Shares of consumer
staple company Clorox (CLX 159.26, +9.40, +6.28%) are trading higher this morning after it reported
better-than-expected 2Q19 earnings while reaffirming its guidance for FY19.
Like its main competitors Colgate-Palmolive (CL), Kimberly-Clark (KMB), and
Proctor & Gamble (PG), the fundamental story heading into its earnings
report was how rising raw material and transportation costs have been putting a
squeeze on margins.
Also like its peers, CLX has implemented price increases across a variety of products in order to offset those rising costs. As we explain in more detail below, it would seem that CLX has had a little more success in pushing through these price increases than some of its competitors.
Bolstered by an improvement in gross margin and strong growth from its Lifestyles segment -- driven by its March 12, 2018 acquisition of Nutranext -- CLX continued to generate strong cash flow from operations of $449 mln year-to-date, up 39% from a year ago. In a market in which investors are feeling more skittish about the global economy, more defensive, "safer" companies that produce plenty of cash flow and offer healthy dividends can become quite popular among investors.
To illustrate that
point, over the past month, the SPDR Consumer Staples ETF (XLP) has gained more
than 5% -- which is a fairly significant move for the "slow and
steady" sector. The question now, though, is whether stocks like CLX and
PG have gotten ahead of themselves in terms of valuation. We'll take a closer
look at that possibility, too.
CLX's Quarterly Results
The company posted EPS of $1.40, comfortably exceeding the $1.31 consensus. In fact, that was its widest EPS beat since 3Q16, when it out-paced analysts' forecasts by $0.11. Additionally, CLX's performance relative to expectations easily surpasses what KMB and CL did as KMB missed on the bottom line by $0.06 and CL beat by a mere penny.
On the top line, revenue increased by 4% yr/yr to $1.47 bln, in-line with expectations. In its core Cleaning segment (which includes its namesake bleach product), net sales were up 6%, reflecting growth across all product lines. The standout performer once again was its Lifestyle segment as revenue jumped by 25%, following growth of 26% last quarter. That said, investors shouldn't anticipate these impressive double-digit sales growth figures to continue for this group. That's because it will soon be lapping its acquisition of Nutranext, which it purchased last March for $700 mln. The vitamin and supplement maker added an immediate $200 mln in annual revenue, providing a boost to its growth rate.
The primary story here, however, is CLX's margin expansion. For the first time since 1Q18, its gross margin increased, up 70 basis points to 43.7%. The improvement was a result of pricing and cost-saving initiatives that it put in place several quarters ago as it anticipated headwinds stemming from commodity inflation and higher transportation costs.
What's especially notable is that both CL and KMB still experienced gross margin erosion this quarter; specifically, a 100 basis point drop for CL, and a 420 decline for KMB. This suggests that perhaps CLX has a little more pricing power than these other brands, and/or, that it is ahead of the curve in terms of its cost-cutting efforts. Either way, it is a clear positive as the gross margin bump may indicate that the worst of the cost inflation may be behind the company now.
In its earnings press release, CLX also reaffirmed its guidance for FY19, projecting EPS of $6.20-$6.40 vs. the $6.32 consensus, on revenue growth of 2-4% to $6.25-$6.37 bln. Furthermore, gross margin is expected to remain steady this year as price increases continue to mitigate cost pressures and foreign currency exchange rates.
So, with these pricing issues mostly behind it, the company says it will now pivot to product innovation and investing in its brands by ramping up its marketing spend. More specifically, it expects that advertising spending will be about 10% of sales this year. On that note, investing in its brands and identifying new product categories that are adjacent to its core businesses has been an integral part of its "2020 Strategy" it put in place five years ago. The primary objective of this plan is to achieve sustainable, profitable growth.
A good example of how CLX has executed on this strategy is its continued investment in its Burt's Bees products, which it bought back in 2007. Since then, CLX has steadily invested in that business, adding new products while bolstering its advertising efforts. Today, Burt's Bees is a very successful contributor to its Lifestyle business segment.
CLX & Other Consumer Staple Stocks Not on Sale
While consumers have been asked to pay more for CLX products, investors have likewise been asked to pay up for shares of the stock. At the moment, CLX is trading with a 1-year forward P/E of 23x. While not egregious for a high growth name, CLX is forecasting EPS to be about flat for FY19.
CLX is also more expensive than peers CL, KMB, and PG, with forward P/E's of 21x, 16x, and 20x, respectively. Based on its stronger margin performance and better top-line growth, it could be argued that CLX might deserve a premium valuation. However, it could also be argued that this group overall is looking a tad expensive.
Consider that the historical P/E for the S&P 500 is around 15-16x, and, that consumer staple companies such as these are mature with slow growth. Another data point supporting this premise is that the historical dividend yield on the S&P 500 is about 4.3%. Each of these companies have a yield of in the 2.6-3.0% range.
Wrapping up, CLX delivered a solid quarterly report and guide. The increase in gross margin and management's comments regarding cost pressures -- namely, that they are largely behind the company now -- are really what have the stock moving higher today, though. That's encouraging news for the consumer staple group as a whole, but, with these slower-growth names charging higher over the past few weeks, the valuations are reaching elevated levels.