A Tale of 2 Staples
- By John Kinsellagh
The consumer staples sector, long a haven for defensive investors in times of economic uncertainty or market downturns, has had a difficult year. Year to date, the sector has risen 9.5%, still well below the 15.4% rise of the S&P 500. Within the past year, there have been skeptics who contend that, due to disappointing earnings, the sector can no longer reliably be considered "defensive." Investors are now more discriminating and no longer view the sector as a whole, but divided between those companies that are struggling, due to profound changes in consumers behavior and diminished loyalty to brand names, and those companies that are adjusting to the new realities of a sector in flux.
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The intrinsic value of CLX
For decades, consumers didn't mind paying a premium for these company's products because they were assured of quality and felt comfortable with purchasing a brand name. Indeed, so ubiquitous were the names of some of these products that, over time, some of the trademarks merged into descriptive nouns that became part of our everyday vocabulary: Xerox, Band Aid, Kleenex. This phenomenon was indicative of these companies established and unchallenged dominance in their respective markets.
The recent performance of the stocks in this sector, however, forebodes a very different future.
The key metric for a relative assessment of the diverse group of staples companies is the direction of organic sales growth. A good example of the evolving nature of the staples sector and the slow divergence among individual companies is provided by an analysis of the fortunes of Clorox (CLX) and Procter & Gamble (PG). A summary review of the key financial indicators for each company is a somber indication of which of the two is likely to survive in a new competitive market and which will likely flounder.
For its most recent quarter, Procter & Gamble posted earnings of $1.25 per share on revenue of $17.44 billion, surpassing the Street's anticipated earnings per share of $1.21 on revenue of $17.16 billion. Organic sales increased 4%, with an 8% surge in its beauty products and 5% growth in its health care division. In a sign that could portend well for P&G, e-commerce organic sales rose a hefty 30%.
P&G expects organic sales for the full year to rise between 2% and 4%, increasing its previous guidance by 1%. The company is also projecting earnings per share growth of 3% to 8% at $4.35 to $4.56 per share, above the analysts' consensus estimate of $4.40.
Even though the company's margins are enviable, commodities and transportation costs have made it more expensive to achieve solid organic sales growth in the new competitive consumer environment. Indeed, GuruFocus notes that Procter & Gamble's revenue per share has been in decline for the last five years.
The company's disappointing revenue per share figures indicate that while it is clearly adopting to the changing complexion of the staples sector, it too is not entirely immune from shifting consumer tastes and declining branding market power with a new generation of customers. As the declining fortunes of Clorox presage, consumers today are willing to try alternative brands and don't necessarily equate Clorox with bleach. This loss of diminished marketing muscle is the result of a new -- and for established staple companies -- painful reality: the erosion of their branding power.
As GuruFocus notes, Procter & Gamble still enjoys remarkable operating margins at 20.06% versus 5.4% median for the industry, outranking 91% of its peers within the staples sector. P&G also shines on return on assets with 8.83% versus an industry median of 3.29% as well as a robust return on equity of 19.71% versus an industry median of 7.12%.
For dividend investors, P&G is hard to beat. The current yield is 2.8% -- an oasis in a desert of paltry fixed-income returns. The company has increased its dividend for 62 straight years, making it an undisputed dividend aristocrat. In addition, the company has plenty of cash available to add to its existing portfolio of products.
Clorox, on the other hand, is struggling. Its performance has been uneven over the past two years. The stock was hammered after its 2018 fiscal first-quarter earnings proved disappointing. For the quarter, Clorox earned $1.62 per share on revenue of $1.56 billion. The consensus was for earnings of $1.59 per share on revenue of $1.53 billion. Gross margins, however, dropped by 1.5 % year over year to 43.4% due to higher manufacturing, transportation and commodity costs. At the time, its guidance for the full year was for earnings of $6.20 to $6.40 per share, below the $6.44 consensus estimate.
Despite its unobjectionable results at the beginning of the year, 2019 looks to be a difficult year for Clorox as consumers continue to shift to different brands or products produced by smaller companies. The company is facing challenges in its household division, primarily in its bags and wraps and charcoal product lines. The company has suffered distribution losses, an ominous sign for a struggling staples company. Although it posted decent results at the beginning of the year, as noted above, its 2018 performance was very much a mixed bag, with a lack of stability in key financial indexes. Such fluctuations are the death knell for a company in the staples sector.
Consumer data from Nielsen indicates trends are worsening for one of its key products, Clorox. The decline will lead to a loss of shelf space for Clorox as well as its charcoal products -- an event that couldn't be more inopportune as the start of the summer grilling will begin shortly. Since the company's charcoal line is a major source of revenue, this is going to adversely impact earnings.
The company has little room to maneuver since it has already raised prices across the board.
A review of its stock price indicates investors have punished Clorox for its inability to pivot to new products. Clorox stock is up approximately 1% year to date. By comparison, the S&P 500 has increased 15.4% and P&G is up 12.8%.
Procter & Gamble shares are up more than 13% for the year as the company demonstrated it was seeing top-line organic growth. P&G solidified its 2018 performance that outranked many of its peers in the staples industry with a strong earnings announcement in January.
Disclosure: I have no positions in any of the securities referenced in this article.
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This article first appeared on GuruFocus.
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The intrinsic value of CLX
