Monday, July 18, 2011

With Clorox in Icahn's Sites, Should You Buy Its Stock?

Clorox (NYSE: CLX) rose almost 9% Friday on news that Carl Icahn had offered $11.6 billion to buy the bleach-maker. But what if the deal does not go through -- would Clorox still be a good addition to your portfolio?

Icahn's $76.50 a share cash offer was designed to spur a corporate deal that could take advantage of cost savings that would result from sharing marketing and logistics. Icahn's 12% premium for Clorox -- it also makes Burt's Bees lip balm, Glad trash bags, Brita water filters -- was intended to spur a competing offer from Procter & Gamble (NYSE: PG) or Colgate-Palmolive (NYSE: CL).

I agree with Icahn's logic here but his efforts could fail. Therefore, it's worth considering whether to buy Clorox if it remains independent.

One reason it might be worth buying is that is has out-earned its capital cost -- but at a slower rate. Clorox earned more after-tax operating profit than its cost of capital, however it's losing ground. Clorox's EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was negative 1%, based on 2009 revenue of $5.5 billion, and EVA that fell from $352 million in 2009 to $322 million in 2010, using a 7% weighted average cost of capital.

The reasons to avoid this stock are more compelling:
  • Disappointing third quarter earnings. In May, Clorox reported an 8.5% decline in its earnings for the quarter ending March 2011 and its earnings and sales ($1.02 and $1.3 billion, respectively) both missed consensus expectations ($1.04 and $1.32 billion). Clorox also lowered its outlook for the fiscal year ending June 2011 and issued 2012 guidance that was below analysts' expectations. Clorox's problem is that its costs for inputs like resin, pine oil, and diesel are rising faster than it can raise prices to cash-pinched consumers -- in May it raised the price on Glad bags by 9.5%. In May Clorox raised its estimates for commodity cost increases from $75 million to $85 million for fiscal 2011 and up $170 million for fiscal 2012.
  • Slow growth with shakier balance sheet. Clorox has grown very slowly. Its $5.2 billion in revenues have increased at an average rate of 3.6% over the last five years and its net income of $268 million has risen at a 0.4% annual rate over that period. And its cash has been falling while its debt has risen a bit. Specifically, Clorox's cash fell at an 18% annual rate between 2006 ($192 million) and 2010 ($87 million) while its debt rose slightly between 2006 ($2.0 billion) and 2010 ($2.1 billion)
  • Expensive stock. Clorox's price to earnings to growth (PEG) ratio of 4.09 makes it very over-valued (a PEG of 1.0 is considered fairly priced). Clorox's P/E is 18.8 and its earnings are expected to grow 4.6% to $4.06 in 2012.
This stock looks like it would not be good to own in the absence of Icahn's efforts to spur a takeover. However, if Icahn ends up buying Clorox at this stated price, the shares still have a few points of profit left. I am guessing that the stock's failure to rise a full 12% reflects investors' uncertainty about whether a deal will be concluded.

Unless commodity prices plunge, I do not see a catalyst for these shares beyond the possibility of a takeover.


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