Investors in Kimberly-Clark (KMB) were pleasantly surprised with a solid fourth-quarter earnings report, accompanied by a reasonably strong outlook for the current year. Despite the solid organic growth rates and sales leverage, I believe the current valuation at 18 times this year's earnings is full enough, making it easy for me to stay on the sidelines.
The divestiture of the healthcare unit will limit reported growth for 2014, despite solid organic growth. Even as Kimberly-Clark tries to please investors, this is not necessarily a good thing with shares trading at this premium valuation.
Fourth Quarter Highlights
Kimberly-Clark reported fourth-quarter revenues of $5.30 billion which is unchanged from last year, and ahead of consensus estimates at $5.28 billion. Yet the company showed very strong cost control throughout the organization which boosted net earnings. Net earnings more than doubled to $539 million, which combined with modest share repurchases resulted in a 106% increase in diluted earnings per share, coming in at $1.40 per share.
On an adjusted basis, earnings rose from $1.37 to $1.44 per share. This was ahead of consensus estimates which stood at $1.39 per share.
Diving Into Fourth Quarter Details
While reported revenues were flat in the final quarter, the company managed to grow by 5% on an organic basis, driven by 4% higher volumes. European strategic changes and the pulp and tissue restructuring resulted in 3% lower sales. Adverse currency movements shaved off another 2% in reported sales. Emerging markets were strong, notably in China.
The restructuring towards higher margins businesses, focus on costs and a lack of restructuring charges resulted in a big boost to gross margins, increasing by 550 basis points to 34.2% of reported sales. Marketing, research and general expenses fell as well, making up 18.8% of revenues, down a 130 basis points. The FORCE savings program allowed Kimberly-Clark to reduce $75 million in recurring costs while restructuring costs tied to the European business were much lower compared to last year.
2013 In Review
Kimberly-Clark had a solid 2013. While the company only managed to increase full-year revenues by 0.4% to $21.15 billion, solid achievements in cost of goods sold and general expenses resulted in solid earnings growth.
As a result, net earnings rose by more than 22% to $2.14 billion, as earnings per share rose by a quarter to $5.53 per share on a diluted basis. The FORCE saving plan continues to boost earnings results, needed to please investors and deleverage the balance sheet. Kimberly-Clark holds about $1 billion in cash and equivalents, but holds roughly $6.3 billion in various kinds of debt on its balance sheet.
Fortunately for investors, the company has a strong track record with 41 years of consecutive increases in its dividend. The current quarterly payouts of $0.81 per share provide investors with a yield of 3.0% per annum. This cost the company about $1.25 billion per annum, or close to 60% of past year's earnings.
Spin-Off Of Health Care
Back in November, Kimberly-Clark announced its intentions to spin-off its healthcare business. Management realized that the pain management and medical devices is a different business with limited overlap with the other businesses owned by the firm. A sharper strategic focus should help both Kimberly-Clark as well as the healthcare unit to capture future opportunities.
The healthcare business reported revenues of $1.62 billion for 2013, making up for 7.7% of total sales. The unit reported operating earnings of $230 million for the year, resulting in operating margins of 14.2%. The unit reports roughly 70% of its sales in North America with the remainder in Europe and the rest of the world. 70% of revenues are generated from surgical & infection prevention and the remainder from medical devices.
Note that the spin-off is expected to be completed in the third quarter of this year.
What Will 2014 Bring?
Investors are happy with the results and the outlook for 2014. For the coming year, Kimberly-Clark sees organic growth of 3 to 5%. Top line growth will be driven by innovation, initiatives and brand investments. Combined with a focus on costs, adjusted earnings are seen between $6.00 and $6.20 per share. This means, adjusted earnings are expected to increase between 4 and 7%, while 2014's results will be impacted by a 3-4% drag as a result of adverse currency movements.
The guidance for this year's earnings is in line with market consensus estimates standing at $6.10 per share.
Trading at $107 per share, the market has boosted the valuation of the producer of Huggies and Cottonelle, among many other brands, to $41 billion. Combined with the guided earnings for 2014, shares trade at roughly 18 times earnings which is not steep. Yet investors will see some paydays this year as the company reckons it will spend some $2.5 billion combined on share repurchases and dividends, at a rate of 6% per annum.
Implications For Investors
Back in October, I last checked out the prospects for the firm, with shares trading around $105 per share at the time. I applauded organic growth, offset by divestitures and adverse currency movements which "masked" the real improvements being made.
The nice earnings leverage under its FORCE program could be a driver for earnings growth in 2013 and 2014 indeed. Note that top line revenue growth will not occur, or be very limited on the back of the anticipated healthcare unit spin-off.
Yet despite owning world-class assets, I believe the valuation at 18 times earnings is fair and full, despite an attractive 3.0% dividend yield and the very strong track record. The 50% payout ratio does leave opportunities for share repurchases, which is not necessarily a good thing as long as shares are trading at a premium valuation. Investors should not focus too much on the dividend yields in this low interest rate environment as a small share price move could easily outpace the gains from the dividends being received.
I continue to like the company, yet the current price makes it easy for me to stay on the sidelines, awaiting better entry opportunities.