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Kimberly-Clark Corporation (NYSE:KMB)

Sanford C. Bernstein's 29th Annual Strategic Decisions Conference (Transcript)

May 30, 2013 10:00 AM ET

Executives

Tom Falk - Chairman and Chief Executive Officer

Analyst

Ali Dibadj - Sanford Bernstein

Ali Dibadj - Sanford Bernstein

All right, so let’s get going. Good morning, I am Ali Dibadj, Bernstein's U.S. household and personal products, and U.S. beverages analyst. Thank you all for joining us for the Kimberly-Clark presentation and we are very pleased to have Tom Falk, the Chairman and CEO of Kimberly-Clark with us and Kimberly has had a fantastic...

Tom Falk

Good morning, everyone.

Ali Dibadj - Sanford Bernstein

Kimberly has had a fantastic run over the past little while. It's done a great job getting through the emerging markets recently. Done a great job fighting competitors, coming up with innovation, dealing with the top consumer, dealing with top competitors and being steadfastly focused on giving money back to shareholders and there also has been a really fantastic stock run and what we want to get through today a little bit more in this fireside chat format, no deck please, let your questions on the cards passing through the isles...

Tom Falk

No flair either Ali apparently but...

Ali Dibadj - Sanford Bernstein

Well, I think we should have a fake fire at some point here, at some point, but to look at the types of questions you want to get at a little bit is what else can we expect from Kimberly-Clark going forward in the context of still the consumer being a little bit weak, competition changing a little bit, we will get to that, commodities being volatile etcetera and to start off a little bit, may be to get some background about the company to start, which is up to you broad question, why don’t just you know give us a sense of your product line-up, give us a sense of how you compete with the top competition that's out there as a company broadly.

Tom Falk

Yes, sure Ali. We are a 140-year old company. Celebrated our 140th birthday last year and we are about 21 billion in sales. We sell in about 175 countries. If you look in 2003 about 22% of our sales were in what we would call emerging markets, so everything except Europe and North America. Last year 37% of our sales were in emerging markets, so seen a big shift in our portfolio in that direction.

About three quarters of our portfolio are in consumer products, a little over half of that they are in personal care products and the balance are in B2B or healthcare, in our K-C professional portfolio.

Ali Dibadj - Sanford Bernstein

When you mentioned emerging markets, can you talk a little bit more about that? Last year you got into 80 new cities into China, you were pushing there eCommerce in emerging Asia, broadly in Asia broadly -- talk a little bit about your scale in emerging markets at this point, how much more runway you think you have and if you can touch on the competitive environment as well there.

Tom Falk

Yes, surely and emerging markets is a exciting place, so we look at Latin America broadly where we have the most scale and we don’t talk a lot about K-C in Mexico, but we -- starting with Mexico and moving South, we've got really strong market shares and are probably the most developed portfolio in that market. Even in that market where you know and Latin America we are seeing the highest single digit growth yet, so good consumer penetration particularly in personal care.

In Asia, we've got -- it's a pretty diverse market. So we've got very well developed businesses in Korea and Australia and you couldn’t debate whether those are really emerging markets or whether they've emerged, but they are in our definition at least but still seeing, you know, over the last couple of years in Korea, seeing high single digit topline growth and in strong innovation there. They are expanding into more categories and driving innovation.

China has been an explosive growth market for us. You know, our diaper business in China last year was up 45% something like that, similar kind of growth in the first quarter. So there are -- it's a combination of expanding into more cities, it's expanding our product range so that we are covering more of the category and you are seeing still consumption growing in those markets are their GDP per capital improves, mom is able to be in the category more often and more frequently.

Ali Dibadj - Sanford Bernstein

So as you think about Kimberly-Clark, we obviously think about the categories and product that you operate in emerging markets certainly the trend, the third big thing that we often hear about is how shareholder friendly you are, can you talk a little bit about how you view uses of cash, return it to shareholders and if you can -- little bit about what's going on in the marketplace for the past couple days arguably a little bit long in that few weeks from a shareholder perspective you know, either they are going to be as committed to be paying a high dividend or have high payout ratio as they've had recently?

Tom Falk

Yes, I mean Ali it's an important point. We never try to forget that the shareholders own the company and so it's their cash and we believe that shareholders should have first call on the cash that we generate in excess of what we need to run the business, so we generate about $3 billion a year in operating cash flow. We spend about $1 billion on capital spending give or take and so that leaves you know, about $2 billion left, dividend is about $1 billion.

We've paid dividends for almost 80 consecutive years. We've increased the dividend now 40 years in a row and that we think has real value creation for shareholders and then the additional cash that we generate, goes into the stock buybacks and so it really is a fundamental philosophy and we are running the company for the benefit of our shareholders and as we generate cash in the business beyond what we need to run it, we will make sure, shareholders benefit from that.

From a yield standpoint, there is no question that we've -- as rates have been down and as those investors for a period of time they expected the duration of low rates lengthening that you saw high yield stocks perform well and as investors are starting to wonder is that duration shortening and our rates going up, you know, you are starting to see a bit of a correction that certainly happened in our space yesterday. Most of the consumer stable stocks will have a high yield, got hit pretty hard yesterday and so you know, again we will see how that transpires over time and in the meantime we are going to keep doing generating cash and putting that cash to work for the benefit of the shareholders every day.

Ali Dibadj - Sanford Bernstein

Does -- you know, we had talked about it from a day or two right, does this mindset of the yield being so important and perhaps and perhaps now getting a little bit more stressed on a relative basis the treasury etcetera. Does that change at all your philosophy in terms of share buybacks versus dividends as you go forward and anticipating that?

Tom Falk

Well we've seen -- you know, even historically and certainly recently when you look at our average borrowing cost, it's still on an after tax basis substantially below our dividend yield. So you can buy back shares even when the stock is at $105 and still be cash positive day one from a -- versus the yield on the dividend. So...

Ali Dibadj - Sanford Bernstein

Okay. So getting -- we may come back to this topic, but getting to the a little bit to the gust of the business if you think about different parts of the world, you have contact in and almost any -- all of them, talk a little bit about the consumer. So the U.S. consumer, European, emerging Asia, Latin America and perhaps Southeast Asia would be helpful.

Tom Falk

Okay. Let me -- well I will take a couple of universal troops is that moms all over the world want their very best products for their babies and so -- and that's true in China or as it is North America and so the challenge is understanding what do they need, how much money can they spend if it's a very low income mom in a market like Vietnam may be the most important need is that everybody in the house gets a good night sleep. So having a diaper that really works well for 12 hours overnight is all she can afford with her income level.

As you get into more advanced economies things like skin health and other things become more important benefits. So just understanding what that mom needs, what problem she is trying to solve and making sure you are there with a relevant product.

I would say broadly around the world we are seeing you know, that trend isn’t changing and you are starting to see moms even wanting to trade up in many areas to get a better quality product. So we are seeing you know in China as the consumer incomes improve, the trend toward a premium product as we launch new products like diaper pants you are seeing that.

Even in kind of shifting to another category in the U.S. in the adult care segment, which you could argue is our most income challenged consumer, your senior is often on a fixed income. We launched Depend real fit for men and Silhouette for Women and that's picked up 10 share points in the category in about a year since launch about four of it incremental and so that's a more expensive product, it's a much better performing product and so you are seeing even a senior on a fixed income is willing to spend more for something that really works better and delivers better protection, better comfort and so particularly in many of the personal care areas, the cost of failure is pretty high.

So if you buy a diaper in a [league] that's -- it doesn’t matter how much the diaper costs, it's a bad day for everybody and so really making sure you deliver a quality product that performs and delivers value is a critical aspect of it.

Ali Dibadj - Sanford Bernstein

If you take it step higher from a macro perspective, when you think of a consumer, what are you seeing about the U.S. consumer, Europe in particular kind of few questions on that, emerging Asia and Latin America kind of regionally.

Tom Falk

Yes, in the U.S. consumer you know, we would say as you talked to retailers about it, it's she is still cautious that it felt the impact of the social security change. It didn’t seem like it affected our categories as much and we make essentials that people need every day for a better life and even in categories like bath tissue and paper towels if you might argue would be areas where you could see some downshifting. You know, you actually saw a pretty solid share performance and you didn’t see private label inroads really in any great extent in a lot of those categories.

So a little bit in bath tissue, but not as much in towels and so we would say broadly if you look in the first quarter, I think in eight of the nine categories we track in North America private label shares were flat or down. We should say okay, broadly either consumer is gravitating toward a better quality product.

Ali Dibadj - Sanford Bernstein

What about Western Europe?

Tom Falk

Western Europe...

Ali Dibadj - Sanford Bernstein

I was just going to contact...

Tom Falk

Actually Western Europe is not as bad as everybody things. Now part of it is our business probably indexes more to the U.K. which has probably faired a little better. I think if you are in Spain and Italy, it's a little bit different story. So Southern Europe is a tougher place, certainly a tougher consumer environment with a higher employment levels, but U.K. our KCP business in Germany is doing very well and so we would say in parts of Europe, things are going reasonably well, particularly the U.K. and Germany.

Ali Dibadj - Sanford Bernstein

We are hearing some worrying-some signs around Brazil in particular just from a consumer perspective. Do you have any perspective on that?

Tom Falk

Yes, our business in Brazil has done really well and you know, there is a lot of activity going on there. We are in fact -- we will be taking our Board to Brazil in a couple of weeks and we will be opening a new diaper plant in North Eastern part of Brazil and you know that we've done well in the São Paulo Rio region, the more developed parts of Brazil.

We've had a presence in other parts of Brazil, but we are expanding ourselves presence putting more of a manufacturing infrastructure in place and we are still getting solid growth rates out of Brazil.

Ali Dibadj - Sanford Bernstein

What about category wise, are you seeing the categories slid there?

Tom Falk

No, no, not really and we are driving good innovation in diapers with diaper pants and other things in that space. We are driving baby wipes in a big way in Brazil and we are seeing solid consumer response to premium performing products.

Ali Dibadj - Sanford Bernstein

Okay. China has been a big driver as you mentioned, as I mentioned of your growth over the past little while here, explosive growth is the word you used, talk about the competitive environment there. We hear a lot about Hang On, we hear a lot about Unicharm now coming in that give you a run for your money in Korea, can you talk a little bit more in detail about China category-wise, your positioning in competitors?

Tom Falk

Yes in China, the big category that we are in is baby care. At this point we are also present in fem care and that business is growing nicely. We are not much of a player in the tissue segment and so as you look across the peers, P&G really competes across all the peers in diapers. Hang On tends to be more in the lower Tiers. Unicharm is positioned where we are kind of mid and premium and we started in Premium and have worked our way down a bit into the mid Tier and that's been part of our growth is in mid Tier sort of the biggest part of the category and as we moved into that, you know, we got a lot of volume growth just by fully participating in that big share of the category.

Where we are launching a new super premium product in China as well because there are some moms where you know clearly are willing to pay more for the very best product and we are importing some of that product from Korea. We would say the toughest competitors in many places are the Japanese competitors, so Unicharm in particular and Cow is aggressively coming in through eCommerce and so -- and many Chinese consumers have a very favorable perception of Japanese made product and so we do want to make sure that we are showing them the quality and value of our products.

Ali Dibadj - Sanford Bernstein

And how is the competition manifesting itself? Is it at a stage where you are still growing the category because of the competition, are you seeing topline slow because pricing isn’t as easy or some combination of that plus margin skills that there might be pressure because one of your competitors, local competitor said, you know, we expect margins to go down in diapers for a while in China, what's your view of that?

Tom Falk

Yes, we are not seeing that yet. I mean, we are going like crazy in China. I mean, we were up 45% last year for diapers. I think we were up 50% in the first quarter. So I don’t think those rates will sustain as part of that is from going into the middle Tier of the category and part of it is city expansion and as you are adding incremental cities, they are generally smaller than the bigger cities that you are in, but having said that, we still see you know strong double digit growth for a long time to come and you know we still, you know we are -- fem care was up 30% in the first quarter and we are really just getting started on re-launching fem care in the second quarter.

So there is just a lot of activity as they come in China. We got a terrific team there and they are very aggressive on how big they think that business can be for us over time.

Ali Dibadj - Sanford Bernstein

And no pressure on margins at this point.

Tom Falk

You know I would say pricing and margins have been pretty stable. In fact if anything we've tried to be even more focused on trade efficiency to make sure we are getting you know full value for the investments that we are making in China.

Ali Dibadj - Sanford Bernstein

Okay. So we'll come back to KCI, K-C International in a second, focus back on North America for a while now the infant care, child care business has been from a volume perspective very challenged, growth rates seems to be the big driver of that, are you seeing an insight to that?

Tom Falk

Yeah I think so. I mean the birth rate appears to have stabilized at that point. It hasn’t turned positive yet and obviously it will take some time for that to fully flux through the category. So as you really have since 2009 probably 8% to 9% decline in the absolute number of annual live births in the U.S. and so as that flows through the training pant category and other parts of the business, you see that in the larger size diapers and training pant category and so the category is you know, is probably still going to be down a percent or so this year, but then should start to flatten out in 2014 and we keep calling that and it keeps sliding out a little farther, but we think that the birth rate has bottomed out at this point in time.

You know I think the other effect that we are really watching is the price gaps between branded and private label and making sure that there is a good value equation with product performance, so we've re-launched some innovation in the second quarter. Just started shipping a new improved Huggies main line product and we will have some more innovation coming across the line later this year.

Ali Dibadj - Sanford Bernstein

Okay. A couple of questions that when you just said, one is what type of things do you track internally to figure out the birth rates besides seeing the birth rates, we've heard from companies who deal with prenatal they are seeing alive, are you seeing the same types of data?

Tom Falk

Yes for years we tracked prenatal vitamin sales as the predictor of birth rate and then that predictor didn’t predict the downturn. When the economy went down and I think it's probably because most of the downturn came in the lower income or Hispanic population who didn’t weren’t as fully penetrated on prenatal vitamin. So that wasn’t as accurate a predictor.

As we back-tested it, the consumer confidence, household formation and male employment have been actually pretty good causal explanations of the birth rate. So the question is at what point that will be stop being good predictors because something else is a better predictor. So we will continue to watch it and challenge our model to see what are the possible drivers of it going forward.

Ali Dibadj - Sanford Bernstein

The other question coming out of your previous answer is around private label. We've heard talk you guys for a while of kind of I think a lot of the same things about private label capacity coming online in the U.S. -- always a potential of that from some overseas players, we haven't -- I don’t know if you guys have seen it yet, but we keep sharing about it. do you think it's around the corner?

Tom Falk

Well, we've seen some in consumer tissue and particularly and in personal care, I mean the big private label player is First Quality and I think they've added capacity over the years and done some acquisitions and they make a decent quality product and they've -- they've partnered with some retail customers to try and drive that business, so it has resulted in some fairly modest share gain over the period of time, but you have also to look at it over a longer period of time and private label shares are lower today than they were in the mid 90s. So yes, it's a little higher than it was two or three years ago, but it's also lower than it was 20 years ago.

Ali Dibadj - Sanford Bernstein

Okay. And second with personal care in North America, the rest of your business -- the fem care business and your Cottonelle business last year at this conference both of those were pretty much on fire doing really, really well, fem care seems to have slowed a little bit and Cottonelle seems to not be as strong as one would have thought last year, can you tell us a little bit about why you think that's the case, competition, consumers, some combination.

Tom Falk

Yes in fem care, we are still getting good growth in Kotex. We have lots of innovation happening there. We are losing -- lost a little bit on our traditional Kotex mainline and so we are going back and looking to see what else we need to do to hold back consumers so that we can now add the growth and you buy Kotex and that's the challenge of managing two brands in the categories, making sure you understand that interaction so that you can try to have your innovation be additive and accretive from a margin and a share standpoint.

And in [condense], I mean we are pretty happy overall with the depend real fitness of the wet launches, a lot of innovation coming and our Poise Fem Wellness launch has gone reasonably well and is tracking with retail expectations and we are seeing actually that Poise Fem Wellness launch actually increased awareness of the underlying Poise brand that we are seeing increased in sample request for Poise products.

So I think adult care for us is a big opportunity, not just in the U.S. but globally where we are really just getting started outside the U.S. and with the lot birth rates in many emerging markets as well, that's a totally open territory to go build the business.

Ali Dibadj - Sanford Bernstein

So low birth rate and aging population...

Tom Falk

Right, exactly.

Ali Dibadj - Sanford Bernstein

On the fem care, let’s go back on the U.S. do you think you have a solution for Kotex, I mean, you buy Kotex was the solution?

Tom Falk

Yes.

Ali Dibadj - Sanford Bernstein

Now you have to deal with that kind of lapping that's gone a little bit and now going back to the core problem, which is the Kotex brand.

Tom Falk

It's a simple solution everywhere else in the world. You drive innovation in better products into the category and so we've got innovation coming on our main line Kotex business with better quality products and upgraded packaging and expect to see that continue to roll out and I think you know we have been the category driver in fem care.

As you look at some of the – where the real value creation has come from a retail perspective has been the things that we've done behind you buy Kotex and we as well Kotex natural balance has basically held position where we are seeing that growth in the category coming from you buy Kotex and the retailers are overall pretty happy with the approach that we've taken.

Ali Dibadj - Sanford Bernstein

Okay. So to spread all the conversation you had about personal care I should think it's a little bit customer tissue, last quarter consumer tissue was really always [product] was the only business that did better than we thought, everyone else did a little bit worse.

Seems like some of that was helped by the flu season, certainly some innovation there as well, but tell us about how sustainable that trend is and whether you think that reverses because our mindset was, okay, this is a different company's personal care company, now it's become I mean let’s call it consumer tissue company, I don’t get it, so talk a little bit about that kind of [thinking] there.

Tom Falk

Sure, we talked about this a little bit on the earnings call. You know the two factors really that drove consumer tissue always is strong cold and flu season and as we've talked over the years, that's hard to predict what the symptomology is going to be and this was more of an upper respiratory cold and flu year which was good and we were there with the right products. We've got terrific brands with Kleenex and that's done well.

And then our Cottonelle business did well in part because of innovation and the things that we were doing right on Cottonelle was in part because one of our competitors had some supply problems and weren’t able to source all the retail promotion activity that they wanted and so we think we managed from that. I assume some of our competitors benefitted from it as well, but the good news was it came to us and didn’t show up in private label.

Ali Dibadj - Sanford Bernstein

Right. One of the -- one of the pieces of it was also on the personal care business that disappointing a little bit I would argue and some it was from KCI, we talked certainly about the regions in the KCI.

Tom Falk

Tougher comps partly as well, first quarter last year was by far their best quarter of the year.

Ali Dibadj - Sanford Bernstein

For KCI.

Tom Falk

For KCI.

Ali Dibadj - Sanford Bernstein

And so talk a little bit about that in terms of what do you think those steady state as you put the goods store in China together with the goods store in Brail, a goods store in some other parts of the world, what do you think the KCI, personal care and then consumer tissue may be growth rates should be over some sustainable period of time.

Tom Falk

Yes, I mean we would say, you know, we were looking at high single digit top line in KCI and study operating margin improvement to narrow the gap between KCI's level of profitability and the overall corporate profitability and so that's absolutely what their strategic plan talks about. They've got lots of growth algorhythm laid out.

It's predominantly personal care driven, there is not as much of a tissue component to it in part because tissue is his more original business where you've got local competitors that have different profit expectations. So we have a decent tissue business in parts of Latin America and parts of Asia, but not necessarily in every market. So it's primarily may be child care, adult fem and adult care driven plan.

Ali Dibadj - Sanford Bernstein

Okay. Let’s take a close look at consumer tissue in the U.S. in particular. We've heard a company has come up with their own -- you know, you guys have [Oxted], they have the TAD technology essentially a fluffier product in consumer tissue, that they believe they can make now at each per price point and can introduce as private label like Cloud as an example there, that's coming out and more aggressively I would say than has been historically, how do you view that competition in consumer tissue, which as you said earlier is one of these categories where one would expect may be trade down and one would expect less loyalty from the consumer.

Tom Falk

Well I would say it's more complicated to make a bulky soft tissue than buying and installing a TAD machine. I mean P&G has been running TAD machines for 30 years, we've been running our TAD machines for close to 20 years and so there is a lot of our end knowledge that goes into how you make fabrics, what kind of chemistry you use to deliver a soft, strong, bulky absorbent sheet of tissue and so some of the private label stuff isn’t bad, but there still isn’t a performance gap that is perceptible by the consumer between the brand and the private label.

When you look at their cost structure relative to ours on the [Oxted] product, we still would say we have a significant fibre advantage where we are putting less fibre in per roll because we can build bulk in a way that's unique and proprietary versus what they can do and so we believe there is still some advantage is there from our scale and our manufacturing process.

Ali Dibadj - Sanford Bernstein

So you are not nervous at all about them coming in and aggressively trying to take some of your shelf space?

Tom Falk

Yes I think it's someone deciding to build a machine doesn’t induce a consumer to buy a different brand and so we would feel pretty good about our Cottonelle trajectory. We got a lot of innovation lined up to support that going forward, it's a very good margin business for us, it's one that we've continued to have investment.

Ali Dibadj - Sanford Bernstein

So let's take a team of folks coming in trying to compete against you in what was innovation, so was innovation higher end products and take that team into China. One of your competitors there Hang On said that they are going to trade up and going to have a brand that's higher quality and in fact I am not mistaken, correct me if I am wrong, they've actually hired at least one of your people if not more of your people to try to bring that 20 or 30 years experience on the personal care side.

How do you think about that from a threat perspective? If it is something you guys have developed internally and are now starting to hire some of your folks, they are starting to compete in your price point range. I agree that's not just they are turning on right turning the machine on, but they may be kind of catching up as well and so is that a competitive threat that grows going forward?

Tom Falk

Well I mean, I would say Ali, one of the things that keeps us focused is we are going to have a bell every day expecting that somebody is going to show up with a better product. You know, there is competitors all over the world that want to eat our lunch.

So whether it's CMPC in South America on Hang On or Unicharm or Cow or Procter, we got tough terrific competition and so that says we got to be good and fast and take good ideas and drive them into the marketplace around the world and yes, there was a guy who used to work for us in R&D and infant care and went to work for Hang On, I think he is retired again from Hang On, but I don’t know for sure, but you mean there is knowledge and art, but can transfer, they are not supposed to take proprietary ideas, but there are certain things that I am sure transfer across but you know, it's our goal is to get this stuff in the market ahead of the competition and if we do that consistently around the world, we are going to be successful.

Ali Dibadj - Sanford Bernstein

Okay. Talk about your competition as opposed to a relatively smaller one in China and talk about Procter & Gamble, you are now going to have to compete with an competitor you used to compete with in an off kind of Procter as competitive events sitting that Procter unless of itself offer. What do you see as changes that could happen given knowing how to use to operate versus what you are seeing in the past few years from them?

Tom Falk

Let me -- I think it's been long enough we are seeing lots of different leaders in that Procter AG is a terrific inspirational guy and I am sure he will come back in and get the team focused, but I would also tell you I mean some of the stuff is more of a distraction to the headquarters levels, so the folks that run P&G businesses in markets all over the world, they get up every day wanting to take market share and be successful in those markets and so I don’t think that's going to change as much as you might think.

There is more focus on in Cincinnati probably, but I think in the emerging markets Procter has always been a tough competitor and so we would say it's always a mistake to underestimate a company with the capability that P&G has and we wouldn’t be doing that now.

Ali Dibadj - Sanford Bernstein

Okay. One question for you, some of these topics went offline and dig down a little bit deeper in your emergence structure, China listing the one child policy can you quantify the impact that could be to our business?

Tom Falk

Yeah, I mean we are starting to see that. I was talking to a Shanghai mom a year or so ago and even then she said, yeah, if both parents are only children, they are allowed to have a second child and so she and her husband were talking about whether they were going to do that and when they were going to do that and so -- but I think a bigger factor for us is going to be increased penetration rate of the category going from two or three diapers a day to four or five or six diapers a day will be a bigger factor in growth from the China category more than the increased growth rate for a while.

Ali Dibadj - Sanford Bernstein

Okay.

Tom Falk

So that takes a while for that, to change broadly across societies as you see even in a market like Korea where the birth rate has gone down, the Korean governments really trying to get it to go the other way and that takes a while for that and there are other factors besides just the government's policy is what age do they marry and you know how much -- what percent of women are in the workforce and all those kinds of things that would impact on growth rate.

Ali Dibadj - Sanford Bernstein

Okay. So one of the impacts on your business obviously is that you are telling mainly from channel and China has performed differently, can you give us a sense of the way you are seeing first half is in the U.S. I guess from channel shifting that's going on, so how is price specifically Walmart attempted and reattempted turnaround going, how about the eCommerce channels becoming bigger and bigger deal, can you talk a little about the shifting in channels you are seeing?

Tom Falk

Yean I would say the two fastest growing channels in North America for us have been eCom and probably the Dollar Stores and so partly the Dollar Store are just adding so many more stores, so as Dollar generally adds 500 stores a year whatever they are doing, they just more outlooks that drive food traffic and eCom I think there are times when the eCom retailers were subsidizing that channel to get mom in the channel initially and they backed off on that a little bit.

And I was talking to someone the other day and I said when I was running the diaper business in the early 90's, our number one customer was Toys"R"Us because they sold diapers at a loss and wanted to put them in the back of a store and force mom to walk all the way through with a cart full of kids of ocean of toys to get to the diapers and so that's not a new phenomenon that a retailer will try to use diapers as a loss leader if you will to cause consumers to want to shop in that space, but they usually eventually back off on that and I think that slows a little bit as the deal structure on eCom has moderated a bit and what our perspective is we want to make sure we are represented whatever mom wants to buy.

And so we've got a great plans with Walmart, we've got a great plans with Cosco, we've got a great plans with Amazon, we are doing great with Dollar General and we want to make sure that we've got robust plans in place wherever she wants to buy and that's changing all over the world and you know in a market like Korea, eCommerce is a huge driver and China is becoming a huge factor.

In part of Latin America, we are seeing [pendulums] which are small diaper stores is an exploding channel for us. They are sort of a Dollar store version in Latin America but they only carry diapers and a few small baby care items and be it in a urban environment and there is hundreds and even thousands of these small shops and finding a way to serve them cost effectively and make sure you win and that channel is key. So we are just trying to make sure we are understanding how mom wants to buy and make sure we've got the best offer and the right product lined up there for.

Ali Dibadj - Sanford Bernstein

And margin implications across these channels.

Tom Falk

We try not to subsidize channels and so it's more in the U.S., it's more about product count. So the bigger the package, the lower the margin generally, because the discount exceeds what your cost difference is. So you know, Club Pacha is typically a little bit lower margin for us than a smaller count pack.

Ali Dibadj - Sanford Bernstein

Okay. And you mentioned eCommerce I think the number you guys quoted yourselves very much tied with a lot of research we've done, you know, Korea is 45% I think of the diaper sales of...

Tom Falk

Yeah I think about even across the 50% in the last quarter, so...

Ali Dibadj - Sanford Bernstein

And we think of I guess the developed world and some sense advance from your eCommerce perspective, I just feel like a relative getting faster or getting better at that and any of the adjust to your strategies from serving those markets, China is a great example, are you prepared to do that? Do you think the consumer package to the industry broadly is prepared to serve eCommerce in a smart way?

Tom Falk

We are all learning at a very breakneck pace and so I think what you will find in the emerging markets is they've tended to skip some developments steps. So if you think about like telephones, they didn't go through rotary bell phones to get to smartphones, they just went straight to smartphones and so I think you may see that and some -- there may be some eCommerce or may be some retail channels that don’t develop to the same extent as they skip and go right to eCommerce.

So it's a different way and so I think what we are trying to do is make sure again we are partnering with the right players that we are making sure our brands are represented in the right way and so there is a lot of work behind the scenes to make sure you have the right digit architecture so that your product appears in the right -- the way you wanted to because it's -- you don’t have a physical shelf, you have to make sure the consumer can get all the information that she needs easily in understandable fashion on a digital shelf.

You have to think about how you -- how do you track your brand image in the cyber space or in the digital space. So we have tools that can track what are consumers about us on blogs, you know, you can wait for them to call you know and tell you about a problem, they are talking about it among themselves and so if you wait until they call you, you are way behind power curve. So it's just a different way of monitoring your business and brand performance.

Ali Dibadj - Sanford Bernstein

Okay. So shifting gears just a touch and getting into margins, one of the question is how sustainable is force your cost savings plan, how much cost cutting do you have left, so can you give us a sense of what's the main drivers of your market expansion will be over the next few years that would be helpful.

Tom Falk

Yes, that's right. It is -- if you go back several years, we were really at the $100 million to 115 million a year kind of cost savings run rate and over as over the last couple of years we've taken it up to the $250 million to $300 million level and I really believe that that level is sustainable and we may be even be able to do better than that at some point in time.

I look at Colgate as a good example of that. They've got a smaller cost base and are generating close to $400 million a year in cost savings, so I would say if they can do that, we should be thinking about that as the right -- the right kind of way to think about a stretched target, but the buckets that we are focused on continue to be the ones we've talked about and so we've put in a global procurement function a couple of years ago and are seeing good savings from that and are beginning to cascade that capability build into the organization where we are developing a more professional purchasing organization and proving their skills and upgrading our talent where we need so and so negotiated material savings will be a part of that.

We are still in the early innings of lien and we are driving a lien capability build or which will drive down ways, drive uptime and speed, improved reliability of our processes and so productivity will be a big opportunity for us. Material specification changes where we find we still have more variability and in spec than we would need to cover the full range of product sizes and if we added up the number of different sizes of fem pads we sell around the world, it far exceeds the consumer need for the different sizes that we have or I think we have over 50 different kinds of diaper waste the last week and we could probably cover the world's needs with five.

And so there is value that takes cost, you got qualified suppliers, you have to sometimes change equipment, you have to test the product to make sure you've got the right one of the five to go into that market and so -- but I would tell you we are still in the early innings in all of those fronts, which gives me great confidence that there is still a pretty big pipeline of cost savings yet to come.

Ali Dibadj - Sanford Bernstein

Can you quantify that a little bit?

Tom Falk

Well, I think that taking it up to the $250 million to $300 million a year level and sustaining that is very doable.

Ali Dibadj - Sanford Bernstein

Now how much do you expect of that dropping to the bottom line?

Tom Falk

You know, I think that that covers some of our normal inflation, you know, you have wage increases at various places. You've got healthcare cost go up, so you use a part of it to cover normal inflation. There is a small amount of it that would normal commodity cost variability and then a portion of it will wind up being reinvested in strategic brand spend and a portion of it will show up in bottom line margin.

If we think about our long range growth margin goals, they are more in you know, 60 to 70 basis point improvement range and we hope to deliver you know, a 40-ish of it to the bottom line in terms of operating margin improvement.

Ali Dibadj - Sanford Bernstein

Okay. Okay. If you think about that commodities, what we've seen over the past little while is much more difficult time for consumer package goods companies to push through those commodity changes into the consumer environment and that might be the short term issue because the consumer is under more difficulty, but as commodities are clearly more volatile, you are now at 9.30 kind of 3% or 4% higher than it was based on the stock market last year, how do you think about the commodity direction now from a longer term perspective and your ability to then offset that through, forget about cost savings for a moment, which was pricing.

Tom Falk

Yes it's one that we used to think about commodities in the abstract area. One of the things we've tried to be more holistic about is thinking about commodity and currency because in emerging markets as it becomes a bigger and bigger part of the business, it's really understanding the inter-relationship of those and so a good example would be our healthcare business and in Japan obviously they suffered because of the topline translation impact at the end, but they sourced most of their product out of Thailand and Mexico and so the pace has strengthened as the end has weakened and so certainly that P&L didn't look very good and so they floated double-digit price increases to try to recover that and so I think in our emerging markets, we have actually have somewhat of an easier time dealing with swings and currency and commodity.

Brazil would be another example where their currency devalued last year and we took double-digit price increases in the first quarter of this year to try to adjust and recover for that and so in the U.S. it's been -- and Europe in particular it's hardly been tougher to get real price increases and so you typically got to couple it with some form of innovation to get any kind of meaningful move in prices.

It's not to say that you have a major shift of full swings of $150 a ton, you couldn’t definitely see those price changes heading at some point in time [afford that] if you see big shifts like that, but in the kind of range that we were talking about you are probably unlikely to see major moves.

Ali Dibadj - Sanford Bernstein

Okay. And particularly healthcare for example as one, you losses of volume get hit pretty significantly right when you took the double-digit pricing up. So it is just...

Tom Falk

Too early to tell, we just took it in -- effective in as our healthcare volumes in the first quarter were weak more because of declines in surgical procedures, less so in...

Ali Dibadj - Sanford Bernstein

...of those price increases. So now you are doubling that and on healthcare in particular, I mean how do you think about that from a business perspective, what's the discussion in the Board room about healthcare? You went through a time where you bought some companies in distribution and now slowed that and stopped that, I mean there has been volatility around healthcare, so how do you think about that business in the Board room?

Tom Falk

Yes, I think the focus on healthcare is to how do you grow the device platform. We think we've got some terrific products of great innovation and are looking at increasing investment in sales force to deliver those. These are businesses that have got 60% plus gross margins and very attractive operating margins and then in the supplies part, how do -- to you maintain enough differentiation to at least hold margin in that part of the portfolio, so it really is -- if you think about the portfolio roles that we have across our business is not like unlike what we are doing with personal care and tissue where you are investing aggressively in personal care and you are selectively managing tissue to generate cash and sustain its margin performance and so healthcare is looking at that the same way.

I think everybody is trying to figure out in the U.S. healthcare market is the affordable care act a good thing or a bad thing, we would say we are somewhat less sceptical that is going to drive increased demand for healthcare which was the promise of it as more people get covered by it only because we've seen now several quarters in a row surgical procedures decline in the U.S. and everybody is trying to figure out exactly what's going on.

The hypothesis is that it's increased prevalence of high deductible plans that are causing people to put off elective surgical procedures and probably some insurance companies requiring more alternative therapies before they'll approve a surgery. So maybe you'll do three months of physical therapy before we let you have your knee surgery and things like that. So I think those are kind of variables.

We had discussions about you know, what are we going to do with our own business and then what's the environment that we are going to be operating in.

Ali Dibadj - Sanford Bernstein

Okay. One of the questions that was around having listed companies in some of the emerging markets, K-C in Mexico is an example of that where you have an ownership stake and you have over time I think the last one was I mean if I am not mistaken that you bought back is that right or...

Tom Falk

We are still in the JV inside...

Ali Dibadj - Sanford Bernstein

What's the [ballpark] recently, I mean is that still a process something you think you are going to go through in terms of buying back some of these JVs, what's the benefit or not of having JVs versus whole ownership of these?

Tom Falk

Yes, I think that it depends on the markets and so in a market like India where we went in to a JV with Hindustan Lever number of years ago. It's a very complex market to distribute. They've been there for 60 years and operated successfully epically and had -- and could give us instant distribution. So we brought brands and innovation in our categories. They brought distribution and local market knowledge and that made for a good joint venture.

And so there are other markets like in Latin America over the years we've brought up most of our venture partners. You know, they were there initially to help us gain entrance to the market, but that at some point they usually would have a liquidation event that they want their money to go do something else with and so they are more them opting out and us trying to aggressively buy them out and where we had partners, we've tried to be good partners over the years.

Ali Dibadj - Sanford Bernstein

So no change in strategy at this point from that.

Tom Falk

No, I would say that opportunistically we all tend to see those move forward. I think there a couple parts of the world, Saudi being one. We are having a local partner as probably more important even if it's not absolutely necessary.

Ali Dibadj - Sanford Bernstein

Okay. Okay. Media spend, ROI and media spend in particular you until Tony showed up and I think had a CMO...

Tom Falk

Never did, and I don’t know 135 years, so...

Ali Dibadj - Sanford Bernstein

At that point, talk about how you are measuring the ROI, tell us about channel shifting that you are seeing or media channel shifting that you are seeing and are you really getting the return? To be fair, I was a little sceptical that you get some of the returns that you did get on Kleenex in U.K. for example spread out, talk a little bit about that and where you think advertising as a percentage of sales should go given what you are seeing from ROI perspective?

Tom Falk

Yes, I mean I would say number one was all of the new digital tools that actually are easier to measure than some of the traditional advertising where you can tell if a consumer clicks through and requests a sample and you can with some of the database technology out there, you can get a better measurable ROI on your spend than we've ever been able to get, which is great.

And I would say you know, we feel like if you have a healthy growth model, you are investing innovation to drive your sales a little bit faster than the category and hopefully that innovation is gross margin accretive that generates some additional funds to fund the innovation of the strategic A&P, which and then also leads to a better operating margin at the other end and so we would say that you should see some slow upward pressure on the amount of spend that we put behind strategic A&P.

We start with a process that we call integrated marketing planning where we are more channel agnostic on how we spend the monies. We have a marketing idea and then team figures out what's the right channel to take that idea to market? Is it a sample, is it digital, is it digital and TV, you know what role would print play and so there is not -- there is not a hypothesis that was going to result in a 30-second television commercial and we've done some launches that were digital-only because that was what the team felt was the right way to hit the target.

Ali Dibadj - Sanford Bernstein

And are you happy with some of the results you are getting from Facebook or from an online channel?

Tom Falk

I would say that we are learning a lot and learning and trying to do more of the things that work really well and do lots of the things that didn't work very well, but there is also lot of experimentation going on and so we are also encouraging the teams to take some smart risks and try some things that seem crazy.

I mean we did a launch of Kleenex in the U.K. after let it out, but it was in other new variance that the whole campaign was guys dressed in superhero outfit handing out samples on the tube at rush hour and I don’t know if that was the best way to do it, but it was an interesting idea and we are seeing some -- we are trying to drive behaviour change in areas like moist bathroom tissue, the Andrex Washlets campaign did phenomenally well.

We are going to use some of the same idea to drive Cottonelle moist in the U.S. So as you find ideas that work, Tony and the CMO teams are sharing those ideas around the world at a faster pace so that you can drive them into other markets before you have to go test it everywhere.

Ali Dibadj - Sanford Bernstein

Okay. Let me turn to very quick questions. One is on M&A, should we expect anything transformative from you guys at best or acquisitions.

Tom Falk

You know, we feel as we've got so many good opportunities in the portfolio today to chase that we are really focused on execution and what we've got on our plate.

Ali Dibadj - Sanford Bernstein

Okay. And lastly if you could just bring it all together long term topline growth, operating profit expansion, EPS growth, what should we expect from...

Tom Falk

Yes, I mean our long term model remains the same. We think 3% to 5% topline is very doable and the categories are growing 3% to 4%, so they get to the high end. We got to have some innovation and some share gain. You know, we should see the gross margin improvement from cost savings in that 60 basis points a year range. We will spend some of that backend strategic marketing and should see operating margin expansion of around 40 basis points and that should translate into you know a little bit share repurchase, high single digit EPS growth over time and improvement in ROIC.

Ali Dibadj - Sanford Bernstein

Okay. Thanks very much for your time. Appreciate it.

Tom Falk

Thank you, Ali.

Question-and-Answer Session

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Source: Kimberly-Clark's Management Presents at Sanford C. Bernstein's 29th Annual Strategic Decisions Conference (Transcript)
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