As the title suggests, there may be some crying in the coming years when it comes to the potential growth of Kimberly-Clark's (KMB) dividend. Yes, we're not kidding. And yes, we know Kimberly-Clark has raised its dividend in each of the past 40+ years. Simply put, the firm's dividend coverage when it comes to cash flow (adjusting for its capital structure) is borderline, spelling long-term uncertainty, in our view. Though we expect mid-single-digit growth in the dividend in the next few years, we think the pace will slow to the single digits in the out years. Let's take a look at how cash-flow based analysis informs this opinion.
Kimberly-Clark is best known for its personal care and consumer tissue brands, which include Huggies, Pull-Ups, Little Swimmers, Depend, Kleenex, Scott, and Cottonelle. Its portfolio remains strong.
Kimberly-Clark has a good combination of strong free cash flow generation and manageable financial leverage. We expect the firm's free cash flow margin to average about 10.8% in coming years. Total debt-to-
EBITDA was 1.8 last year, while debt-to-book capitalization stood at 51.4%. Yes, companies can have strong cash flow and still not be able to grow the dividend at a fast rate. Sometimes the dividend cash become too big -- that can happen after 40 consecutive years of increases!
Though Kimberly-Clark has raised its dividend in each of the past 40+ years, its Dividend Cushion score, while above 1, is not great. We don't expect much more than inflationary annual dividend expansion going forward.
Return on Invested Capital
Kimberly-Clark's dividend yield is above average, offering just over a 3% annual payout at recent price levels. We prefer yields above 3% and don't include firms with yields below 2% in our dividend growth portfolio. So Kimberly-Clark barely fits the bill thus far.
However, we think the safety of Kimberly-Clark's dividend is poor (please see our definitions at the bottom of this article). Yes, we said it. We think it's poor. We measure the safety of the dividend in a unique but very straightforward fashion. As many know, earnings can fluctuate in any given year, so using the payout ratio in any given year has some limitations. Plus, companies can often encounter unforeseen charges, which makes earnings an even less-than-predictable measure of the safety of the dividend in any given year. We know that companies won't cut the dividend just because earnings have declined or they had a restructuring charge that put them in the red for the quarter (year). As such, we think that assessing the cash flows of a business allows us to determine whether it has the capacity to continue paying these cash outlays well into the future.
That has led us to develop the forward-looking Valuentum Dividend Cushion™. The measure is a ratio that sums the existing cash a company has on hand plus its expected future free cash flows over the next five years and divides that sum by future expected dividends over the same time period. Basically, if the score is above 1, the company has the capacity to pay out its expected future dividends. As income investors, however, we'd like to see a score much larger than 1 for a couple of reasons: 1) the higher the ratio, the more "cushion" the company has against unexpected earnings shortfalls, and 2) the higher the ratio, the greater capacity a dividend-payer has in boosting the dividend in the future. For Kimberly-Clark, this score is 1.2, revealing that on its current path the firm may not be able to cover its future dividends with net cash on hand and future free cash flow.
Here's the guts of the calc (emphasis on order of operations):
(Next five years expected free cash flow + Current Net Cash)/(Next five years expected dividend payments) = 1.2
(11,963+764-5,426)/(6,205) = 1.2 -- these are our assumptions
Now on to the potential growth of Kimberly-Clark's dividend. As we mentioned above, we think the larger the "cushion" the larger capacity it has to raise the dividend. However, such dividend growth analysis is not complete until after considering management's willingness to increase the dividend. To do so, we evaluate the company's historical dividend track record. If there have been no dividend cuts in 10 years, the company has a nice growth rate, and a nice dividend cushion, its future potential dividend growth would be excellent, which is not the case for Kimberly-Clark. We have the firm rated as having very poor growth potential. The combination of the size of its future dividend payments coupled with the size of its debt load limit its ability to substantially raise the payout year after year in the future (out years).
And because capital preservation is also an important consideration, we assess the risk associated with the potential for capital loss (offering investors a complete picture). In Kimberly-Clark's case, we currently think the shares are fairly valued, so the risk of capital loss medium. If we thought the shares were undervalued, the risk of capital loss would be low. All things considered, we do not like the potential growth and safety of Kimberly-Clark's dividend. We think there are better places to look even after considering the firm's stellar track record of dividend increases. We care about the future.