Can Household Names Be Good Investments?
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Peter Lynch, the legendary portfolio manager of Fidelity’s Magellan Fund, advised investors to know their investments and to invest in what they know. Most consumers know household names, with hardly a thought of their investment potential. Three household consumer names that are also interesting stocks are The Clorox Company (NYSE: CLX), Snap-On Inc. (NYSE: SNA), and WD-40 Co. (NASDAQ: WDFC).
Clorox is of course associated with its namesake bleach products but only about 14% of total sales are derived from bleach. The company also sells Glad trash bags, Kingsford charcoal, Pine-Sol household cleaners, KC Masterpiece sauces, and many other consumer products. By controlling operating expenses (consistently around 25% since 2006) and reducing share count (down 9.8% since 2006), Clorox has grown earnings per share and operating cash flow by 6.7% and 6.0% respectively, compared to just 2.4% annual compound growth in revenue since 2006. Activist shareholder Carl Ichan has attempted to unlock value in the company but so far has been unsuccessful in his attempts to find a buyer.
For the year ended June 2013, the consensus estimate for earnings per share growth is 5.7% which is a reduction from the 7.9% growth anticipated just 90 days ago. The forward P/E multiple at the recent price of around $69 is 16.2x so the forward price to earnings to growth (PEG) multiple is 2.8x. This PEG multiple is high as I favor companies that trade at multiples closer to 1.0x and anything above 2.0x is too excessive for my comfort. This PEG is especially troubling for a company whose earnings estimates are being cut.
Snap-On Inc., the owner of the fleet of famous “Snap-on Tools” vans that are on the roads every day, has been servicing independent vehicle repair shops since the 1930’s. In addition to its premium hand and power tools (it’s the largest manufacturer & distributor in the U.S.), Snap-On’s repair systems and information business (approximately 29% of sales) controls more than 50% of the independent repair shop market and should continue to grow because of ever increasing complexity of automobiles. The company has grown revenue by 2.5% compounded annually since 2006 but has been able to grow earnings per share by more than 22% annually by expanding its operating margin from 6.5% to 16.6%. This is impressive but cash flow from operations has lagged during this time, actually declining by 8.7% compounded annually as growth in working capital has outpaced sales growth.
The consensus EPS growth estimate for Snap-On is 8.4% for the year ended December 2012 and 13.8% for 2013. These estimates are largely unchanged from 90 days ago, reflecting analysts confidence with their projections. However, because operating cash flow has weakened while earnings per share has been growing rapidly, I am reluctant to accept the growth expectations at face value. The forward P/E at the recent price of about $60 is 12.2x for 2012 and 10.7x for 2013, making the forward PEG 1.5x for 2012 and 0.78x for 2013. These are appealing PEG multiples but I believe they are overly optimistic given the poor operating cash flow since 2006.
WD-40 Co.’s primary offering is the eponymous WD-40 lubricant but the company also markets 3-IN-ONE OIL, Lava and Solvol hand cleaners, and several household cleaning products. Together, WD-40 and 3-IN-ONE OIL constitute about 80% of company sales so the focus is on lubricants which are tied closely to oil prices. The company has pricing power to pass on oil cost increases to customers because the WD-40 brand essentially created the lubricant spray market and dominates with about 80% share. WD-40 has grown revenue by 3.2% compounded annually since 2006 and has been able to translate gross margin expansion into earnings per share growth of 5.2% annually during that span. However, cash flow from operations has grown much slower at 1.4% compounded annually since 2006 due to growth in working capital.
Analysts consensus earnings estimates currently call for growth of 10.7% and 8.9% for 2012 and 2013, respectively, and are slightly increased from 90 days ago. The 2012 estimate has been increased by 3.0% over the past 90 days while the 2013 estimate has been raised by 1.2%. The forward P/E at the recent price of about $47 is 19.8x for 2012 and 18.2x for 2013 which indicates forward PEG multiples of 1.9x and 2.1x, at the extreme end of my preferred range of 1.0x-2.0x. These multiples are not appealing and may even be understated given the weakness in cash flow relative to earnings.
Clorox, Snap-On, and WD-40 are household names but are not compelling investment ideas at this time. Clorox and WD-40 both sport excessive PEG ratios and have only average growth potential. Snap-On has greater growth potential from evolving automobile designs but has had poor cash flow growth in the past 5 years which ultimately will restrain earnings growth. Snap-On and WD-40 have had decent share price appreciation over the past 6 years with both rising by about 6% annually, which is more than the S&P 500 which has been flat. They also offer dividend yields above 2%. Clorox’s share price has essentially matched the S&P 500 performance but the current 3.72% dividend yield makes Clorox a potential investment for income seekers.
56Steve has no positions in the stocks mentioned above. The Motley Fool owns shares of The Clorox Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.