, there was not a single year in 10+ years where revenue was not larger than the previous year. Much of this growth and consistency is due to McCormick’s strategy of making substantial acquisitions a core part of their growth strategy.

Earnings and Dividends

McCormick Dividends
(Chart Source: DividendMonk.com)

The EPS growth rate and the dividend growth rate were both 10% per year, on average, over this period. The current dividend yield is fairly low, at only 1.87%, even though the payout ratio is reasonable for this type of company at over 40%. McCormick has raised its dividend for 27 consecutive years without a miss.

Approximate Historical Dividend Yield at Beginning of Each Year:

Year Yield
Current 1.87%
2013 2.1%
2012 2.5%
2011 2.5%
2010 2.8%
2009 3.0%
2008 2.4%
2007 2.1%
2006 2.3%

 
As can be seen, the yield has been dropping over the past few years even though the dividend is being consistently increased each year. This is because the valuation of the stock has inched upwards, and the result is that despite having a long history of consistent dividend growth and a reasonable payout ratio, the yield is unfortunately low.

How Does McCormick Spend Its Cash?

During the fiscal years 2010, 2011, and 2012, McCormick reported about $890 million in cumulative free cash flow. During the same time period, $450 million was spent on dividends, $300 million was spent on share buybacks, and $490 was spent on acquisitions.

Balance Sheet

The company’s total debt/equity ratio is under 0.8, but 100% of existing shareholder equity consists of goodwill. The ratio of total debt to net income is about 3.3x, and the interest coverage ratio is just over 10x.

Overall, McCormick is making moderate use of leverage while maintaining very healthy interest coverage and credit scores.

Investment Thesis

Developed countries are becoming increasingly health aware, and due to this, people will be looking for healthy yet flavorful foods more than in the past. Spices and herbs are a great way to add taste to food while keeping the meal healthy, or even increasing the healthiness of the meal with antioxidants.

McCormick expects Herbs and Spices to be the third-fastest growing flavor category after Soy-Based Sauces and Stock Cubes through 2017 (with 10+% total industry growth during that time period), and they have the leading worldwide market share in that industry. By maintaining their existing market share, increasing market share with organic growth or acquisitions, riding the growth of the whole industry, and maintaining decent pricing power, revenue growth can continue to be substantial. In 2012, the company introduced over 250 new products.

The company is also aggressively expanding into emerging markets and China. Asia/Pacific currently accounts for only 10% of McCormick revenue, but it’s growing at a rate that exceeds overall company growth, so there is a tremendous growth opportunity there and they are keen on continuing to tap into it.

I consider McCormick to be in a strong position compared to other food companies because their products are rather expensive per unit of weight and volume. Spices and herbs only make up a tiny part of a meal. Like most of the food industry, the company faces headwinds from commodity costs, transportation costs, packaging costs, and so forth, but I believe their operations in the spice business may buffer them to some extent from these problems compared with companies that sell cheaper, larger, heavier foods in bigger packaging. The company also has private-label products to capture some of the lower-margin spice purchases.

Risks

Like any company, McCormick has risks. McCormick is a large global company and is subject to international political and currency risks. Generally the largest risk that companies in the food industry face is rising commodity costs.

McCormick is fairly diverse overall, but has sensitivity to a few large customers. Pepsico is the largest customer for McCormick’s industrial segment, and accounts for 11% of total McCormick revenue. The top three customers for the industrial segment account for over half of the revenue generated by that segment. Wal-Mart is the largest customer for McCormick’s consumer segment, and also accounts for 11% of total McCormick revenue.

Conclusion and Valuation

The company’s long-term goals, as of this writing, are to increase sales by 4-6% per year, increase EPS by 9-11% per year, and maintain a dividend yield of around 2%, although of course they have control of the payout ratio but not the actual yield. This is in line with, and slightly conservative compared to, their historical performance. The result is that the company aims for 11-13% annual shareholder returns, which is higher than the historical S&P 500 average growth rate.

Investor returns, however, are based on two variables. The first is the company growth during the holding period, and the second is the change in valuation between the times when the stock is bought and sold. The longer the stock is held, the less relevant the second variable is, but it always has an impact. Buying an over-priced stock can undermine performance for investors even if the company continued to perform well by steadily reducing the valuation over the holding period. This is what happened to companies like Walmart and Coca Cola over the last decade, where they had strong fundamental performance but flat stock performance because long-term reductions in their earnings multiples were precisely enough to offset the steadily increasing EPS.

If, for example, EPS increases by 9% per year over the next 10 years, and the earnings multiple at the end of the period is only 15 compared to the current figure of 24, then the stock price would be about $108, not adjusting for stock splits. The investor would have also received about $20 in dividends per share, plus approximately $10 in additional value if those dividends were reinvested. Therefore, the rate of return from today’s price of about $73 to the value of roughly $138 ten years later would represent a rate of return of around 6.5%. This would be a less than ideal rate of return, but those are fairly pessimistic estimates about a reduction in earnings multiple from 24 to 15, and company EPS performance of 9% annually, which is on the low end of their 9-11% long-term target.

Repeating the estimate but using 10% EPS/dividend growth, and assuming an earnings multiple of 18 at the end of the ten year period, results in a ten-year stock price of $142, $21 in dividends, and another $11 in value if dividends are reinvested, for a total of $174. The result is a rate of return of over 9%, even though there was a hypothetical reduction in earnings multiple from 24 to 18.

The conclusion I draw is that McCormick is not particularly attractively priced currently because it has no margin of safety. It’s also not likely attractive to many dividend investors even though it has the characteristics of a dividend stock (fair payout ratio, a quarter century of consecutive dividend increases, overall stability) primarily because the high valuation pushes down the current yield. Quantitatively, however, a reasonable positive rate of return can be expected on the current price even if the valuation falls substantially and if the company’s performance clocks in at the low end of its estimated range, and this expected return increases as the estimates become more generous for ending valuation and fundamental performance.

For a defensive company, I view the company as a “hold” at this time.

Full Disclosure: As of this writing, I have no position in MKC.
You can see my dividend portfolio here.

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