As High Inflation Persists, Clorox's Dividend Continues to Look Safe

Since our last note on Clorox in February, inflation has accelerated and run hotter than expected. Rising costs have further squeezed earnings and driven the firm's trailing payout ratio to over 100%.

Despite the operating environment turning even more challenging than anticipated, we believe Clorox's long-term outlook remains intact, and the company's dividend remains safe. However, we do expect inflationary challenges to persist for a while longer.

From resin used in plastic containers to non-woven fabrics for wipes products, prices of the cleaning product maker's essential materials have risen by 25% to 50% over the last two years, on top of the overwhelming increased costs to ship goods.

While it's possible prices of raw materials and transportation may continue to climb, at some point, demand will soften and force input prices back to reasonable levels. With many consumer staples companies experiencing a substantial contraction in margins and the Fed actively raising interest rates, we could be approaching that point.

Until then, Clorox's robust portfolio of premium cleaning products and financial strength can maintain its growing dividend.

In fact, while inflation has shifted many consumers' spending habits, Clorox's net revenue has only contracted 4% over the last nine months. These resilient sales numbers, especially given how much Clorox's business boomed during the pandemic, are a testament to the value of Clorox's premium products in the eyes of consumers.

Despite maintaining reasonable sales volumes, Clorox's squeezed profit margins will likely take a few years to return to historical levels as certain raw material prices moderate (e.g. volatile crude oil prices drive resin prices) and the bleach maker takes additional pricing actions. 

Even so, we believe the company still has enough flexibility to announce the firm's 45th consecutive annual dividend increase in the coming weeks, albeit with a low single-digit raise appearing most likely.

To illustrate this flexibility, Clorox reduced advertising expenses by almost $50 million last quarter. If the company were to raise the quarterly dividend by just $0.01, the increased cost to the firm would be just $5 million – or only 10% of the money saved on reduced advertising spend.

Further cost-cutting measures are likely, along with price hikes, as Clorox works to restore profit margins and protect its payout.

While dividend coverage may remain stressed in the short term, Clorox's otherwise strong financial profile, including a BBB+ credit rating, provides the firm with flexibility to weather this storm without materially adjusting its capital allocation priorities.

Looking beyond the current challenges, Clorox has a long and stable operating history and boasts a strong portfolio of essential consumable products, with over 80% holding the number one or two spots in category market share.

Although there will likely be continued volatility as Clorox works through inflationary challenges, the company's strong brand portfolio, in the long run, should help restore margins, improve dividend coverage, and support moderate growth. 

Investors who share our long-term outlook may find now an interesting time to consider the company, with the stock trading at a decade-high dividend yield of almost 4%. However, investors should anticipate slower dividend growth in the next few years until profit margins are restored. 

We will continue to keep an eye on Clorox and provide any updates that could threaten the dividend's outlook.