Kimberly-Clark: Near-Term Overpriced, But Long-Term Emerging Markets Favor Company

Summary

Recent earnings grew due to organic sales growth, cost savings, input cost deflation and margin improvements, offsetting adverse currency effects and rising marketing expenses.

Revenue decreased due to adverse foreign currency effects while organic revenues increased due to volume and organic sales growth in developing and emerging markets.

Adjusted operating profits (excluding restructuring costs) increased due to organic sales growth and cost savings from the company’s cost reduction strategy.

To combat slowing revenue and earnings growth, the company is restructuring its business to achieve cost savings to allow for investment in targeted growth opportunities.

The company’s shares are overpriced, but long term the company can improve growth through cost controls, product development, acquisitions and focusing on emerging markets.

The consumer products company Kimberly-Clark (NYSE:KMB) has long been a favorite dividend growth stock for more conservative investors to invest in. KMB sells consumer and other products and the company's business has the following three divisions: 1) personal care, 2) consumer tissue, and 3) K-C professional and other. Despite the company's market leading products, innovative product development and marketing capabilities and outsized growing dividend, KMB's shares trade near their 52-week high and at a price-to-earnings ratio far above the high end of its 10-year average price-to-earnings ratio. We recommend that investors do not buy KMB's shares now and wait for at least a 15 percent share price pullback and preferably a 20 percent share price pullback.

KMB, along with other consumer product companies, has struggled in recent years with slowing revenue and earnings growth due to a difficult economic environment. As the company adjusts to such economic circumstances, it is engaged in an ongoing restructuring initiative to improve organizational efficiency, underlying profitability, and increase its flexibility to invest in targeted growth opportunities. KMB expects to complete its restructuring program by the end of 2016, with cumulative pre-tax savings from the restructuring to be at the high end of its previously announced range of $120 to $140 million by the end of 2017. The company's transformation in recent years has succeeded to push the company's shares near all-time highs, but now growth in its product categories are slowing, market share growth is slowing and its shares already reflect favorable commodity pricing for its products. Although KMB will benefit long-term from continued penetration in emerging markets, slowing near-term earnings growth makes the company's shares pricey. Near term, however, KMB's market share growth in important markets such as China, Brazil and Russia is slowing as competitors continue to invest in such markets.

KMB's most recent earnings report saw earnings grow several percent from the year-ago quarter due to organic sales growth, cost savings, input cost deflation, margin improvements and lower tax rate that more than offset adverse currency effects and rising marketing expenses. Revenue, however, decreased mainly due to adverse foreign currency effects. Excluding adverse currency effects, the company's organic revenues increased due to increased volumes and organic sales growth in developing and emerging markets. Adjusted operating profit (excluding restructuring costs) increased due to organic sales growth and cost savings from the company's cost reduction strategy. The company experienced a decrease in input costs, but adverse currency effects and higher administrative and selling costs offset such input cost declines. As one can see from KMB's most recent earnings report, the company's revenue growth continues to be inhibited by adverse currency effects. With respect to earnings, the company can only benefit so much near term from its restructuring strategy in the face of slowing near-term growth in emerging markets. Therefore, we suggest potential investors avoid the company's shares near term despite an almost 3 percent dividend yield given the headwinds the company faces and the fact that such shares are currently overpriced. Long term, however, KMB has too many options such as its innovative product and marketing development abilities, cost controls and targeted acquisitions to reignite revenue and earnings growth.

First quarter 2016 earnings

In late April 2016, KMB announced adjusted earnings of $1.53 per share, a 7.7 percent increase from the year-ago quarter due to organic sales growth, cost savings, input cost deflation, margin improvements and lower tax rate that more than offset adverse currency effects and rising marketing expenses. The company's revenues were $4.476 billion, a 4.6 percent decrease from the year-ago quarter due to adverse foreign currency effects. Excluding adverse currency effects, the company's organic revenues increased 2 percent from the year-ago quarter due to increased volumes and organic sales growth in developing and emerging markets. Adjusted operating profit (excluding restructuring costs) increased 0.4 percent from the year-ago quarter to $818 million due to organic sales growth and $95 million of cost savings from the company's cost reduction strategy. The company experienced a decreased in input costs, but such input costs were offset by adverse currency effects and higher administrative and selling costs.

Revenue for ADP's personal care products division decreased 4 percent from the year-ago quarter to $2.2 billion due adverse currency. Operating profit for the division decreased 1 percent to $449 million due to adverse currency effects and increased marketing, research and general spending, offset by organic sales growth, cost savings and lower input costs. Revenue for the company's consumer tissue division decreased 5 percent from the year-ago quarter to $1.5 billion due to adverse currency effects and product mix offsetting higher selling prices. Operating profit for the division decreased 4 percent to $280 million due to adverse currency effects more than offsetting cost savings. Revenue for the company's K-C professional and other division decreased 4 percent to $0.8 billion from the year-ago quarter due to adverse currency effects and product mix offsetting higher selling prices and improved volumes. Operating profit for the division increased 12 percent to $150 million due to organic sales growth and cost savings, partially offset by adverse currency effects.

ADP expects adjusted earnings per share for 2016 to be from $5.95 to $6.15, a 3 percent to 7 percent increased from the prior year. The company expects organic sales to increase 3 percent to 5 percent in 2016.

Our view

While we believe that KMB's shares are overpriced near term that does not mean we do not believe that the company will not excel long term. All that we are trying to convey to readers now is that you should avoid the company's shares until the company's shares sell off by about 15 percent to 20 percent. Long-term, however, the company will excel because it has a strong brand portfolio of products, a history of innovation and cost restructuring activities that will continue to enable it to offset any adverse input costs and currency effects. Further, while KMB also faces competition from start-up companies selling products into the organics category, we see no reason why KMB will not be able to effectively compete in such category through internal innovation and acquisition of start-up companies participating in the organic premium product marketplace. In addition, over the long term KMB will be able to increase revenue and earnings growth by expanding into non-traditional categories, a focus on emerging markets and through innovation that will allow it to increase prices. Adverse unfavorable demographics, however, such as low birth rates will continue to adversely effect the company's baby care businesses.

KMB's shares trade at a forward price-to-earnings ratio of 21.50 based on 2016 earnings estimates of $6.10 and 19.90 based on 2017 earnings estimates of $6.58. KMB's price-to-earnings ratio for the previous 10 years has ranged from 10.4 to 19. Therefore, KMB's shares are overpriced with respect to earnings estimates for 2016 and 2017. We believe that a potential investor in KMB's shares should wait for share price to pull back to a range of $102.00 to $108.50 to establish a full position (a forward price-to-earnings ratio in the range of 15.5 to 16.5 based on 2017 earnings estimates).

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Disclosure: I am/we are long KMB.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.