Kimberly-Clark, P&G Both Good Defensive Bets

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Includes: KMB, PG
by: Takeover Analyst

With concerns looming over a double dip, investors should consider low-beta stocks as opposed to rushing to traditional debt securities. The personal products industry offers a defensive play against macro headwinds. Since 2008, the stocks of Procter & Gamble (NYSE:PG) and Kimberly-Clark (NYSE:KMB) are down 15.4% and 1.6%, respectively, while the S&P 500 is down by more than 16%. Both firms have betas below 0.5 and return a good amount of cash through dividend distributions. Kimberly-Clark's dividend yield is an impressive 4.08%, Procter & Gamble's a more modest 3.4%.

From a multiples perspective, both are slightly undervalued at 13.1x forward earnings for Kimberly-Clark compared to 13.7x for Procter & Gamble. Analysts currently rate the former a "hold" and the latter a "strong buy", although I view both trading at roughly the same discount to intrinsic value. Procter & Gamble may have stronger brands, but its competitor is making major progress in pricing, supply chain improvement, and cost cutting. In addition, Kimberly-Clark is the less volatile of the two stocks, and has a major opportunity for market share growth in the emerging markets. As I previously argued, Procter & Gamble is also more vulnerable to the macroeconomy than what meets the eye, given substantial exposure to Europe and substitute products.

At the third quarter earnings call CEO Tom Falk provided his outlook for the consumer goods firm:

We expect our momentum with revenue realization and targeted growth initiatives to continue, led by K-C International, while continue to operate financial discipline, focusing on cost savings, control of overhead spending and cash generation...

In terms of sales, we've taken our volume growth assumption to the low end of our 1% to 2% target range. This reflects somewhat lower expectations for portions of the develop markets, particularly in the North American infant and child care categories. In addition, as a result of the recent strengthening of the U.S. dollar, we expect less benefit from changes in currency rates in our previous plan. The weaker Mexican peso has also caused us to lower our expectations from our equity income from K-C to Mexico. On the other hand because commodity costs have moderated in some from the peak levels that we experienced this summer, we now expect about $100 million less cost inflation in 2011 than we previously estimated.

So putting it altogether, we're now targeting our 2011 adjusted earnings per share to be in the range of $4.80 to $4.90 per share.

The results were roughly in line with expectations, as organic sales grew by 3%. At the same time, the weak performance in personal care operating margins -- down 300 basis points from the same quarter of last year -- was disconcerting. I model operating margins declining from 33.2% in 2010 to around 32.4% by 2013 if this trend is not abated within the next quarter. That said, the market position of Kimberly-Clark remains solid with shares up or even in the year to date for 6 of its 8 consumer businesses. Top line and margin growth in emerging markets should help offset inflation and the implications of unstable volumes elsewhere.

Kimberly-Clark's top brands include Kotex, Depend, Kleenex, Huggies, and Snugglers. By contrast, Procter & Gamble has a much larger slew of recognizable names: Vicks, Charmin, Mr. Clean, Pringles, Tide, Bold, Bounty, Duracell, Old Spice, CoverGirl, Tampax, Oral-B, Gillette, and Fusion. I like how Procter & Gamble's product portfolio has broader applications than its competitor, and in that view it is the competitor to beat.

From a liquidity perspective, both are burdened with a fair amount of leverage. Kimberly-Clark has $6B worth of net debt on its balance sheet, which represents 22.2% of market value, while Procter & Gamble has $30.3B worth of net debt, or 17.6% of its market value. Reducing leverage would decrease the risk of both firms, although Kimberly-Clark stands to better penetrate the market through debt financing.

As I described earlier, Procter & Gamble could substantially benefit from a restructuring in order to unlock shareholder value. Stripping assets where there are risks from substitute products can help clean off the balance sheet and make investors more confident about future payouts. I would even be in favor of increased marketing in remaining segments to saturate high-margin businesses.

Consensus estimates for Kimberly-Clark's EPS are that it will increase by 3% to $4.82 in 2011 and then by an average of 8.45% in the follow years. My model forecasts revenue expanding by a CAGR of roughly 4.5% over this same time period.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.