Seeking Alpha
Long/short equity, newsletter provider, valuentum
Profile| Send Message|
( followers)  

Summary

  • Kimberly-Clark earns a ValueCreation™ rating of EXCELLENT, the highest possible mark on our scale.
  • The firm has a good combination of strong free cash flow generation and manageable financial leverage.
  • Kimberly-Clark has raised its dividend in each of the past 40+ years, and its Dividend Cushion score indicates future dividend increases are in store for investors.

One of the reasons our members love us is that we tell the story through the numbers. Every income statement says something, every balance sheet has a history and every cash flow statement reveals a firm's true intrinsic value. The numbers talk--and we think every investor should listen to them. Let's see what they say about Kimberly Clark (NYSE:KMB).

But first, a little background to help with the understanding of this piece. At Valuentum, we think a comprehensive analysis of a firm's discounted cash-flow valuation, relative valuation versus industry peers, as well as an assessment of technical and momentum indicators is the best way to identify the most attractive stocks at the best time to buy. This process culminates in the Valuentum Buying Index, which ranks stocks on a scale from 1 to 10, with 10 being the best. If in-depth academic research on our process is your fancy, please click here.

Essentially, we're looking for firms that overlap investment methodologies, thereby revealing the greatest interest by investors (we like firms that fall in the center of the diagram below). At first, this may sound strange, but we think it is genius in its simplicity. By focusing on what drives stock price movement, namely valuation and technical/momentum analysis, we position our members to identify the stocks that are most likely to appreciate. Said differently, all investors are interested in stocks that go up. We think those stocks are ones that are underpriced and are just starting to get noticed by the investment community as being so. More interest in the shares by various investment methodologies --> more buying in shares --> greater likelihood of price-to-fair value convergence. Though we show our work like all good students do, it doesn't get more simple than that. Here's the process in a flow chart (DCF = discounted cash flow).

(click to enlarge)

If a company is undervalued both on a discounted cash-flow and on a relative valuation basis and is showing improvement in technical and momentum indicators, it scores high on our scale. We think it just makes sense -- underpriced stocks that are just starting to go should be the ones on your radar. Kimberly-Clark posts a VBI score of 6 on our scale, reflecting our 'fairly valued' DCF assessment of the firm, its neutral relative valuation versus peers, and very bullish technicals. The rating is actually better-than-average, so we have no qualms with Kimberly-Clark. However, the most actionable ratings are 9 and 10, which are our favorite stocks. We compare Kimberly-Clark to peers Clorox (NYSE:CLX), Johnson & Johnson (NYSE:JNJ), and Procter & Gamble (NYSE:PG) for relative valuation purposes. Relative valuation has its pitfalls, but we think it is helpful as a check against the discounted cash-flow derived fair value, which we discuss below.

Our Report on Kimberly-Clark

(click to enlarge)

Kimberly-Clark's Investment Considerations

Kimberly-Clark's Investment Highlights

• Kimberly-Clark earns a ValueCreation™ rating of EXCELLENT, the highest possible mark on our scale. The firm has been generating economic value for shareholders for the past few years, a track record we view very positively. We expect the firm's return on invested capital (excluding goodwill) to expand to 30.1% from 23.2% during the next two years.

• 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 11.9% in coming years. Total debt-to-EBITDA was 1.7 last year, while debt-to-book capitalization stood at 52.8%.

• The firm's share price performance has trailed that of the market during the past quarter. However, it is trading within our fair value estimate range, so we don't view such activity as alarming.

• Kimberly-Clark has raised its dividend in each of the past 40+ years, and its Dividend Cushion score indicates future dividend increases are in store for investors.

Kimberly-Clark's Business Quality

Kimberly-Clark's Economic Profit Analysis

The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital (ROIC) with its weighted average cost of capital ((OTC:WACC)). The gap or difference between ROIC and WACC is called the firm's economic profit spread. Kimberly-Clark's 3-year historical return on invested capital (without goodwill) is 19%, which is above the estimate of its cost of capital of 9.1%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely
outcome, in our opinion, and represents the scenario that results in our fair value estimate.

Kimberly-Clark's Cash Flow Analysis

Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Kimberly-Clark's free cash flow margin has averaged about 8.6% during the past 3 years. As such, we think the firm's cash flow
generation is relatively STRONG. The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At Kimberly-Clark, cash flow from operations increased about 20% from levels registered two years ago, while capital expenditures expanded about 13% over the same time period.

Kimberly-Clark's Valuation Analysis

Our discounted cash flow model indicates that Kimberly-Clark's shares are worth between $68-$113 each. We think having an informed margin of safety is the only way to invest. Though a lot of investors target precision in their numbers (a pointless approach because precision will always be wrong), we target being correct. A look at Kimberly-Clark's performance during the past few years reveals that having a range of probable fair value outcomes is much better than assigning a single point estimate, which will always be wrong (because the future is inherently unpredictable). The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers.

Kimberly Clark's estimated fair value of $90 per share represents a price-to-earnings (P/E) ratio of about 20.4 times last year's earnings and an implied EV/EBITDA multiple of about 12 times last year's EBITDA. We think this fair value estimate is reasonable, implying that Kimberly-Clark is trading at the high end of our estimated fair value range. This just means that the company is fully valued and is not as timely of an idea, as let's say, another firm that was trading at the low end of the fair value range.

Our model reflects a compound annual revenue growth rate of 2.5% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 3.3%. Our model reflects a 5-year projected average operating margin of 17.7%, which is above Kimberly-Clark's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 2% for the next 15 years and 3% in perpetuity. For Kimberly-Clark, we use a 9.1% weighted average cost of capital to discount future free cash flows. Since all value is based on the future, assumptions are inevitable and wrong (nobody can predict the future) -- we recognize that as such with our margin of safety bands.

(click to enlarge)

Kimberly-Clark's Margin of Safety Analysis

Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $90 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for Kimberly-Clark. We think the firm is attractive below $68 per share (the green line), but quite expensive above $113 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.

Kimberly-Clark's Future Path of Fair Value

We estimate Kimberly-Clark's fair value at this point in time to be about $90 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of Kimberly-Clark's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $110 per share in Year 3 represents our existing fair value per share of $90 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.

Pro Forma Financial Statements

(click to enlarge)

(click to enlarge)

(click to enlarge)

Source: What The Numbers Say About Kimberly-Clark

Additional disclosure: PG and JNJ are included in the Dividend Growth portfolio.