Kimberly-Clark Is The Classical Defensive Stock

|
About: Kimberly-Clark Corporation (KMB)
by: Zoltan Ban
Summary

Given the longevity of the current cycle and growing signs that suggest some potential for an economic downturn in the next few years, it's time to look at defensive stocks.

Kimberly-Clark fits the classic profile of such a company with the right product and brand lineup.

The stock should show resilience in face of global economic difficulties, but its dividend, while decent, is not close to being the highest among defensive names.

As I pointed out more than two months ago, I am starting to look at defensive stocks in the face of what is now a very mature global economic recovery, which started all the way back in 2009. It is not so much the case that the length of the recovery dictates that a recession must now be near, but generally speaking, a number of factors tend to come into play which eventually leads to such an outcome sooner or later. In response to my own conclusion on this matter, I decided that it is time to start sifting through typical or less typical defensive stocks with the intent of starting to shift my own portfolio towards such assets, mostly having a longer-term strategy in mind. Thus far, I have covered Kraft Heinz (KHC), Procter & Gamble (PG), Lockheed Martin (LMT), and Cameco (CCJ). Of these names, I already own Cameco stock, which is not a typical defensive stock, but as I pointed out, given the nature of the uranium market, I do expect it to hold up well in the event of a recession. For this article, I want to cover the advantages and disadvantages of Kimberly-Clark (KMB), which is about as typical as it comes in terms of being a defensive stock given its product lineup and dividend offer.

Global developments affecting the odds of a recession

Before I start looking at the particular features that Kimberly-Clark offers as an investment opportunity, I want to briefly review the bigger-picture situation, which is what, in my view, warrants the precaution I feel I should start taking as an investor in order to appropriately position for the next half a decade or so. I should note that the timeline I have in mind here is the next five years or so, meaning that I am by no means trying to pinpoint the exact moment when the global economy and the stock markets will turn. I am, in effect, looking to position for a probable downturn in the next three years or so, with an eye to sell into the early stages of a new recovery.

The many factors that make another economic downturn likely in the next few years include an end to the trend of declining interest rates throughout the global economy. Since 2008, central banks around the world have been pushing interest rates down, with the positive effects lasting for many years after the monetary loosening trend ended. Government debt and mortgages were all refinanced at those lower rates for many years after interest rates flat-lined, while new debts were made within that low interest rate environment. The US Federal Reserve has been making headlines with its monetary tightening lately, but we should realize that even without that tightening, the global economy eventually stopped benefiting from ever-declining debt-servicing loads, given that most of the outstanding higher-interest debt had been refinanced at a much lower level by the time the Federal Reserve started tightening. As things look right now, it seems we are set for higher interest costs as a percentage of the global economy, because global debt growth continues to outpace the growth in the economy, while interest rates cannot go further down in order to compensate.

The trade war that is increasingly being ratcheted up is just starting to take a toll. There is always a chance that it will eventually be reversed, and perhaps we may even see lower tariffs prevailing across the board. On the other hand, it may be that it will just keep ratcheting up and we may move into other forms of economic conflict, aside from trade tariffs. We may see the active mutual undermining of each other's economies through various means among the world's largest economies, with smaller economies perhaps caught up in the middle or targeted through proxy wars as the big players play for influence.

The global geopolitical picture is not improving much either, and it could be a catalyst for another economic downturn. The situation within the EU is looking particularly glum, with Brexit still on course and still uncertain what it will look like. There is also no limit to tensions and acrimony between the remaining members of the EU, with ideological divides becoming wider between member nations and within them as well. To make matters worse, there seems to be an economic slowdown on the way, with the latest quarterly growth figures not looking particularly bright. The overall rate of growth for the EU was 1.9% compared with last year, while Germany actually experienced a quarter-on-quarter contraction of -0.2%. Italy's economy also stalled out with 0% growth compared with the previous quarter. Delivering on economic growth would be one of the prerequisites to toning down the ideological civil war that is paralyzing the EU, given that it is one of the sources of growing divisions.

While it may seem unbelievable to many, given the recent market action in oil futures, I still believe there is a strong chance of an oil price spike within the next few years. There are, of course, the geopolitical uncertainties, which can easily lead to a massive supply disruption. Then, there is also the fact that current oil prices are making it less and less likely that investment in oil exploration and production will be adequate going forward. It has arguably been inadequate since the 2014 oil price crash. It is possible that we will start seeing the effects of this in the next year or two.

Kimberly-Clark's product and brand lineup are ideally suited for hard times

With a product lineup such as Depend, Kleenex, Huggies and many other paper products meant mostly for personal care and hygiene, it goes without saying that Kimberly-Clark is well-positioned to weather most economic storms. After all, I doubt that the use of infant or adult disposable diapers would decline in the event that there would be an economic downturn. The alternative of reusable products for such use has gone out of style a very long time ago. There is, of course, the matter of competition, which may force all producers of such products into price wars as a way to preserve market share. In the absence of depression-like conditions for a prolonged period of time, I doubt that this will be a huge factor, therefore the company's brand line-up is what I would consider attractive when contemplating the possibility of a recession.

I personally think that such products have potential to continue seeing sales growth even in the event of a deep prolonged economic downturn. The global middle class will most likely continue to expand even if the global economy slows down. After all, even in the 2008-2009 period, while we were in the midst of arguably the worst economic crisis since the Great Depression, some developing world economies were still expanding at a rate that we in the developed world can only dream of doing in the best of times. Once households join the ranks of the global middle class, they tend to quickly and eagerly embrace such newfound luxuries as disposable diapers.

Kimberly-Clark's financial profile

For the third quarter of this year, the company saw a 2% decline in sales compared with last year, mostly due to foreign currency effects, which accounted for a 3% decline, while organic sales increased by 1%. This is definitely not a growth stock by any means. Of particular worry is the loss in profitability, with net earnings attributable to shareholders declining by 20% compared with the same quarter of last year. The company recorded net earnings of $451 million on revenue of $4.6 billion, which is a profit margin of 10%. A big factor in the decline in net earnings was a 6% increase in the cost of goods sold. It seems that the cost of raw material inputs is weighing on its ability to produce profits. By Kimberly-Clark's own estimates, input costs may have increased by over $700 million in the past year.

We should keep in mind that in the event of a recession, there is a strong possibility that input costs will decline. One of its main inputs being wood, we could easily see prices plunge, given that other less-essential uses such as in furniture will most likely increase market oversupply of the raw material, as global sales of such goods made of wood will most likely decline. In other words, while most companies will struggle to maintain revenues and profits whenever the next economic downturn will hit, there is a good chance that Kimberly-Clark will actually see an improvement in profitability.

As I pointed out already, I am looking at a buy and hold time frame of about five years, therefore the dividend situation becomes important - because after all, in the absence of significant gains in stock value, one might as well just park it in cash if the dividend is not enticing enough to take a risk. I do expect a slight decline in stock value in all defensive stocks in the event that there is a market-wide selloff in response to a global economic downturn, with a full recovery in stock value early on in a recovery.

Kimberly-Clark offers a 3.5% dividend, which is not at all bad, but the likes of Kraft Heinz are far more attractive in this regard with a 4.9% dividend. It is true that there is more perceived risk to Kraft's stock value, which is why its stock declined to such low levels that the dividend is now so much more attractive. Kimberly-Clark, on the other hand, is seen as a more steady, more solid company with a product lineup that, in theory, should provide investors with more security. After all, Kraft Heinz does face the ever-present threat of sudden consumer eating habits shifting, which can change dramatically with every new diet craze that comes our way. I doubt that consumers will ever move away from disposable diapers in quite the same way as they might from some particular food products, for instance. At the same time, there is nothing stopping Kraft Heinz from adapting to consumer tastes, so perhaps the risk to its stock value may not be as great as the market may perceive it to be.

At this point, I find it hard to decide whether the higher perceived safety in Kimberly-Clark stock is worth giving up on higher dividend yields from the likes of Kraft Heinz. In order to justify it, there would have to be expectations of significantly higher stock gains, comparatively speaking, over the next few years. At this point, I am not absolutely convinced that will be the case.

Disclosure: I am/we are long CCJ. 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.