Can Clorox Keep Its Momentum Going Into Next Quarter

As dividend aristocrats and dividend growth stocks like Procter & Gamble NYSE: PG, which operate in essential everyday products, begin to announce their first quarter 2023 earnings results, it becomes evident that expanding free cash flow and operating margins on the back of inflationary pressures coupled with tight supply chains are the new norm for these "cash flow king" companies. In addition, a secondary theme is also developing in the cost-cutting department of these businesses, as Procter & Gamble focuses on efficiency and creating shareholder value.

The Clorox Company NYSE: CLX is set to report earnings in early May 2023, the company has already shown some similar momentum following Procter & Gamble's lead to restructuring its cost base, implementing layoffs, and seeing an acceleration in margins with a pleasant subsequent effect to shareholders via double-digit growth in earnings per share. What stands out in question for the upcoming earnings announcement is, can they keep the momentum going and close the stock performance gap against that seen in Procter & Gamble stock?

The Past as a Representation of the Future

Clorox stock has performed relatively poor relative to a peer like Procter & Gamble, in the sense that CLX shares declined by as much as 34% from its peak in 2021 to the trough in 2022, while PG shares rallied by an almost mirror 35% during the same lookback period. The gap in stock performance can be mainly attributed to the lifeblood of investor sentiment and returns on invested capital. As Procter & Gamble sustained 14-15% returns on invested capital during the period, Clorox saw its metrics decline from 19.5% to 12%, with a subsequent 34% contraction in earnings per share. What this means for investors looking back can be positive rather than negative.

Seeing the gap in Clorox's financials and stock price performance, management has taken the initiative to push past macroeconomic tailwinds for help. As inflationary pressures in the United States, coupled with a strong dollar, cause companies operating in everyday products and essentials to pass on input costs onto consumers and be justified for it, Clorox's operating margins increased by 1.8% on an annual basis when taking the fourth quarter of 2022 into perspective. Even though sales expanded for the year at a 1.4% rate, costs of goods sold declined by 3% to allow gross margins of 36.2% for the quarter; the decline in cost of goods sold can be attributed to the entrenched buying power of the company alongside strong currency dynamics. A more hands-on approach apart from the "invisible hand" of the market is to start expanding margins within the business; Clorox management has announced a restructuring plan that will effectively eliminate 200 positions in the company, which is preparing to increase efficiency and productivity in existing roles while at the same time reducing the cost burden of payroll and benefits to employees.

Clorox management's ultimate view on the restructure is to return the company to pre-pandemic profitability, margins, and cash flow levels to sustain and expand its current dividend yield. In addition, further recovery and expansion in free cash flow for Clorox will allow management to entertain the possibility of returning more cash to shareholders via buybacks; today's Clorox dividend yield from the company stands at 2.85%, where historically it has hovered around lower levels, a sign that the stock may have some potential upside especially when facing fundamentals momentum.

Looking for Clues Ahead

Clorox analyst ratings deem the stock an overwhelming "hold" while also assigning a 10%+ downside from current levels, however markets have a different opinion by causing the stock to rally by nearly 20% in the beginning of 2023. Perhaps some investors and other participants accustomed to the business cycle and the way that Clorox handles it can find comfort in the stock's 41x P/E ratio, which is significantly higher than its price to free cash flow ratio of only 28.5x for one of America's preferred brands; according to an investor day presentation, Clorox products are in nine out of every ten households in the U.S.

The discrepancy in the earnings and free cash flow figures can be attributed to the income statement reflecting a significant goodwill impairment charge of $329 million, which is not reflected in the cash flow statement and thus created the difference in free cash flow and net income.

Perhaps this large gap is what is causing analysts to think the stock is overvalued; others may look at the dividend yield and say that there is still some upside amid fundamental bullish signs; markets can come together and agree that there are internal and external signs that the stock may see a breakout in the following earnings announcement.