STOCK WATCH


Can Clorox Clean up in a Recession?

Elizabeth Ody

The consumer staples giant is a keeper even if the ailing economy creates obstacles for it in the short term.



Investors have been following earnings reports skittishly lately -- looking for any weaknesses deserving of punishment. Take Google (GOOG), which dropped 8.6% on February 1, to $515.90, after missing the average earnings estimate by just one penny when it reported the night before.

But consumer staples companies, such as Clorox (CLX), which earns its revenue from such humble items as plastic wrap and laundry detergent, are a different story. The company reports earnings February 4. Sure, a big miss could be taken by Wall Street to mean the worst is yet to come. But ultimately, regardless of whether it meets its mark exactly, Clorox has a time-tested product line and innovative new additions that make it a long-term keeper.

The nearly 100-year-old consumer staples giant, while synonymous with bleach, has fingers in everything from trash bags to salad dressing to kitty litter and charcoal. And, of course, people don't stop doing laundry, cleaning up after the cat or taking out the garbage just because the economy hits a rough patch.

"Every business has a degree of economic sensitivity, but [Clorox] certainly has a lot less than most," says Don Yacktman, manager of the Yacktman fund, which has 4% of assets in Clorox.

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The company, which has a market capitalization of $9 billion, has been a boring but reliable grower. Clorox increased sales in fiscal 2007, which ended June 30, by 4% to $4.8 billion-in line with the company's revenue growth target of 3% to 5%, which it has met in each of the last six years. Foreign markets account for a modest 17% of sales-predominantly in the cleaning-products lines.

The company also has cut costs by more than $100 million in each of the last six years.

But there's lasting quality under Clorox's stodginess. Sixty-two of the company's brands hold the first or second position for market share in their category. "If Clorox catches a cold, then anybody who competes with them is going to catch pneumonia," Yacktman says.

Clorox faces two strong economic forces. One is the drop in consumer spending. The Commerce Department reported, on January 31, that purchases rose only 0.2% in December, compared with 1% the month before. Although "people aren't going to stop buying toilet paper and detergents," as Morningstar analyst Lauren DeSanto says, they may start trading down to lower cost private labels.

Rising commodity costs are a bigger concern. Resin, an ingredient of just about anything made of plastic, has risen sharply in price for the past few years, partly after hurricanes Katrina and Rita destroyed a substantial portion of the country's related chemical manufacturing capacity.

Rising costs of soybean oil, for salad dressings, and cornstarch, for charcoal briquettes, have also squeezed the company. In the past, Clorox has largely been able to pass these rising costs on to consumers. But it may not want to flex its pricing muscles on an already crunched buyer.

P&G said in its recent earnings report that although it is seeing a "modest slowdown" in the U.S. market growth rate, it hasn't yet seen evidence that consumers are switching to cheaper private labels. But unlike Clorox, P&G derives substantial revenue from its personal care products -- 53% come from the company's beauty, health care and Gillette razor product lines.

As DeSanto says, consumers may be reluctant to change brands for their makeup or toothpaste, "but if you're looking at a toilet bowl cleaning product, maybe less so." P&G, which is also grappling with commodity costs, plans to raise prices on some products by 4% to 8% over the next few months.

But should the economy's troubles linger and deepen, Clorox may benefit from some longer-term insulating factors.

In particular, says Bob Goldsborough of Ariel Capital Management, the global resin supply could jump 30% because Saudi Arabia is expected to boost production capacity in the next year or two. "Resin matters so much more than anything else for Clorox," he says.

In January the company also unrolled its first new product line in two decades -- Green Works cleaners. The plant-based line of cleaning products, sold in recycled packaging, will carry a Sierra Club endorsement.

The line, of course, will face the same obstacles in a recession as the company's staples because consumers may not be willing to pay a premium for a brand-name or eco-friendly cleaning product. Nevertheless, Green Works "may be one of the biggest new product launches in Clorox's history," says Connie Maneaty, an analyst with BMO Capital Markets.

The company's $925 million acquisition of Burt's Bees similarly points to a new direction for Clorox. The line of beeswax personal-care products-birthed out of a home-based honey business in the '80s-generated $170 million in revenues in 2007.

The expensive acquisition is expected to clip earnings by 10 to 15 cents in fiscal 2008. But Burt's will benefit from Clorox's extensive distribution capacity and is expected to be a strong bonus in fiscal 2009.

Analysts advise investors to keep their eyes on the company's volume growth, which will be a key indicator of whether consumers are switching to generic brands, when the company releases earnings February 4. Maneaty rates the stock "outperform" and gives it a price target of $74. Clorox closed at $63.09 February 1, up 2.9%.

Could Clorox be the canary in the coal mine? Probably not. As Maneaty points out, the unusually wide 20-cent range of earnings estimates, from 44 cents to 64 cents per share, signals that there's some confusion surrounding expectations for the company.

But if the company doesn't deliver the average earnings estimate of 54 cents per share, the stock will almost certainly take a beating from an anxious Wall Street. Patient investors, however, could find a buying opportunity in a proven company.




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