- Ben Roberts
Is Kimberly-Clark Corporation anything more than an income stock?
- The company is relatively cheap compared to the Consumer Staples market.
- Low organic growth has posed problems for the company
- Dividend Yield has reached an attractive 3.41%.
- Here we discuss the growth outlook for Kimberly-Clark and the companies value proposition outside of its dividend.
- Our price target is $100.
Kimberly-Clark Corporation (NYSE: KMB) is a leading manufacturer of personal care and tissue products. Its brands include Huggies, Pull-ups, Kleenex, Cottenelle and many others. It also has a brand aimed at the commercial market, K-C Professional. North America currently generates over 50% of its revenue, 10% in Europe and the rest primarily in Asia and Latin America. The company is divided into three operating segments, Personal Care, Consumer Tissue and K-C Professional. KMB provides an interesting investment proposition given its strong dividend and stable EPS growth, however the stock price has suffered a decrease of 1.5% YTD which is far below the S&P 500 return of 17.16% YTD. In our view, continuing price decreases may create an opportunity for value investors to add KMB to their portfolios. The company is currently trading at $113 with a P/E (TTM) of 18.34x, which is a discount to the market. This is due to the fact the Consumer Staples Select Sect SPDR ETF (XLP) is currently trading at a PE multiple of 20.4x. Below, we will discuss KMB’s current growth prospects, a breakdown of segment performance and the company's current value proposition.
Is growth even possible?
Given that long term global macroeconomic trends point towards growth opportunities for the company, recent years have seen flat revenue growth as the company's growth prospects have come to a stand still. In theory, the market for basic consumers products should experience growth given population growth and middle class spending power growth in emerging markets. Even with relatively strong margins, the right brands and global positioning, KMB has not been able to benefit from these trends. Rather the company has focused more on reducing costs rather than enabling growth opportunities and thus we are sceptical of the recent performance of CEO Thomas Falk.
Low growth is expected in FY18 as the company continued its trend of missing the 3-5% organic growth target. However analysts argue that this low growth is already priced into the $113 price. The company’s past growth has been driven by the Personal Care segment. However, recently, the segment has come under pressure from falling birth rates in North America and increased competition from Procter & Gamble (NYSE: PG) and private label offerings. Basically, the company is expected to struggle which may lead to further slumps in stock price. J.P Morgan has set a price target of $100 which reflects our present sentiment. As flat growth is currently being priced in, any new initiatives such as inflation covered pricing or restructuring could provide some price upside.
Personal Care offers a wide range of products that allow consumers to take care of themselves and their families. Products that come under this segment include diapers, training pants, baby wipes and feminine products. These products are sold under brands such as Huggies, Pull-ups, GoodNites and Kotex. The segment comprises just under 50% of KMB’s total revenue and 56% of operating profit while holding a 14% share of the personal care / family care market. The strength of this division lies in their brand equity, the aforementioned brands are some of the most recognisable brands and are trusted by consumers worldwide.
A lot of K-C’s current strategy involves leveraging this brand equity in order to drive expansion into new markets however FY17 results have been varied with organic growth being flat or negative through Q3. Recent Q3 results showed organic growth to be -2%, with volume and net price being -1%. This is not a strong outlook for the segment that drives both revenue and profit for the company. As with the other segments of the company, currency fluctuations have a large role in determining growth. This suggests that even with the recent downturn in the USD, the segment still did not experience positive organic growth in the 1-3% range. However sales volume growth has been positive through FY17, suggesting that while population growth can drive volume growth other factors may be affecting growth opportunities for the segment.
The consumer tissue segment offers a product range that include facial and bathroom tissue, paper towels, napkins and related products. These products are sold under brands like Kleenex, Scott, Cottenelle and various other brands. Consumer Tissue makes up 33% of total revenue and contributes 34% of operating income. The segment has seen decreases in revenue since 2014, this is attributed to negative foreign currency fluctuations rather than decline in volumes. On the other hand, operating income has seen relatively strong 3-year growth of 5% given revenue decreases over the same time period.
The company continues to highlight the effect of foreign currency rates on revenue figures of developing and emerging markets, this suggests that short term profitability is being hindered by currency fluctuations especially in the consumer tissue segment. This is highlighted by unfavourable currency rates reducing net sales by 25% FY15 and by 7% FY16 in developing and emerging markets. In our view, the currency effects have flowed through to FY17 results as current positive currency fluctuations have not yet been fully realised with only +1% in Q3 revenue growth being attributable to fluctuations. In the long run, we expect the offsetting effect of unfavourable rates to decrease however bottom line pressure is increasing for KMB and we are worried about the effect that the FORCE cost savings program will have on future growth. Our question is how can a company grow that is consistently reducing research and marketing expenditure.
Kimberly-Clark’s commercial minded segment aims to create exceptional workplaces by offering a range of products including wipers, tissue, towels, apparel, among others. Revenue and operating income has been flat since 2013 which poses questions about the growth viability for the segment given that the various sectors that KC-Professional serve such as healthcare and Aviation have grown exponentially over the same period. Healthcare expenditure is expected to grow 4.3% Y/Y through 2020 in North America, thus it would be expected that C-Professional should capture at least a portion of this growth. However due to continually flat revenue growth, the segment may face significant future challenges.
The segment reported Q3 revenues of $0.8B, an increase of 3% and operating profit of $173 million, a 10% increase. The significant increase in operating profit was attributed to sales growth and continued cost savings while sales growth was attributed to positive growth across all geographical markets. Again, KMB’s focus on saving money is the offsetting factor for segment growth through FY17, while this effort has been ongoing for several years, stretching margins to artificially create growth can only last for so long. Obviously, KMB is valuable due to its dividend but the company may face problems when dividend growth is no longer possible with the current payout ratio standing at 63%.
KMB’s strong history as a dividend stock has always made it attractive to income investors, however questions must be asked around the sustainability of dividend growth in the long run. The company currently pays a dividend yield of 3.41% and has a 3-year dividend growth rate of 4.3%, this is very attractive compared with a comparable company average of 1.88%. The dividend payout has increased for the last 44 consecutive years and we believe increases even marginal ones are not going to change given the company continues to be profitable.
For an investor wanting a steady dividend, KMB is an attractive stock given its relatively cheap price. The yield of 3.41% is satisfactory for someone who is only looking for income and doesn't mind stock price fluctuations however the company's current performance does leave us wanting more. In our view, short term outlook is good for income investors as KMB has the FCF to cover payouts however long term outlook is bearish unless we see slowdown in dividend payout growth and share repurchase levels. KMB has a business model that will most likely last forever, however, without significant changes to operating structure, we may see stock price weakness over the next several years.
Recently, some analysts have been offering up the idea of KMB as an acquisition target for multinationals such as Kraft Heinz (NASDAQ: KHC) as they seek to diversify from traditional food processing. A Citi analyst sees a difficult road ahead for KMB describing their position as:
“It feels to us as if KMB is in a tough spot, [T]he competitive environment has intensified, category growth feels sluggish, reinvestment needs are likely going up, commodity pressures will likely increase over the next 12 months, and we expect the company to go thru a CEO transition in the not-too-distant future."
While KMB would be expected to remain an independent company, a takeover could take place given the company's current relative weakness. Given that Berkshire Hathaway's (NYSE: BKRB) proposed Kraft Heinz - Unilever (NYSE: UL) merger was turned down, the company may be looking to add personal care products to its portfolio. While an acquisition could provide upside for shareholders, we do not see high chances of an acquisition occurring in the short term. The current EV is $45B, hence an acquisition offer should come around $65/75B to be interesting, a price tag not for everyone.
KMB has an interesting ownership makeup given that all senior executives hold less than 0.1% of the shares outstanding. It also must be noted the large institutional ownership of KMB (71.8%) , the largest shareholders being:
Vanguard Group - 7%
BlackRock - 7%
State Street - 5%
Bank of America 3%
This level of ownership lines up with the view of KMB as as solid company with consistent cash flow generation. In our view, KMB may benefit from activist investor involvement as the company is in need of rejuvenation and growth generation initiatives. Given the company is trading at a relatively cheap price and constant flat or negative revenue growth since 2011, there may also be opportunities for activist investors.
We have constructed a DCF analysis, using a projected EPS growth rate based on estimates provided by Reuters.
Growth Rate (Growth Stage): 5.43%
Discount Rate: 6.24%
Terminal Growth Rate: 3.00%
EPS (Basic): 6.07
Growth Value: $58.21
Terminal Value: $47.61
Fair Value: $105.82
Margin of Safety: -7%
This analysis suggests that KMB is basically trading at fair value even with present levels of flat revenue growth. The inputted projected EPS growth rate of 5.43% and terminal growth rate 3% are both lower than previous years and reflect the company's current guidance. In our opinion, KMB provides safe incomes for dividend investors while operating in a relatively stable industry which is reflected in the valuation. The implied -5% margin of safety is in line with our expectations for the stock as we see decreasing margins put downward pressure on the stock price, while this is not a recommendation to sell, we would not look at buying KMB at this point in time. Further, the company has negative tangible book value of $3.76 that needs to be deducted from the valuation, implying overvaluation of 10%.
KMB is a solid company that has a number of well known brands and has relatively stable cash flows, albeit flat. The company continues to return value to its shareholders in the form of its well above average dividend yield of 3.41% and share buybacks ($5B over the last 4 years). However apart from the dividend the company has low growth prospects with revenue being flat since 2011 and earnings growth being stimulated through the FORCE cost savings program. I would expect leadership changes in the next few years. The company is in dire need of fresh ideas and should aim to provide shareholder value outside of its strong dividend. While the 3.41% dividend would be attractive to an income investor, we believe that organic revenue growth above 5% is not possible unless some macroeconomic trends improve or operating structure transformations. Hence, for the moment, we will stay on the sidelines.