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Kimberly-Clark: The Favorable Industry Outlook Ensures The Safety Of Dividends

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About: Kimberly-Clark Corporation (KMB)
by: Dilantha De Silva
Dilantha De Silva
Long/short equity, value, growth at reasonable price, research analyst
Summary

Kimberly-Clark has failed to grow its revenue in the last 10 years, but things are finally set to change with the promising industry outlook.

Growth will likely come from all of its business segments, but the highlight would be the increase in demand for adult diapers and adult care products.

The cost optimization initiatives are helping profit margins, and so is the restructuring program.

Shares yield 3.1% at the current market price of around $133.

Investment thesis

Kimberly-Clark (KMB) shares have gained 28% in the last 12 months, trumping the performance of the broad market and its industry peers, as measured by the S&P 500 Index and the Consumer Staples Select Sector SPDR ETF (XLP).

(Source: Reuters)

This stellar performance came on the back of a top line decline of 0.45% in the trailing twelve months period.

The future looks promising for Kimberly-Clark, mainly due to the market opportunities that are opening up on a global scale. Profit margins will also improve in the future as the cost-cutting initiatives and the business restructuring plan gain traction. Shares are trading slightly below my fair value estimate, and the dividend yield of 3%, which comes on the back of a safe dividend, makes KMB a buy for income investors.

Company overview and business strategy

Kimberly-Clark Corporation is a manufacturer and marketer of personal care and consumer tissue products. The company operates under 3 primary business segments - Personal Care, Consumer Tissue, and K-C Professional - and distributes a range of products under each of these categories.

Personal Care and Consumer tissue segment

K-C Professional segment

Disposable diapers

Wipers

Training and youth pants

Tissues

Swimpants

Soap

Baby wipes

Apparel

Feminine and incontinence care products

Sanitizers

(Source: Company filings)

Founded in 1872, Kimberly-Clark currently has 5 brands with sales exceeding a billion dollars. These brands have literally helped the company become the consumer staples giant it is today, and management has identified the importance of investing to ensure the continued growth of brand awareness across the globe.

Billion-dollar brands

(Source: Company presentation)

The company focuses on improving the sales from its core brands and gaining market share in Asian markets, which are expected to grow at much higher rates than the U.S. and other developed countries.

Another business strategy is to monitor operating expenses carefully to identify money-saving opportunities. A cost optimization plan, along with a restructuring plan, has already been introduced to achieve this objective.

Distributing wealth to shareholders is another business priority, which the company has honored for decades through dividends and buybacks.

Industry analysis

The outlook of the global baby care market, adult diapers market, and the feminine care market could impact the revenue and earnings of Kimberly-Clark, as the company has a presence in all these industries.

A research report released by the Market Insights projects the global baby personal care market to grow at a compounded annual growth rate (CAGR) of 6.3% through 2025 to a value of $90.1 billion from $55.4 billion in 2019. The drivers of the market include the increasing wealth of parents across the globe (especially in underdeveloped regions such as Asia) and the growing focus on providing better healthcare solutions for babies. According to Grand View Research, the toiletries segment will grow at the highest rate due to the increased demand for disposable diapers and baby wipes.

Asia would be at the center of this expected growth, as income levels are rapidly rising and a middle-class society is emerging in densely populated regions such as India. Data from Reuters indicate that the GDP per capita in India will continue to grow at high-single digit rates through 2024.

India - GDP per capita growth

(Source: Reuters)

Fertility rates will also play a part in the growth of the industry, and African countries lead the table, with Niger topping the list at 7.153 children per woman, followed by Somalia at 6.123 children per woman. Higher childbirths in these regions might not translate into growth opportunities for Kimberly-Clark and its peers due to the low penetration of baby care items in Africa, probably due to the low level of income.

Importantly, the fertility rates in China and India are at 1.635 and 2.303 children per woman, respectively. Though these numbers are well below that of Africa, Europe and the U.S. have much lower expectations. With projections for a higher level of disposable income in the next 5 years, coupled with better-than-average fertility rates, the Asian region will be the driver of the baby personal care industry.

The disposable incontinence products market is also expected to grow exponentially in the future. According to data from Global Market Insights, this market will cross the $15 billion market by 2025, with a CAGR of 7.1% from 2019 to 2025. The U.S. currently holds the number one position from a total sales perspective, but the Indian market is projected to grow at a much higher rate through 2025.

(Source: Global Market Insights)

The primary demand driver for this industry is the growing number of adults over 40 suffering from incontinence in both developed and developing regions in the world. For instance, according to data from the National Health Service, between 3 and 6 million people suffer from some form of urinary incontinence in the United Kingdom.

On a global scale, more than 423 million people were reported to have incontinence-related problems at the end of 2018.

(Source: The Global Forum on Incontinence)

Incontinence is positively correlated with age and is more common with women than men. However, as the population gets older, this gap is expected to decline.

(Source: The Global Forum on Incontinence)

Despite the millions of adults who are suffering, according to data from Reuters, less than half are actively using adult diapers to combat this health condition. A Reuters poll conducted in the U.S. indicates that many adults are embarrassed to seek medication for incontinence and use diapers. However, along with technological developments and increased awareness on health-related matters, many adults would feel comfortable to use diapers in the future, which presents a robust growth opportunity for Kimberly-Clark.

Once again, the Asian region will prove to be the driver of this industry. For instance, according to data from the Global Forum on Incontinence, there are more than 236 million patients in Asia at the moment, which is more than half the total number of patients in the world.

The aging population will only increase the addressable market opportunity for the company. The latest data from the United Nations reveal that one in six people (16%) would be over 60 years or older by 2050, in contrast to just one in eleven (9%) in 2019. Life expectancy is on the rise as a result of improving healthcare facilities around the world, and many developing countries are focused on providing free healthcare to adults.

These developments paint a very positive picture of the outlook for manufacturers of adult diapers and sanitary products, including Kimberly-Clark.

The feminine care industry is expected to grow at a CAGR of 6.8% through 2023 to $52 billion. There are multiple tailwinds for the industry. The increasing awareness about hygiene among women and the growing preference for sanitary products in Asia are the two primary drivers of the industry.

Overall, the industry outlook for Kimberly-Clark is supportive of long-term growth. The increasing competition in the industry and the commodity-like nature of consumer tissues which limits the pricing ability of the company would turn out to be headwinds in the future. However, the expected growth in baby care products and the new market opportunities available for its adult care products will more than offset the loss arising from these challenges.

Financial performance

The return on invested capital (ROIC) averaged 21% in the last 5 years, which is an indication of the high-quality earnings profile of Kimberly-Clark. The ability to price products better has certainly helped the company achieve such high margins, even when the competitive landscape has been challenging, particularly due to the rise of new players in the industry. Even if ROIC deteriorates in the future as a result of growing competition, Kimberly-Clark would still be able to earn returns in excess of its cost of capital of around 8.5%. This guarantees economic profits for the company, as well as shareholders’ returns.

Erin Lash, Senior Director of Morningstar who covers Kimberly-Clark, believes that ROIC would average just above 25% in the next 5 years. In her report, she cites the presence of a narrow economic moat resulting from the massive scale of the company and intangible assets such as the brand value as reasons for this expected expansion of ROIC.

Revenue, however, has remained flat during the last 10 years, which is one of the reasons why many investors are waiting on the sidelines.

(Source: Company filings)

In the third quarter of 2019, the company reported organic sales growth of 4% and a total change of 1% in comparison to the corresponding quarter of 2018, driven by the positive impact from the increase in net selling prices. However, the bulk of future gains will come in the form of volume gains due to the opportunities the company is pursuing. On the other hand, softening commodity prices do not provide many opportunities for Kimberly-Clark to hike prices.

Operating margin, on the other hand, improved 110 basis points despite higher advertising spend and selling, general, and administration expenses. The increase in the gross profit margin due to price hikes was one of the reasons behind the expansion of the operating margin. Also, the company benefited from its plan to eliminate unnecessary overheads. For instance, Kimberly-Clark saved $95 million in the third quarter with the successful implementation of its FORCE (Focused on Reducing Costs Everywhere) program and the restructuring of its business. So far in 2019, the company has saved $300 million with these initiatives, and it now plans to save around $400 million for the full year.

Dividend safety analysis

Kimberly-Clark shares yield 3.07% at the market price of around $132.60 as on Monday. The annual payout of $4.12 per share translates to a payout ratio of 60%. Importantly, the company has covered its dividend payments with free cash flow in the past, which adds a degree of safety for income investors.

(Source: Company filings)

Organic revenue growth is expected to average between 1% and 3% in the next 5 years, which should help margin expansion along with the restructuring of its business operations. As a result, operating cash flows will grow in the future, even though top line growth would not be spectacular.

Since reaching a peak in 2016, the total debt-to-EBITDA ratio has declined in the last couple of years, which indicates a strengthening balance sheet. This is also a positive sign for dividend investors.

(Source: Reuters)

The dividend distributions are safe, and the company would be able to maintain dividends at the current level for at least the next 3-5 years.

Outlook

Investing in brands and innovations is a key strategy of the company, and these cumulative expenses account for over 5% of revenue (about $1 billion), which has helped Kimberly-Clark stay competitive in the industry. In the third-quarter earnings conference call, management indicated a hike in advertising expenditures in the future, especially related to digital marketing operations. These expenditures should be looked at as investments in its most important intangible asset: the brand value of the company. Brand awareness has been the secret sauce behind the success of Kimberly-Clark in the past, and digital marketing initiatives will help the company stay on top of the competition for many years to come.

The company has shut down many of its underperforming operations, including the Western and Central European diaper business, lower-margin consumer tissue operations, and the healthcare business. This will help profit margins expand in the future, and management believes the cash savings could be allocated to further strengthen the brand value of Kimberly-Clark.

Higher commodity costs, in particular for fiber and energy, proved to be a headwind for the company in 2018. However, Mike Hsu, the CEO of Kimberly-Clark, expects fiber prices to soften in 2020, which would be favorable for the company. This positive impact could be offset by a further strengthening of the U.S. dollar, which is very probable given that global economic growth is expected to weaken in the next few years. At times like this, investors tend to flock to safe-haven assets, including the U.S. dollar.

Company management is focused on improving its revenue mix as well. In the third quarter, positive shifts in the revenue mix contributed 1% to the top line growth, which is a trend that is expected to continue. The growth in popularity of higher-margin products is necessary to implement this strategy successfully, which the company plans to do by initially offering such products at a discount.

For Kimberly-Clark, the next few years would be about benefiting from the expected growth in the industries it operates in. To do so, the company has to continue its investments in improving brand value. The cost-cutting initiatives will provide a further boost to margins as well.

Valuation

Kimberly-Clark shares are currently trading below the price-to-earnings multiple of the paper products industry. However, historically, shares have traded at a discount to the industry multiple.

(Source: Reuters)

To calculate the intrinsic value of Kimberly-Clark, I used a discounted cash flow model with the following key assumptions:

  • Average revenue growth of 0.8% in the next 5 years
  • Cost of capital estimate of 8.5%
  • An EBITDA multiple of 12 to calculate the terminal value

With these assumptions, the fair value per share comes to $140.31, which represents an upside of 5% from the current market price. An investor might look at the shares as fairly valued given that upside is limited. However, dividend investors should find KMB trading at attractive prices, especially considering the growth opportunities available for the company in the future.

Upon request, I can share the full Excel model that I used, which can easily be edited with your own assumptions (this includes all the historical averages to help investors use educated assumptions).

Conclusion

Even though Kimberly-Clark shares have appreciated 28% in the last 12 months, income investors can still find value. There are multiple growth opportunities available for the company, and the adult diapers segment stands out due to the low penetration rates at present and the growing addressable market opportunity. Shares are trading 5% below my intrinsic value estimate with a yield of just above 3%. There are no imminent threats that would impair the ability of Kimberly-Clark to honor its commitment to pay quarterly dividends at the current rate in the next few years.

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