Clorox

Clorox's fourth-quarter organic sales slumped 13% as it lapped the retail inventory buildup ahead of its ERP rollout a year ago. The adjusted gross margin compressed 370 basis points to 42.8% as volume deleverage and inflation outpaced cost savings.

Why it matters: With its ERP rollout in the rearview, we think Clorox should begin to benefit from improved decision-making, demand planning, and operational efficiencies. We don't expect Clorox to siphon brand spending, despite stepped-up inflation in the year ahead. The fruits of these efforts are evident in the return to market share gains for Hidden Valley Ranch and Glad trash bags (estimated at about 20% of sales, qualitatively cited). We forecast the firm will direct 13% of sales annually to research, development, and marketing.

The bottom line: Our $155 fair value estimate for wide-moat Clorox shouldn't change much after incorporating fiscal 2026 results and fiscal 2027 guidance (3.5%-4.5% organic sales growth and $5.70-$6.00 in adjusted EPS), as a slightly revised near-term outlook negates time value. At a 35% discount to our valuation, we think investors should stock up on shares. From our vantage point, the market's reluctance has hinged on the significant noise in its results over the past several years. We posit Clorox is poised to drive profitable sales growth due to its commitment to extracting inefficiencies from its operations to fuel brand spending. We expect this will result in 3%-4% sales growth and mid-40s gross margins over the longer term.

Coming up: CEO Linda Rendle is slated to step down for health reasons once a successor has been tapped. Our Exemplary Capital Allocation Rating remains in place. Clorox has faced vast challenges in her six years at the helm, including postpandemic volume fatigue, rampant inflation, and a cyberattack. Through it all, Clorox has prudently spent to support its brands and capabilities. We don't think she is leaving based on the business' performance.

Cat litter (which we estimate accounts for a mid- to high-single-digit percentage of sales) remains a laggard. While we acknowledge the intense competitive backdrop (as it goes head-to-head against wide-moat Nestle and no-moat Church & Dwight), we surmise that the actions taken to enhance the product and packaging, combined with surgical adjustments to price points, should stabilize the business before long. From our vantage point, new products aligned with evolving consumer trends can bolster a brand's standing with consumers and retailers, strengthening its competitive prowess.

We're trimming our fair value estimate for Clorox to $154 per share, from $155. The change reflects more pronounced cost pressures (stemming from its Purell acquisition and the conflict in the Middle East). However, we haven't wavered on our long-term assumptions—3%-4% annual sales growth and high-teens operating margins. Our revised valuation implies a 17 times enterprise value/adjusted EBITDA multiple on our fiscal 2027 forecast.

Clorox has faced many challenges over the past few years, including rampant inflation, aggressive competition, a cybersecurity breach, and waning consumer spending. Despite all of this, we still think it employs a tactical approach, anchored in investing in consumer-valued innovation supported by advertising, pursuing cost savings, and surgically raising prices. We aren't altering our long-term expectations for gross margins that approximate the mid-40s levels that have historically characterized the business over our explicit forecast horizon.

We didn’t anticipate that cleaning volume would hold at the outsize levels seen at the height of the pandemic, but we believe the strength of Clorox's brands is resolute; its disinfecting wipes have been gaining share (excluding the supply issues that resulted from the cybersecurity breach). And we believe that even as concerns surrounding covid have faded, the annual cold and flu season can also ignite sales for Clorox’s cleaning fare, particularly as the firm remains focused on tailoring its mix to align with evolving consumer trends.

Even before the pandemic, Clorox had begun a path to enhance its product mix by investing in innovation and marketing to better align its offerings with evolving consumer trends. We think this will help stabilize the business over time. We forecast that around 10%-11% of sales will go to advertising and about 2% to R&D annually, totaling about $1.2 billion in aggregate investments. The company’s ability to manage costs while fueling brand spending will support operating margins averaging in the high teens.

We assign Clorox a wide economic moat based on the strength of its eclectic brand mix and entrenched position with leading retailers. We surmise its leading edge also underpins scale advantages. Return on invested capital, including goodwill, has averaged nearly 22% over the last 10 years. Despite potential inflationary headwinds eating into margins, we forecast ROIC to average 20% annually over the next 10 years, about 3 times our 7% cost of capital estimate.

Clorox has faced a barrage of headwinds over the past several years, following outsize demand at the outset of the pandemic, the subsequent supply chain malaise, rampant inflation, and, in 2023, a cybersecurity breach that forced it to take some information technology systems (including ordering) offline. But through it all, Clorox has continued to execute its strategic playbook, which centers on supporting its leading brand mix through innovation and marketing across price tiers.

We forecast Clorox will expend around 2% of its revenue on research and development—more than industry peers wide-moat Colgate-Palmolive and narrow-moat Kimberly-Clark and just behind wide-moat Procter & Gamble (five-year averages of 1.8%, 1.5%, and 2.5%, respectively)—while also marketing these offerings to consumers (around 10%-11% of sales annually), as even value-added new products can fail to win at the shelf if consumers aren’t aware of them. We don’t posit that the onslaught of challenges has extinguished its commitment to enhancing its digital capabilities and streamlining its operations—a $500 million investment over a multi-year horizon. We see this as a prudent way to boost agility and push decision-making closer to the end consumer, enabling it to keep pace with evolving preferences and future supply chain volatility. We believe this spending is strengthening Clorox's competitive position, as it has rebuilt its shelf presence, similar to its inventory revival during the pandemic.

The judiciousness of these investments is evidenced in Clorox’s enduring share position in its categories, most of which boast significant private-label penetration. Clorox dominates the North American bleach aisle, amassing nearly 63% share (according to Euromonitor), up from less than 59% in 2016, which is about double the low-30s share held by lower-priced private-label fare. Further, the firm controls 41% of the domestic toilet care category (up from 33% in 2016), eclipsing the 23% share held by wide-moat Reckitt and the 5% mark held by private label. Clorox has also historically led the field on its home turf in charcoal (about half of the category), trash bags (about one-third of the market), salad dressings (excluding mayonnaise), multipurpose cleaners, and water filtration.

These commanding market positions also bolster Clorox’s standing with leading retailers, lending additional credence to its intangible asset moat source. We believe the power of these relationships has really come to light since the disruptive security breach in August 2023. Retailers worked with Clorox to facilitate manual ordering and shipments, and even as its systems came back online, the company quickly rebuilt its inventory position (recovering the vast majority of lost distribution points), which we attribute to its strong retailer relationships.

Building on its strong brand intangible assets, Clorox has developed scale benefits relative to these niche operators, particularly around sourcing and logistics. It co-owns mines to obtain specific clay for its cat litter products, and it procures charred wood, the primary raw material for charcoal, from mills located near its manufacturing facilities.

We surmise the scale of its stalwart brand portfolio has given the firm a cost edge. To assess its position, we’ve attempted to home in on direct operating costs related to manufacturing and distribution, while removing discretionary expenses such as advertising and R&D, noncash costs including depreciation and amortization, and nonrecurring expenses, to gauge which firms are best positioned to overcome customer acquisition costs. On this basis, Clorox boasts a direct operating margin of around 32%, close to the 35% average for the generally moaty household and personal care companies in our coverage universe. However, when excluding the outsize direct operating margins of moaty beauty care firms L’Oreal and Galderma (55% for each), the industry average falls to 32%.

When taken together, we expect Clorox to continue to outearn our estimate of its cost of capital for the 20-year horizon required to assign the firm a wide economic moat rating.

Covid highlighted the necessity of Clorox’s disinfecting products. Demand for its cleaning fare (which accounts for around one third of Clorox's consolidated sales base) may persist.

Clorox's ERP upgrade is poised to deliver significant enhancements to decision-making and demand planning, replacing a system installed more than two decades ago and increasing margins back to the high teens that have historically characterized the business.

The acquisition of Purell stands to boost growth prospects for the consolidated business, as Purell has grown at a mid-single-digit clip for decades.

Beyond stepped-up promotional spending, cat litter remains Clorox's Achilles' heel, with share down 100 basis points to 16% since 2020 (Euromonitor).

Private-label penetration tends to be significant in categories where Clorox operates—such as bleach, charcoal, and trash bags—and volume could suffer if consumers trade down to lower-priced alternatives.

The combination of inflation and impending tariffs alongside a tepid consumer spending backdrop may constrain the firm's margins.