Kimberly-Clark (NYSE:KMB) is considered to be a boring stock by many analysts. However, the company's restructuring plans, higher than industry return on equity, improved cash flows and attractive dividend yield makes me think differently.
The company is undertaking several strategic changes in its Western and Central European consumer and professional businesses. The strategic changes involve the sale or closure of European facilities and streamlining the administrative organization. In 2012, the company exited the diaper category in all countries of this geographical segment with the exception of Italy. Moreover, it divested or exited some of its lower margin businesses, mostly in the consumer tissue segment.
After the divestment or exit from these businesses, the operating margins of these segments have improved over the first nine months of 2013. These restructuring actions are expected to be completed by December 2014 and we can expect that these actions will bring further improvement in operating margins.
Divestiture of Health Care Segment
Kimberly-Clark management announced that the company will pursue a tax-free spin-off of its health care business that is no longer proving to be a strategic fit to the company's other businesses. The divestiture and the European restructuring would enable Kimberly-Clark to focus on its Consumer and K-C Professional segments which currently report the highest operating margins. The focus on these two segments could further improve the company's performance and eventually increase its net earnings.
On the other hand, the operating margin for the health care segment has declined by 14 basis points. The segments' YoY revenue growth in the first three quarters of 2013 experienced a decline of 90 basis points whereas the Consumer and K-C Professional segments have shown a YoY growth of 240 and 80 basis points, respectively. Therefore, the divestiture would help the company to focus more on profitable segments and improving its margins.
New Product Launches
Kimberly-Clark is focusing on its research and development and bringing new products into the market. In 2013, the company made several product launches. In November 2013, it introduced the new KimVent , MICROCUFF, Subglottic Suctioning Endotracheal Tube which provides more effective clearing of potentially harmful clogs.
In September 2013, the company launched a cold and flu predictive tool that can determine where the flu will hit next. The tool is the first and only one of its kind in the market.
The launches will bring new revenue generating opportunities for the company and eventually expand its market share.
During the first three quarter of 2013, Kimberly-Clark revenues have grown by 60 basis points over. From 2010 to 2012, the revenues grew at a CAGR of 2.2%. The revenue growth is expected to rise in the future since the company has started focusing on its higher revenue generating segments.
Moreover, the demand for sanitary products has surged over the years thanks to the rising population and the increased awareness of hygiene. Be it baby diapers, baby wipes, adult diapers or feminine hygiene products, there is a growing trend in the sales of all of these segments. The highest demand growth is seen in the Latin American and Asia Pacific markets whereas the European and U.S. markets have reached saturation. Therefore we can say that Kimberly-Clark has taken a timely step by exiting from the European diapers market.
Apart from that, the demand for tissue paper, toilet paper, facial tissues and adult incontinence products has also surged. The tissue industry is projected to experience a considerable growth in the next few years.
This higher demand along with the company's new innovations and the growth and cost-saving initiatives will help it to deliver higher returns to its investors. The company expects to deliver $5.65 to $5.75 per share of adjusted earnings by the end of 2013 reflecting an 8% to 10% year-on-year growth.
Higher Returns on Assets and Equity
To calculate the company's required rate of return through the CAPM model I have taken the relevered beta. As the company's debt level is higher than its peers and the overall industry average I unlevered its raw beta and then relevered it by taking the weighted beta. The calculation gave a beta of 0.445 for Kimberly-Clark.
Click to enlargeBy incorporating the relevered beta, a risk rate of 2.71% taken from 10-year Treasury bond yields and a market return of 9%, the required rate of return on Kimberly's stock equals 5.51%.
However, the company generates much higher profits from the money shareholders have invested and this is depicted by its return on equity (ROE). The company's ROE is 39.9% compared to the required rate of return of only 5.51%. ROE is also better if we compare it to the company's peers and the industry average. Compared to Kimberly-Clark, Procter & Gamble (NYSE:PG) has an ROE of 17%, Energizer Holdings (NYSE:ENR) has an ROE of 17% while the overall industry is an average of 22.5%. Only Colgate Palmolive provides an ROE to its investors higher than Kimberly-Clark.
Similar to ROE, Kimberly-Clark provides a higher return on its assets compared to P&G, Energizer and the industry average. The return on Kimberly-Clark's assets is 9.5% compared to the 8.1% return on P&G's stock and the 6.2% return on Energizer's stock.
The company is expensive based on price-to-earnings and price-to-book ratios which suggest that the company's earnings growth is weaker than the growth required to maintain the current stock price.
The company is undervalued based on the price-to-cash flow ratio compared to Procter & Gamble and Colgate Palmolive since it has very attractive cash flows. Its operating cash flow during the third quarter of 2013 was $912 million compared to its operating cash flow of $844 million in 2012 reflecting an increase of 8%. The operating cash flow increase is the result of lower pension contributions and improved working capital. I expect that the cash flow will further improve in the future once the company has completed its strategic changes in Europe.
Kimberly-Clark cash conversion cycle has also improved because in the first three quarters of 2013 the cycle is down by 4 days compared to 2012. Management is working on further improving the cycle. The higher operating cash flow has enabled Kimberly-Clark to generate more cash after laying out its capital expenditures. This makes the company's stock inexpensive on a price-to-free cash flow ratio basis as well compared to its peers' average. Kimberly-Clark generates $5.71 free cash flow per share compared to the $3.73 generated by P&G, $2.97 generated by Colgate Palmolive and the $10.62 per share generated by Energizer Holdings. Since price-to-cash flow and price-to-FCF are better predictors of a company's stock price than price-to-earnings and price-to-book, I would say that Kimberly's stock has the potential to provide good returns to the shareholders. The higher cash flow supports the company's better return on its equity.
Attractive Dividend Yield and Share Repurchase
Better cash flow along with higher gains on equity will enable Kimberly-Clark to give more dividends to shareholders. The company's dividend yield is better than all three of its competitors and the industry average.
Moreover, Kimberly is giving profits to its investors through share repurchases. During the third quarter of 2013, the company repurchased $150 million and will continue to buy more shares till the year-end of 2013.
Kimberly-Clark will continue paying handsome profits to investors through better dividends as the company's stock price appreciation, share repurchases and future outlook seem to be brighter. I expect that the company's future earnings will improve due to the rising demand for its products, new product launches and the improving margins. The company is already achieving better than expected returns on its equity and assets and an improvement in future earnings would further increase these returns.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by APEX Financial Consultants. This article was written by one of our research analysts. APEX Financial Consultants is not receiving compensation for this article (other than from Seeking Alpha). APEX Financial Consultants has no business relationship with any company whose stock is mentioned in this article.