We have often been seen as pessimists. We agree that we focused on what can go wrong and we rarely accept hype and hope. It is therefore rare for a stock to perform much worse than our worst expectations. That’s exactly what the Clorox Company (CLX) did when it reported fourth quarter 2021 results.
A little history
We covered CLX 4 times and didn’t even give the bulls a modicum of hope.
Our thesis rested on three legs. The first being that the valuation was completely outlandish for a slow-growing company. The second being that commodity price pressures would squeeze earnings far more than analysts expected. Finally, investors were basing their expectations on the 2020-2021 timeframe and rebasing to 2019 would mean the stock was even more expensive.
Q2-2022 results (year-end is June 2022)
You don’t want to see an outright dip in sales when a company is trading at these levels. You definitely don’t want to see any margin compression with this. But that is precisely what we got.
Net sales decreased 8% to $1.7 billion, compared to a 27% increase in the year-ago quarter, or a 19% increase on a two-year basis. The drop in sales reflects a drop in volumes of 10 points and a favorable price mix of 2 points. The exchange rate remained stable and organic sales1 for the quarter was down 8%.
Gross margin decreased by 1,240 basis points to 33% from 45% in the prior year quarter, mainly due to higher manufacturing and logistics costs and raw materials.
Source: Clorox Q2-2022 Results
The 33% gross margins have not been updated in the table below, but see how they would compare to the past. Even during the global financial crisis, we haven’t seen anything this low.
Those gross margins led to earnings forecasts that might have had you screaming “Son of Bleach!”.
Diluted EPS between $3.80 and $4.05, down between 32% and 27%, respectively.
Adjusted EPS between $4.25 and $4.50, down between 41% and 38% respectively.
Source: Clorox Q2-2022 Results
Even the top end is so far off the street that we don’t think the analyst community has done their due diligence.
Valuation & Outlook
CLX is now trading at $151.50 as of this writing after hours.
As awful as that sounds to those who chased it all down to over $225, keep in mind that it’s still 34 times the winnings! Are these hollow incomes? Maybe, and we think it was a quarter kitchen sink. The street will still have to downgrade all these projections of hockey sticks which have no basis in reality. CLX is going to grow maybe 4-6% from here and you have to decide what you want to pay for it. Historically, anything over 20 times the payout has been a bad bet. Price to sales ratios have historically bottomed near 2.0x and keep in mind that sales are down.
Both of these figures imply serious additional disadvantages. Income investors can salivate over the dividend and CLX is certainly a worthy aristocrat. Again, note that the current adjusted result is now lower than the dividend. That is, the dividend payment is greater than 100%. Can the dividend be maintained? Right now, we should say yes. We expect CLX to be able to rebound from these weak earnings and for things to improve as fiscal 2023 approaches. The risks come from commodity markets though, and if the strength of inflation persists and we see another round of downward earnings revisions, it could be a different ball game 12 months from now.
We were expecting a rough report and actually suggested in the comments section of our last article that the first buying point would be the next earnings slump. Well, we passed out and we can tell you that we don’t feel the same anymore. Earnings are even well below our estimates and inflation has also exceeded our high range. This is a dangerous setup and there are plenty of trapped longs who bought this in the $200s “because it was going up”. After careful consideration, we maintain our sales rating on this and would be looking to get back to it in 3 months. If inflation recedes, the next quarter is better, and CLX drops another 20%, we might consider moving to a neutral rating.