Back in February, I said Clorox (CLX) investors would get cleaned out if they bought the stock at its current valuation. Well, the stock is up about 4% since then, and I still believe investors will get cleaned out.
I was worried then that investors were buying into an overvalued consumer-staples company with little top-line growth. Furthermore, Clorox's better-than-expected earnings were being driven by gross margin expansion, which was coming to an end. In fact, management implied as much in their guidance.
Fiscal year 2016 (ending June) has been one for the record books. The company blew out the first quarter with a 6% increase in organic sales. Gross margins skyrocketed 220 basis points and earnings per share were $0.14 greater than expected. Investors were ecstatic. Hedge funds backed up the truck and bought the stock hand over fist.
Then, when the second quarter rolled around, organic sales rose just 3%, much less than forecasted. What? The company would have missed the consensus EP) estimate if not for another big boost from the margin fairy godmother. Gross margins jumped 120 basis points. With higher gross margins and tight expense control, operating margins widened 250 basis points. Yeah, 250. Who does that nowadays?
On the call afterwards, management lowered the boom. The company's third-quarter guidance was below consensus and implied the rest of the year would slow. Margin improvements would be more modest. In the first half of the year Clorox squeezed out 429 basis points of margin! The margin party was over and the "Beat the Street" game was coming to an end.
Then, like Rocky Balboa, CLX gets off the mat and finds a way to top the third-quarter consensus EPS estimate by $0.10, with better-than-expected organic sales. Pow! Sales rose 5%. Gross margins, once thought to be DOA, came back to life, increasing 210 basis points to 45.3%. The big jump came from cost savings, better pricing, lower commodity prices -- especially oil prices -- and slightly higher shipment volumes. Oh, and it didn't hurt that Clorox regained distribution of Clorox Disinfecting Wipes at Action Alerts PLUS holding Costco (COST) . Apparently, Costco customers can't live without their disinfecting wipes. Nobody saw that coming.
Operating margins got a big boost, too, widening 110 basis points to end the third quarter at 18.3%. Based on a solid third quarter, management raised guidance for the fourth quarter. They even announced a 1% increase in advertising spending to drive sales. What?
With the bears on the ropes, Clorox is set to report fourth-quarter results before the open on Wednesday, Aug. 3. This has to be the quarter when margin expansion slows -- and slows dramatically. I expect gross margins to be up just 15 basis points on 3.3% organic sales growth. The consensus is looking for revenue of $1.58 billion, but I wouldn't be surprised if revenue was a touch higher, since the consensus is looking for slower organic growth than I am.
Last year, fourth-quarter margins jumped 271 basis points to 45.6%. There is no way Clorox can beat that number. It was the best margin quarter in at least two years.
The consensus EPS estimate is $1.28, down from last year's $1.44. Analysts think the company will earn $4.95 for the year, which would be up 8%. Operating income for FY 16 is expected to increase only $70 million. The expected 8% increase in earnings is mostly coming from share buybacks.
For FY 17, everyone is modeling EPS of $5.22 on a 3.5% rise in revenue, meaning CLX is trading at 25x FY 17 earnings estimates. (This is totally crazy!)
Gross margins in the first three quarters of FY 16 increased 220, 120 and 210 basis points, respectively. How can they beat those comparisons? EPS in the first quarter of FY 16 jumped 19%! You think management can do that again in the FY 17's first quarter?
There's no way I would buy a consumer staples name trading at 25x next year's earnings with 3% organic growth and impossible gross margin comparisons.
I still think investors in Clorox will get cleaned out.