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Stock Analyst Update

Clean Up with This 5-Star Stock

Plus two other stocks that recently hit 5 stars.

Mentioned: , ,

Following is a roundup of stocks that recently jumped to 5 stars. By way of background, we award a stock 5 stars when it trades at a suitably large discount--i.e., a margin of safety--to our fair value estimate. Thus, when a stock hits 5-star territory, we consider it an especially compelling value.

Clorox Company
Moat: Narrow | Risk: Below Average | Price/Fair Value Ratio*: 0.79 | Three-Year Expected Annual Return*: 17.8%

What It Does: Clorox (CLX) mainly produces chlorine and nonchlorine bleaches, food products, and cleansers. The company also makes other well-known consumer products under a variety of brands, including Pine-Sol, Formula 409, Glad, Armor All, Liquid-Plumr, Brita, and Kingsford and Match Light charcoal products. With its Burt's Bees acquisition, it is expanding into the natural and organics personal-care category.

What Gives It an Edge: Morningstar analyst Lauren DeSanto credits Clorox with a narrow economic moat owing to its lineup of leading household cleaning brands, Hidden Valley Ranch salad dressings, Fresh Step Cat Litter, and its namesake bleach brand. Most of the firm's brands hold the number-one or number-two market share position in their categories, conferring significant economies of scale. In addition, DeSanto thinks Clorox's recent acquisition of the Burt's Bees brand allows the firm to expand into the natural and organics personal-care category with strong brand equity.

What the Risks Are: Clorox's strong brands face a consolidating retail environment in which pricing power isn't guaranteed. During fiscal 2007, the firm's five largest customers accounted for 42% of revenue. Manufacturing improvements that have boosted gross margins during the last few years might be harder to come by, and Clorox will likely continue to be pressured by rising costs for resin and agricultural commodities.

What the Market Is Missing: As with many companies in the household products sector, Clorox has been hit with significant raw material cost increases, which are hammering the company's gross margins. While the market is understandably concerned about this, DeSanto argues that Clorox has historically absorbed these increases through a combination of price increases and manufacturing efficiencies, which the firm still has at its disposal. Also, DeSanto thinks the market was expecting higher recent growth rates from the firm's legacy brands. DeSanto remains focused on the long run, however, and believes the Burt's Bees acquisition and the company's new Green Works line of organic cleaners give Clorox new platforms for growth, allowing the firm to reinvest in its legacy brands to keep them healthy and generate strong cash flows into the future.

Other New 5-Star Stocks
Allstate Corporation (ALL)
Microsoft Corporation (MSFT)

* Price/fair value ratios and expected returns calculated using fair value estimates, closing prices, and cost of equity estimates as of Friday, Feb. 8, 2008.

Jeff Viksjo does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.