The Clorox Company (CLX) Earnings Call Transcript & Summary

Good morning, everyone. My name is Nik Modi, RBC's senior HBC beverage packaged food and tobacco analyst. Welcome to the RBC Global Consumer Conference. I'm pleased to welcome Clorox Company to the conference this year once again. I'm joined by Clorox's CFO, Kevin Jacobsen. Over the last 12 months, Clorox has navigated through an unprecedented level of cost inflation and is focused on pricing and productivity initiatives to offset some of these impacts. While the level of demand for many of Clorox' products is normalizing from peak during the pandemic, several categories remain above pre-pandemic levels. So clearly a very topical time to discuss all of these topics. So Kevin, thank you again for being at the conference.

Thanks, Nik. Thanks, everyone, for coming today. .

Absolutely. So look, let's start with portfolio demand, right? It's been quite a ride in the last 2 years with the peaks and troughs. So based on some of the numerator data, we looked at some of the categories, household penetration has increased others have come down a little bit. So maybe just give us kind of a state of the union on demand dynamics for the portfolio.

Sure. If you think about The Clorox Company, where we were before the pandemic. If I look at our last strategy period, we averaged about 2% growth across our portfolio. We've seen a significant increase in demand broadly across our portfolio. I think the cleaning and disinfecting portion is fairly straightforward. But I would tell you the change in consumer behavior is really benefiting the entire portfolio. If you look at our results over the last 3 years, we've averaged about 5% growth per year. Now what's very different is that demand is much more variable. In the past, before the dynamic, is a fairly consistent demand signal. What we're finding now is while we're seeing elevated demand, it is much more volatile in terms of how that's playing out. I would say there's really 2 drivers I see that's driving this increased demand for products. The first is, if you think about the IGNITE strategy we launched about 3 years ago, our focus was on increasing the value of innovation that we drove in the marketplace. And we're having very good success increasing sales driven by a more robust innovation program. The other big change, though, that you folks are all familiar with is the change in consumer behaviors. It is very clear to us what we're seeing with consumers is a long-lasting change in how they react, both to the cleanliness of their environments, which is a global transformation we're seeing with consumers. But also if you think about consumers spending more time at home, we're seeing the benefit to our categories, broadly, what we call our household essentials portfolio. People are creating more trash in their homes, they're eating more salads, drinking more filtered water barbecuing more on the weekdays. And so our belief is, I don't know how frequently people are going to return to the office, but I don't suspect it's going to be 5 days a week. We think that's a lasting trend that benefits our business, plus the ongoing dynamic we're seeing that increased demand for cleaning and disinfecting products. And so we think that's a long-term tailwind for us. Having said that, what I tell folks is, I think it's going to continue to be very bumpy for the next several quarters as we work through this transition from a pandemic to an endemic state. Retailers figure out the inventory levels they need to carry to manage an endemic environment. Consumers can figure out how they want to operate in this environment. I think it's going to create bumpiness, but I feel very confident in that long-term tailwinds we're seeing.

And just piggybacking off of that, I mean, when you think about there's all these theories running around during the pandemic on what consumer behaviors would last, right? Now you talked about a few in terms of cleanliness, but what about self care, right? When you think about your vitamins and supplements business. What about at-home pet in terms of more pets being in the household? Just throw some thoughts out there in terms of some of the durable themes and trends that you think will last well into the future.

Yes. And those are certainly 2. What I would say is, if you folks may recall of you followed the company a little over a year ago, 1.5 years ago, we raised our sales expectation going forward from 2% to 4% to 3% to 5%. That increase was driven by all these changes we're seeing in consumer behavior. We talked about the one that I think is probably the most obvious, which is consumers are much more aware of the health and hygiene in the spaces they go into. And we think that's a lasting trend. I've talked about consumers spending more time at home, that's a benefit. If you look at pet adoption rates, if you look at our litter business has grown significantly. It's one of our faster-growing businesses as more consumers have brought pets into their homes, If you look at grill ownership and grilling on weekdays, that's a trend we're seeing. And then to your point, Nik, we're certainly seeing more focus on self-care. So our Brita business is people drink more filtered water as they take more vitamins. These are all tailwinds we're seeing that we think are long term in nature. That is one of the reasons why we raised our sales expectations going forward because we think they're lasting.

Yes. And switching from top line to gross margin. I mean, obviously, a big area of focus for investors right now. Maybe just talk about some of the incremental pressures here. What are you really thinking about and really think about from a commodity labor and logistics standpoint to kind of catch all in terms of gross margin?

Yes. And maybe if you'll allow me, I'll build on that a little bit. I'll talk a little bit about what we're seeing from a cost perspective. But I think it was probably, hopefully, more interesting to you folks are what are we doing about it? I would say from a cost perspective, the 2 biggest issues we're dealing with is commodities and logistics. And we've announced about $530 million worth of cost inflation this year in those 2 buckets. To dimensionalize that in a normal year, if I look back before the dynamic, we would average maybe $50 million to $60 million worth of inflation on any given year in those 2 areas. This year, we're dealing with $530 million. So it's a significant ramp-up. Now I talked about commodities and logistics. The truth is we are seeing inflation across every aspect of our P&L. Commodities and logistics tends to be the biggest. It's probably 75% of the inflation we're dealing with. But inflation is broad-based that we're managing through. I would say through the pandemic for the most part, we came through it with our gross margins generally intact. We entered the pandemic with gross margin slightly below 44%. Last year, we ended up at 43.6% or 43.7%. So pretty much intact. This year, though, we're going to see our margins contract about 800 basis points is our expectation. And that's really driven by this extreme cost environment that's come on over the last 18 months. We're taking actions in really 3 big areas. And our commitment is to rebuild margins. Now we think that's going to take a little bit of time to be able to do that. But the 3 areas we're focused on is number one, pricing. That's probably going to be the biggest lever we pull to address cost inflation. We are taking 3 rounds of pricing this year. We've announced and implemented 2 already. We had 1 in the fall. We took one into effect in April, and we're in the process of announcing another one right now that will take effect in July. So pricing will be certainly a big component of recovering margin. We're also going to continue to drive our cost savings program. For any of you folks who follow us, we target 175 basis points of EBIT margin expansion each year through cost savings. We've been able to do that through the pandemic. We're on track to do it again this year. And you should expect we'll continue to do that going forward. And then the other opportunity for us is within our supply chain as a result of the disruptions in the broader supply chain, we have built up tens of millions of dollars of cost trying to manage the disruptions we're dealing with. And that's anywhere from increasing our supplier base, increasing our use of contract manufacturers. We have to hold more inventory now to be prepared for the disruptions we're seeing in the supply chain. All that's added a tremendous amount of cost to our supply chain, and we're going to be able to take that out over time. Those are really the 3 big drivers that we think will put us on a path to rebuild margin. Nik, what I'd tell you is a lot of times you talk about margin isolation and that is not how we talk about it at Clorox. For us, the real goal here is to rebuild margin while maintaining top line momentum. As I just said, before the pandemic, this company is growing about 2% a year. We're now averaging 5% growth per year. We want to continue to invest in our brands, continue that momentum while we rebuild margins, and we'll have to do that at the appropriate pace, which means is going to take us a little while to get there. But we think that's how we maximize the value of the company over time.

And I guess this is the million dollar question, right, in terms of the time it will take to get kind of rebuild those margins. How should investors think about that time frame, what are the big drivers, right? Is it just receiving of cost? Or is there something else that you're thinking about?

Yes. So for us, as it relates to the cost environment, maybe that's a good place to start. We're in the process of developing our plans right now for our next fiscal year, which starts in July. We're assuming it's going to be an ongoing inflationary environment. So we are not assuming over the next 12 months, cost deflation is a source of margin recovery. Now we don't think the inflationary environment is going to be as difficult as what we're dealing with this year. We think it's going to moderate, but we still think we're going to see general inflation in the marketplace. And so the areas we're going after are the 3 I just spoke about. It's pricing. It's our cost savings program. And it's taking out supply chain costs that we've built up. We think that's a primary path of rebuilding margin. And then we're going to see how it plays out. I feel good about the things that we directly control. But I have to acknowledge in this macro environment, we're going to have to continue to react to how the market changes. And that's, I think, important for any company right now is your agility to address a changing marketplace.

Yes. And I think that's kind of a good segue into the next question, which is obviously the topic of pricing is an evolving discussion. Recent commentary coming out of the retailers has not been constructive in terms of their own margin pressures, right? And so as a key supplier to many of these retailers as foot traffic drivers to some degree. How do you think about some of the pressure that retailers are under and the potential implications to overall CPG pricing and the pricing landscape?

Yes, certainly a very dynamic environment, and it's hard to know exactly how this is going to play out. I don't think anyone -- Nik and I were talking earlier. I don't think anyone has been in this environment before when you're talking pricing that's 15% to 25% in the course of 12 months. How retailers react? How consumers react? What I can tell you to date is we've executed 2 rounds of very broad-based pricing, that's gone very well. We've had good constructive conversations with retailers. And I think, Nik, what's -- I've been in this industry for 25-plus years, and I've taken lots of price increases in my career. What's different in this environment is there's a much greater understanding of the environment we're operating in. In the old days, you may have spent some time trying to educate the retailer on the cost environment you're facing, why you need to take a price increase? You don't really have to have those discussions anymore. Everyone understands what's going on in the marketplace, and they understand the pressure we're under to recover the cost inflation we're dealing with. So it certainly made these conversations, what I would describe as more constructive. And as I said, the last 2 rounds we've taken have gone very well. The retailers have accepted it. I would say it's early to assess the second price increase we've taken. The first one we've taken went well. What we're seeing is the elasticity is slightly lower than what we've seen historically. So the consumers reacted fairly well as well. But I think, Nik, to your point, like where does this go from here? I think the conversation we have retailers right now, clearly, there's a conversation about the need to take pricing. They understand that. What helps us, and I can't speak for other manufacturers don't speak for Clorox. But what helps us is, our focus on innovation, retailers are very much still focused on they want to drive growth in their categories. And so if you can bring innovation into those categories and you can help them grow, particularly in a time when they see consumers coming under more financial pressure, that is a source of value that they want to have a constructive conversation about how we partner and innovation. And then the other area we've been very focused on is value superiority. How do we make sure that we offer products to consumers that give them superior value to the competition, that also matters to retailers that we're giving the best value we can, particularly at a time when consumers get even more focused on value when they're under financial constraints. If you look at our portfolio, we've been focused on value superior for years. We've tested the highest level we've ever had. About 75% of our portfolio, consumers tell us they see us offering consumer value to competition. And so that's a very good place to be when you think the consumers coming under even more pressure because while they're always focused on value, I can tell you, in my experience, during times of recession, they get even more focused on making sure their dollar goes as far as it can. And so nobody ever hopes for a recession, but I'd say I feel pretty good about the strength of our portfolio and our ability to weather this. And then maybe the last perspective I give folks is, if you think broadly about the economy and the consumer under pressure, then you have to think about how does that impact every category and every category is a little different. If you think about consumer goods, our categories have been fairly recession-proof. If I go back to 2008, 2009, collectively, our categories declined by less than 0.5%. Consumers every day still have to buy trash bags. They have still to buy litter for their litter box. And so we don't see significant declines in our categories. In the best of time to grow 1% to 2% during the worst recession we've had historically, they declined less than 0.5%. And then it's similar for our brands, they've been very recession proof as we focus on value and we focus on connecting with the consumers to make sure they understand that value proposition. In the last recession, we grew sales in 8 of our 10 business units, and we grew sales overall as a company if you look at 2008, 2009. So fairly recession-proof categories, and our portfolio has been shown to be fairly recession proof as well. So I don't look forward to it, but I would say, I don't think our categories -- our brands have ever been in better shape heading into a potential recession in the U.S.

And just on the pricing commentary, right? So Clorox has always been pretty good with revenue management and pricing and promotions. And you guys have had very good analytics behind that. But I would say the industry, generally speaking, has not been as good, but those capabilities have been evolving. As you look at kind of the industry landscape across your categories, do you believe what you see in the marketplace that the rest of the competitors have kind of caught up in those capabilities? So if we do get a promotional environment, it won't be this kind of helter skelter kind of overshoot type scenario that one would worry about, but it's going to be much more measured, much more analytic, much more logic and rational.

Yes. I'll give you my perspective. And again, you're talking to other companies, I don't say whatever they'll say, I think there's going to be a greater level of rational behavior because we're all facing the same cost environment. I don't think anyone is immune to this environment. You can see it in our financial performance. I think that will keep some natural lid on the level of promotional activity. Well, we all want to drive top line. At the same time, we have to manage an extremely difficult cost environment. I think that will maintain a level of rational behavior that may not have been existence in previous rounds.

Yes. And then from a price gap standpoint, how do you feel about where you are, especially in bags and rafts because I know that's been a pretty kind of give and take back and forth type of dynamics. So maybe just give us a state inning there.

Yes. On total price gaps, let me tell you what we're trying to accomplish and then I'll tell you where we're at now, but I think what's helpful is where we trying to get to. Our intent is to be competitive in every category in which we compete. To do that, our goal is to get back to similar price gaps we had before this round of pricing began. We think we compete with our innovation, we compete with our brand-building capabilities, and we have price gaps that make sense for our consumers. So we want to get back there, and we think that allows us to be very competitive. I would say it's going to be very noisy. It's been noisy. I think if you look at scanner data, that will continue to be true for the next couple of quarters because pricing continues to unfold. We are taking pricing, competition taking pricing, it's coming at different times at different amounts. It seems to be fairly rational as we look at the behaviors. I don't know what my peers will do nor should I. But what I'm seeing in the marketplace is it's fairly rational. I expect over time, we'll get to a place where our price gaps are about where they were before all this began. But I think in the near term, there's just going to be a lot of noise as the cycles are different. The amounts are different. As it relates specifically, Nik, to your question on Glad, I would expect by the round of pricing we're announcing right now that go into effect in July. Price gaps will be generally in line to what they were before this round of pricing began is our expectation. We'll have to see how that plays out, but that's what we expect to occur in the next couple of months.

Yes. And I'm just curious from your standpoint, as the CFO of a company, a large company, the environment feels like it's a lot more volatile than it's ever been and it doesn't feel like that's really going to change in the future, right? .

It's your observation.

So I'm just curious from just philosophically from your standpoint, when you think about processes at the company and capabilities like, what do you think you need to do differently to make sure you can navigate this kind of new normal relative to history?

Yes. it really plays out in every aspect of our business. You have to become a much more agile company, and you have to be prepared to pivot more quickly because the old days of, you would have a sole-source supplier and you had a consistent demand signal, I don't think those days are coming back. Now the extreme volatility we're dealing with through the pandemic, I think you're going to see that moderate a bit as we get into an endemic environment. . But I don't think you're ever going to get back to the stability we had before. And so that changes almost every aspect of your business, how you plan your business, how you produce products. And I'll just give you a couple of examples of that brings it to life. And if you think about our environment before the pandemic, we might have one supplier in the U.S. who supplied one of our raw materials, and you could count on that supplier. They never missed their shipment to our plants. And they're very reliable. There is this -- I think this phrase in the industry, you had a just-in-time supply chain, and all you try to do is lower the cost to make it more and more efficient, less and less costly. You now move to this environment of more just in case. I can't rely on just one supplier. I have to be prepared that supplier goes down because they have an issue with COVID and they can't staff their facility. I have to have a redundancy in place. And so I think going forward, you'll see more resilient supply chain that require more backup capabilities than we've had, more qualified suppliers. You'll see forecasting cycles that are very different in terms of how you forecast demand with more scenario planning. We do a lot more scenario planning now than we've ever done before. And I think that's a permanent condition of this environment. I don't think we're going to go back to the environment we had before the pandemic.

Yes, I agree. And let me just repeat the question just so for the webcast. The question was around inventory levels at -- within the supply chain and within the customer, within the retailer universe.

Yes, it's a great question. Let me start with retailers. I think the retailers right now are trying to figure out what is the right inventory level to hold in an endemic environment. I think during the pandemic, particularly including disinfecting as whole as much as possible. Every surgeon came along. They did not want to be the retailer did not have product on shelf. I think as we move into an endemic, they're trying to figure out consumer shopping behavior and what's the right level of inventory to hold. And so I think that's an evolving area of activity that we're all going to learn through, I think, over the next 6 months. You've sort of seen announcements from the Walmarts and the Targets and others. They're clearly trying to figure out what the right inventory levels are. I think for us, we're going to be able to reduce inventory levels over time as the supply chain disruptions moderate. If I just talk about Clorox, we typically held 50 to 55 days of inventory on average across our portfolio. I'm now in the low 60s. I need to be in the low 60s because I have more disruptions. I was talking to someone today. During the pandemic, we had over 200 force majeure declared on us by our suppliers. And so we've had to build excess inventory in the system. So when a supplier goes down for a week or 2, I don't stop my ability to ship to my retailers. We've had co-packers who can't produce for us or they can't get supply because it's tied up in a port. All those activities have played out that have required us to hold excess inventory, safety stock, as we call it. I think over time, if you assume that supply chain disruption is going to come down, we're going to be able to reduce that safety stock inventory. Right now, I don't think it goes down to the environment, as I said earlier, to where we were before the pandemic because I think there's going to be more volatility than we've had previously, but it will certainly come down from the environment we're dealing with right now. And I would say probably in the last quarter, you're starting to see some of that, like the COVID disruptions in manufacturing, it has been less frequent as we're getting more reliability of people coming into the plants and working. I can't count on that going forward, but at least over the last 90 days or so, we've seen some improvements. I've seen some improvements in transportation, which is certainly an encouraging sign. I'd like to believe that's going to continue. If that does continue, that's how we start taking cost out of the supply chain, and I think inventory is part of that.

Excellent. Private label has always been a concern within the investor community with Clorox, yet the company has shown very good resilience over time. So maybe just talk about the narrative around Clorox and private label, if we do get into tougher economic times, and especially as inflation continues to linger.

Yes, it's always a question on Clorox private label. I would say we have exposure really in 3 of our categories, our Bleach business, our Bags and [indiscernible] Business and our Kingsford grilling business are where our primary competitor is private label in many cases. . We've competed very effectively to your point, Nik, over a very long period of time against private label. Private label doesn't innovate. They don't build brands. And so that's not a bad dynamic to have private label and a branded player in a category and we've been able to build share in those environments over a long period of time. Now as you go into our potential recession are certainly in an environment where consumers are under more pressure, there's always this general belief that that's going to be a benefit to private label. What I've always found in my career is what consumers focus on is value and don't misunderstand price points with value. Consumers understand value propositions. It's the product performance, it's the price you charge is the strength of your equity. Consumers get hyper focused on superior value and which brand provides that to them. And so as we talked earlier, we've historically done fairly well through recessions. As I said, the last major recession we had in the U.S., we grew 8 of our 10 businesses, and we grew overall if I recall right, and if I pull out an acquisition, we grew 4% during that recessionary period. And so our business has performed quite well in spite of a major U.S. recession because consumers want value, and that's something we're able to deliver to them. Having said that, I don't think any competitor lightly, I don't take private label lightly. You have to work very hard every day to make sure you provide superior value. But historically, we've been able to do that, and I feel confident we can do that going forward.

And just to be clear, these blind wins or the product superiority, the benchmark, I recall for many years ago was 60%, and you right now just declared at 75%.

Yes. So 75% of our portfolio. So of all our sales, 75% of the sales are from brands that consumers tell us they see as providing superior value to the next best competitor in the marketplace. And in the case where we could be against private label, that's private label, we're testing again.

Right. Got it. market shares have certainly improved. So maybe you could just give us a little update on how you're progressing there. And some of the work I've done with retailers, I mean, some of your new products have really done well, especially this Clorox [ wipes ]. So maybe you could talk about that a little bit. .

Thanks for that one. Good knot. We're really super excited about that one. So maybe I'll just I'll talk shares in general. What we said a year or so ago was we were losing share broadly across our portfolio, and a lot of that was driven by our lack of ability to supply product. We just could not keep up with demand. And it's -- you folks probably don't remember this, but it's burn edged into my mind. Just a year ago, more than 50% of our portfolio was on allocation, meaning we could not supply the demand signal we're receiving from retailers. And what that means is it gave opportunities for competition to get on shelf and for competitors to build share. If you looked at the wipes category probably a year ago when we could not fully supply product, there's probably 60 manufacturers that showed up creating a wipes product that was on shelf, and we were losing share. We knew when we could get our production capacity up and we knew demand would also moderate. And when that occurred, and we got back to a more fully supplying demand, we would start growing shares again. That's exactly what we're seeing. So one example we're quite proud of is if you look at our wipes business, we've grown share double digits for the last 3 quarters and in fact, I was just looking at scanner data yesterday for the last 13 weeks through the third week of May and were up 10% again. So we've taken pricing, but because we've gotten back on shelf because we offer superior value to consumers, they understand that. They are quickly moving away from all these tertiary brands and they're buying Clorox again. And we're seeing that fairly broadly across our portfolio. We grew share overall as a company through our third quarter. And again, we continue to grow share as I look at the more recent scanner data. Now what we have to see play out is there's quite a bit of pricing going. We're taking a lot, competition is taking a lot. So again, I think there's going to be some noise in share data for the next several quarters, so that sells out. But what I'd tell you, Nik, is our commitment is to win in the categories where we compete and that means helping to grow the categories through innovation and then growing share within those categories. That's what we're working to do. I think it will be bumpy and noisy for several quarters. But if I look out beyond the noise, I feel very good about the work we're doing to do that.

And on the innovation?

Innovation has been great. As I said, when we launched our IGNITE Strategy about 3 years ago, one of the ways we intend to accelerate the sales of the company was by creating bigger, more scalable innovation platforms, and that's what we've been focused on. We have significantly increased the sales we're getting from innovation over the last couple of years. . You've highlighted one product, but we've got a number of really significant new products we've launched. We're really excited about misters. This is a disinfecting misting spread if any of you folks hopefully have used it. We just launched it about 3 months ago. We think, to a certain extent, it disrupts this category. It's a much more preferred package as a much more preferred usage occasion for the consumer. It's a scent based product. And so we've seen really nice share growth very early on. And it's a nice place to innovate because you have consumers much more interested in this category as a result of the pandemic. So innovation and cleaning and disinfecting, we're seeing really good consumer response to. And so usually expect to see us continue to innovate in the space.

And with market share trending in the right direction, if inflation or if costs continue to get worse, how do you think about A&P in that regard? I mean has this become a lever like sometimes in the past across EPG, hey, it's a big pool of spend. Let's preserve our margins, let's cut back a little bit. Like how do you philosophically think about that at Clorox?

Yes. Philosophically, we don't think about it that way. And I know you're not suggesting we do. But in fact, we did just the opposite. While I think many competitors were cutting advertising investments during the pandemic we lean in and we spent more. We typically spend about 10% of sales in advertising. During the pandemic, we increased that to 11% even at a time when we had a difficult time supplying product because here's what we knew. We were seeing significant increase in health and penetration. Millions of new consumers were coming into our franchise for the first time. We knew that was a unique opportunity to engage and build loyalty with new consumers and that generate very nice returns for us. And I think we're seeing that. Our household penetration generally is higher now than it was before the dynamic. Many of those consumers who came into our franchise have stayed. So we think that was a good investment. Advertising is a strategic investment in creating long-term value. You will not see us cutting that as a way to make quarters or our way to make years. We just think that's a wrong choice. You're right. I can deliver more earnings in any given year. I think anybody who's run a business knows that, that just starts the despair if I start under-investing in my brands. And so if we want to create long-term value, we're going to continue to invest in advertising.

Excellent. And as we wind down time here, Kevin, so for existing Clorox shareholders, potential new Clorox shareholders, what message would you give about the company and future prospects?

Yes. And the clock says, you have 30 seconds. So here's what I'd say. I feel very good through this pandemic about the things we directly control. If you think about our innovation program, our cost savings program, the work we're doing on pricing, it's all going very well. I recognize, though, we're operating in a macro environment that is incredibly challenging. Our commitment is to rebuild margins and do that at the appropriate pace it allows us to maintain top line momentum over time. . I think it's going to be bumpy for the next several quarters, but I feel very good about the long-term opportunities to accelerate the growth rate of this company and rebuild margins. And I think that's how we maximize value for investors over time.

Excellent. Well, Kevin, thank you again for being here at the conference.

Great. Thanks, everyone. Thank you for joining.