Clorox (NYSE:CLX) beat their Q3 earnings forecast handily back on May 1st and are certainly going to repeat this performance again with Q4. In the age of Covid and sheltering in place, May 1st feels like it was years ago and the amount of uncertainty surrounding the economy, corporate operations, and literally everything was extremely high. Management’s conservatism made sense back then, but with the benefit of hindsight we can now reasonably forecast where the numbers landed for Calendar Q2 (Fiscal Q4).
Normally, I publish earnings previews a few days before the release, and generally put a position on at that time. Given the price action of Clorox in recent weeks, my read is that there is a non-trivial earnings ‘frontrun’ going on, so I’ve decided to initiate my long position early – concurrently with this post.
Management’s EPS guidance for the entire FY 2020 was in the range of $6.70-$6.90. Using the midpoint of those value ($6.80) and subtracting the first 3 quarters of EPS ($1.61, $1.47, and $1.92) yields a remainder of $1.80 for Q4. Shockingly, this means their guidance was for Q4 to be weaker than Q3. The revenue guidance mirrors this with 4-6% YoY Revenue Growth, putting the quarter at 1.79B, slightly higher than Q3.
The sell-side analyst story is slightly more bullish, with a revenue forecast of 1.89B and EPS at $2.01. Keep in mind that analysts are (effectively) paid to make management look good so it’s not a surprise that these estimates are also on the light side.
Constructing my forecasts for the quarter follows a reasonably similar approach to what I did in my previous quarterly forecast. This quarter however, we have the benefit of having the last quarter’s “Covid bump” numbers to give us some grounding. Here’s a summary table of Management Guidance, Analyst Consensus and my numbers. After the table I’ll explain the rationale of my build-up.
Source: Company Filings, Capital IQ, and my forecasts
To me, the best way to forecast revenues is using the very detailed segment data that they release.
Source: Company filings and my forecasts
Last quarter, in fiscal Q3, the company had the strong headwinds of the Covid pandemic spreading across the world. It’s important to note that the revenue spike associated with Clorox’s cleaning products only started in the middle of February, thus, only 1/2 of the quarter was “affected by the Covid bump.” Over the entire FQ4 (April-June), Covid has run rampant across the USA and many countries across the globe. Based on “baseline sales” of about $500M, and “6 weeks of Covid bump sales” of +$170m, it’s pretty easy to see that when the entire calendar quarter is affected by Covid, you should see a number north of $800M.
There are a handful arguments about why this may not be the case which I think I can dismiss. First, Q3 results could be the result of severe inventory depletion at the end of the quarter, and thus those revenue gains aren’t sustainable. I’d say that’s not the case because the company finished Q3 with higher inventory levels than what they started with. They increased production in an amazingly fast manner.
A second argument could be that Q2 resulted in stockpiling that isn’t continuing into Q3. A few answers to that – my very imprecise channel checks on Amazon show that Clorox cleaning products are still regularly sold out. In addition, given the massive demand for cleaning products (and potential “winter return of Covid”), I find it hard to imagine large retailers: Walmart, Target, Amazon, etc. would not be stockpiling as many of these cleaning supplies as they can possibly acquire.
Lastly, the company has publicly said they’ve increased output of their cleaning products of 40%, which is likely a conservative number as well.
Long story short, I’m feeling confident with $800m revenues in the cleaning segment for Q4, and think that has moderate upside as well. I’d also hazard a guess that management’s conservatism around this number (overall revenues in general) is based on potential plant closures that could have happened but ultimately didn’t (remember, May 2020 was a very different world).
The second major revenue increase that I’ve forecasted is in the Household products category. Specifically, this category has seasonal strength in FQ4 (Calendar Q2) because of their Grilling segment. It doesn’t take a genius to figure out that grilling is a hot segment given people are at home, and also trying to spend more time in their backyards. Here’s the Google trends data:
Source: Google Trends
So for Q4, I’m expecting the company to draft the strength of Q3, benefit from the seasonal grilling bump, and also the “Covid grilling bump.” This brings Q4 segment revenues up from $500M to $625M.
For the Lifestyle and International segments, my forecasts aren’t too contentious and do not contribute significantly to the story.
Gross Margin Forecasts
The company’s gross margins improved from their historic average 44% level to 46.7% in the last quarter (this is an all-time high for them). Once again, those improvements only took effect during the second half of the quarter, which means they realistically exited the quarter with a gross margin closer to 49% (6 weeks at 44%, 6 weeks at 49% gets you a quarterly average of ~46.5%).
Having exited the quarter at 49%, I see little to no reason why that would have fallen in FQ4, and in reality it likely increased. Here are the reasons why it would have increased:
Source: Company Filings
The cleaning segment is by far their most profitable segment. Due to Covid, sales in their cleaning segment are continually increasing to be a larger proportion of their sales, thus increasing the company’s blended gross margin.
When you’re continually sold out of your products, price becomes a helpful mechanism to help balance supply and demand. To be clear, I’m not suggesting that Clorox increase prices, or price gouge, or anything of that nature. But from my experience, manufacturers provide many different flavors of promotions (volume discounts, etc.) and clearly, Clorox would be paring those discounts back at a time like this, thus effectively increasing gross margins.
My cursory examination also suggests that Clorox is experimenting with different types of product packaging (flat pack wipes vs. containers of wipes for example) which I imagine is designed to streamline production, transport, and ultimately provide higher gross margins and output.
I’ve forecasted an increase of SG&A from 25.4% of Revenues to 27.5% of Revenues. Following a similar approach as above, the typical rate is around 24% which means last quarter’s exit-SG&A % would be closer to 27%. I’ve further increased this due to higher operating costs associated with Covid (social distancing, expensive transport, etc.)
Putting it all together, I arrive at an EPS estimate of $2.26 compared with the analyst consensus of $2.01 and management guidance of $1.80. In other words, a very significant beat (especially for a sleeping consumer products company).
The Bigger Picture
Covid hopefully won’t be here forever, so it’s certainly fair to say that the extent of the gains (30-50% higher Free Cash Flows) may be fleeting. However, there are many other factors that are driving the longer-term prospects and valuation of the business. I’ll summarize them here now and hope to write about them in a longer future article:
Trading Multiple & Valuation
With the 10-year treasury a full 100 basis points lower than where it was 9 months ago, the discount rate applied to equities (CLX specifically) should be a full point lower. In most equities, this is offset by the equity risk premium increasing by more than 100 basis points since the economy is far riskier now than it was 9 months ago. I doubt that’s the case for Clorox, and thus the EV/EBITDA multiple it should garner should be significantly higher than historical levels (multiples are the inverse of discount rates!).
B2B & Branding
Clorox has signed deals with Uber, United Airlines, Cleveland clinic, etc., to push the Clorox brand forward in the mind space of consumers. Aside from negative cost marketing (they’re getting paid to have companies advertise their name as “the industry standard of cleaning”) this is likely a high-margin B2B sales channel for their cleaning products. The money at this time is probably inconsequential, but could potentially grow significantly.
Consumer & Brand Perception
Even in a post-Covid world, I can imagine a long-lived significant change in consumer behavior. Cleanliness will take a higher priority in consumers’ minds and this matters at the business level as well. Restaurants would prefer to use bottles of “Clorox” cleaner instead of mystery-green liquids, just like they prefer to have Heinz ketchup bottles instead of “bottles of red tomato sauce” on their counters.
Trading & Valuation Algorithms
“A single quarter datapoint is a spike- but two data points is a trend.” I can see algorithms picking up the last two quarters of results and “getting bullish” on the company as their metrics will undoubtedly “score high” using traditional quant metrics.
I don’t think I’m the only one with forecasts that are this high, and as I alluded to in my introduction, I think funds are positioning to be long Clorox into earnings because of this expected beat. In other words “the whisper number” is pretty darn high. Even so, looking at my numbers, I see the potential for a “monster beat” coming from Clorox and I think a stock price in the $250 range is entirely reasonable.
NB: Nielsen released some data read-outs regarding revenue growth numbers. I don’t have the source data but I would be very surprised if the +17.6% number over the last 12 weeks can be correctly applied to Q4 YoY growth for Clorox as a whole.
Disclosure: I am/we are long CLX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.