Clorox (CLX) owns a broad collection of iconic brands, but its namesake product is highly correlated with cleaning. The stock took off in 2020 as the coronavirus spread across the globe and disinfecting surfaces to stop the spread became a priority. Eventually, though, pandemic concerns eased.

Today Clorox stock is trading down roughly 30% from the high-water mark achieved in 2020. Here’s what went wrong and why investors should still like the shares.

Ups and downs for Clorox
Demand for cleaning products spiked in the early days of the pandemic as people started to clean just about everything in an attempt to avoid the illness. There was so much buying that Clorox couldn’t keep up, so it hired contract manufacturers to produce its products for it. That kept retailers’ shelves filled, but it came at a high cost. Investors only looked at the demand side of the equation in a time of market turmoil and sent Clorox’s shares sharply higher.

Then inflation started to rise, and demand for cleaning supplies started to drop. The end result was massive margin compression. For example, gross profit margin had long hovered in the mid-40% range but fell down to the mid-30% range. Investors, perhaps understandably, dumped the stock.

Management was confident that it could get margins back on track. The game plan was pretty simple and followed the plan used by just about every consumer staples company: Cut costs and raise prices. There were some easy fixes, like getting rid of high-cost contract production, but management admitted that getting back to the historical margin range was likely to be a multiyear effort.

Clorox’s efforts are going quite well, thanks
The company is now many quarters into the process, and it appears to be executing at a high level. For example, in the fiscal third quarter of 2023 (ended March 31), organic sales rose a solid 8%, led by price increases. Gross margin improved 590 basis points year over year to 41.8%. And adjusted earnings, which leaves out items the company believes are one-time in nature, rose 15% compared to the same stanza of fiscal 2022. All in, it was a solid quarter.

That said, there are some caveats. For example, price increases were quite large in some business lines leading to very material volume declines. Management said that the volume declines were in line with expectations, but other consumer products companies are doing a better job at balancing price increases and volume declines. At some point, Clorox will need to address the volume issue when the price increases run their course.

However, given the company’s long-term success and the fact that it is executing on its current plan to improve margins, it seems like a good idea to give it the benefit of the doubt here. It’s worth noting that Clorox has increased its dividend annually for over four and half decades. That’s a record that requires both commitment and execution to achieve.

Over the past decade, meanwhile, the average annual dividend increase was 6.5%. In today’s high-inflation environment, that may not sound like much, but this is a boring consumer staples stock, and that figure is pretty solid. That said, the average has been brought down by slower dividend growth during the recent lean years, as you would expect. To put a number on that, the last increase, made in mid-2022, amounted to just 1.7%. The increase in 2019, before the pandemic upended the world, was 10.4%.

While it may take some time, Clorox is clearly making progress in getting back toward 2019 performance levels. And that would likely mean a return to more robust dividend growth rates. The stock’s 2.8% dividend yield, meanwhile, is still toward the high side of the historical yield range, suggesting the shares remain relatively cheap.

Not an overnight success
To be fair, Clorox still has a lot of work ahead of it as it attempts to return to pre-COVID levels of business performance. But it has, so far, executed fairly well on its recovery plan. That’s a very good sign for the future. In fact, during the earnings conference call, two analysts pressed the company on its earnings potential. Analyst earnings models suggest huge earnings upside in the future, and they wanted to make sure they weren’t missing something. Management didn’t really try to temper the analysts’ positive outlooks.

— Reuben Gregg Brewer

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Source: The Motley Fool