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Why Clorox Isn't Really Shining

By Louise Lee In August, Clorox Co. (CLX) will begin shipping Glad Press 'n Seal, its new and improved plastic food wrap. What's so great about it? An adhesive on the wrap is designed to create a seal tight enough to prevent food, even liquids, from spilling out of containers. The newfangled wrap will sell for about $2.99 for a 75-foot roll at retailers.

The launch is expected to be one of the Oakland (Calif.) company's more high-profile product introductions this year, and Clorox anticipates a big hit with consumers eager for tidier food storage. Analysts are watching closely as well. Glad Press 'n Seal could add 2% to 3% to Clorox' annual sales of $4 billion, estimates Lehman Bros. analyst Ann Gillen Lefever.

But here's the rub: Clorox is also expected to spend a pretty penny on marketing and advertising for its new product, enough to preclude any increase in gross margins and earnings in the Glad business, at least initially, Lefever estimates.

"A BIT UNCOMFORTABLE." That's only one of the caveats that keeps analysts cautious about Clorox, maker of such ubiquitous household brands as Liquid-Plumr, Formula 409, and Hidden Valley salad dressings, as well as its eponymous laundry bleach. Many worry that increases in advertising and marketing budgets could produce inconsistent earnings growth into 2004.

Largely because of rising ad spending, Clorox is forecasting earnings of 57 cents to 62 cents a share for the fiscal first quarter ending in September, an estimate that's 11 cents to 16 cents lower than analysts' earlier projections. "We're a bit uncomfortable with the degree to which Clorox' results are impacted by new-product launches," says Merrill Lynch analyst Carol Warner Wilke, adding that those costs are "normal events" in the business that shouldn't affect earnings growth.

Equally troubling is that overall sales growth isn't rising along with ad spending. Competition in the home-products industry is fierce, and new products frequently just cannibalize sales of existing goods. Smith Barney analyst Wendy Nicholson notes that during each of the most recent three quarters, Clorox' advertising costs rose at a double-digit rate, while sales remained either flat or increased slightly. And in the current quarter, Nicholson expects a 29% jump in ad spending but only low single-digit sales growth.

STUCK IN NEUTRAL. On top of these issues, Clorox in coming quarters is likely to face higher prices for essential raw materials, in particular resin, which accounts for about 6% of its cost of goods. And Clorox' overseas business, mostly in Latin America, is expected to continue to struggle amid that region's weak economic environment.

Add it all up, and it's no surprise that Clorox stock has bounced between $31.92 and $48.37 during the last 12 months. These days it's trading around $44 -- exactly where it was a year ago.

Analysts applaud Clorox for its aggressive cost-cutting efforts, expected to save about $250 million this year, or about 6% of its total revenues. Those savings have helped boost margins and produced a 139% jump in net earnings during the quarter ended Mar. 31 from the comparable quarter a year ago. But "at some point, earnings growth has to come from sales growth," says Patrick Schumann, analyst at Edward Jones.

FULLY VALUED? Not to worry, says Clorox CEO Craig Sullivan. "As we look ahead to 2004, we expect to achieve our top-line and earnings targets for the year," he said in a statement in early May. "Top-line growth is projected to accelerate through the year behind significant new-product activity.... Our strategy to cut costs everywhere is expected to again deliver a high level of cost savings in fiscal 2004."

Schumann agrees that Clorox is well positioned for growth -- long term. It's selling off peripheral brands such as SPB insecticides, focusing on core products, and creating product extensions, such as its April launch of Formula 409 Wipes. That's why Schumann, for one, rates Clorox shares a buy. He's expecting 11% to 12% annual earnings growth in coming years on annual sales gains of 3% to 5%.

Most analysts, however, think the stock is fully valued for now. While Clorox may be cleaning house when it comes to cost-cutting, they wonder about its struggle to keep sales increasing. That's something investors may not take a shine to. Lee is a correspondent in BusinessWeek's Silicon Valley bureau

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