- Kimberly-Clark is often viewed as a recession-proof safe haven investment because it sells goods that see very little demand destruction under most circumstances.
- While the assumption about the demand for Kimberly-Clark products being recession-proof is correct, the current recessionary pressures are of a supply-side nature.
- Kimberly-Clark is not immune to threats to its operations due to supply issues. It needs energy, materials, transport logistics for inputs, and transport of finished goods.
- Some of its operations may also be exposed to trade and geopolitical frictions.
- Even though the threat of a recession seems to be rising, I decided to sell about 2/3 of my KMB stock position, in order to diversify to manage risk.
Investment thesis: After decades of the world being used to worrying exclusively about demand issues when it comes to economic slowdowns, we are now seeing the emergence of a new era, where supply issues are more likely to dictate the shape of economic cycles. Kimberly-Clark Corp. (NYSE:KMB) has been thought of as a safe-haven stock that investors saw as a safer option to be invested in when things get bad. A somewhat decent dividend offering made it a great option for riding out rough market turbulence over the decades.
The nature of the latest market upheaval makes Kimberly-Clark a less attractive safe haven option, mainly due to the fact that it has significant exposure to global supply chain disruptions, which is one of the main factors that are driving the current stock market. At the same time, it does produce many products that most people are unwilling to give up on in favor of spending on other goods, in other words, we consider them to be necessities of life, before many other goods or services. In this respect, Kimberly-Clark has a relative advantage within the context of consumers increasingly cutting back on discretionary spending in order to cover the costs of necessary goods and services. KMB should increasingly be thought of in these terms as an investment option, rather than as a safe-haven investment in the face of market & economic turbulence.
Kimberly-Clark Q2 financial results:
KMB sales increased by 7% in the second quarter of the year compared with the same period a year earlier. At the same time, the cost of products sold rose by 9%, meaning that profitability is being squeezed. For the first two quarters combined, the cost of sales increased 11%, even as sales increased by 7%, meaning that there is a significant squeeze equivalent to 4% of revenues. For the six months of 2022, net income declined by 3%, mostly on the back of higher costs of goods sold, coming in at $960 million, on total revenues of $10.2 billion. The net profit margin came in at 9.4%, which is still quite healthy. It is perhaps a reflection of the fact that KMB has enough pricing power to pass on the greater part of the increase in the costs of production.
KMB's product lineup amounts to a largely non-discretionary profile.
Before I delve into the evolving reshaping of the US and the global economy that makes for a strong case for investors to seek out companies that produce goods that consumers will see as absolutely essential to their basic well-being, I want to just briefly make my argument for why KMB fits the profile.
Most often, we think of essential goods and services as food & shelter. This may well be true, but certain goods & services do qualify as near-essential. For instance, disposable diapers, both for infants and adults probably fit in this category for the overwhelming majority of people in the developed world. For instance, between giving up on disposable diapers in favor of reusable, or giving up on buying that new couch, most consumers would prefer the latter if faced with the choice. Even when it comes to other essentials such as food, I am sure that many people would prefer to plant a garden, and perhaps raise some poultry around the house rather than having to deal with the daily inconvenience of washing reusable diaper cloths.
Bottom line is that KMB products do have staying power on people's list of essentials, which is why it is generally thought of as a safe haven stock, one wants to own when hard times hit. Even so, we have to reconsider the viability of the argument that it is a safe haven stock, given new dynamics that we see emerging. Supply chain disruptions, the steady rise in input costs, and other factors that define the current onset of rough times ahead mean that KMB can no longer be considered a defensive stock because it can be hit by supply chain disruptions, spiraling production costs, as well as geopolitical disruptions in supplies or sales, same as any other major multinational company. These risks have to be priced in, but perhaps the risks are more than offset by the fact that its sales are not likely to be heavily impacted on the consumer demand side. This makes for a different investment dynamic within the context of a stagflationary global economic environment for the foreseeable future.
The odds of a stagflationary economic environment persisting keep rising.
In order to understand the arguably new role of KMB's products on the market, we have to gain a better understanding of the fundamental changes taking place within the market itself. Much of the Western World is being confronted with a massive surge in inflation, after more than a decade of worries about stagflationary pressures. At the root of the stagflationary trend is a sustained decline in the World's ability to produce as much of everything that the consumer market demands.
We should keep in mind that higher prices also come with rising interest rates, which are set to converge on the consumer, delivering a multi-directional squeeze. In other words, the price of everything is going up, for many people at a faster rate than the rise in their incomes, while the cost of borrowing in order to buy certain items is also going up. For instance, the average loan rate on credit cards is at the highest level since just before the COVID pandemic, and in my view, we will see the highest rates of the current century so far, within months.
Nominal average hourly wage growth year over year is lagging significantly behind official inflation rate growth.
The difference is not dramatic by any means, but behind those averages which are already bleak, we certainly have many people and households that are falling behind, even as others may be getting ahead. Individuals and households that are falling behind are certain to cut spending, as their incomes can no longer keep up while borrowing on credit cards and other lines of credit is starting to be more and more expensive. Those who are getting ahead, in other words, their incomes are more than keeping up with inflation are not all likely to spend all of their net earnings gains on consumer goods. The net result is therefore an outcome that can only lead to consumer demand growth that is going to be stagnant at best, while in a worst-case scenario, it can start to crater.
US inflation numbers as of late are suggesting that we may have turned the corner, and inflation is now set to start declining. I disagree with this view. I think it has been only a temporary reprieve, as I shall explain in greater detail in an upcoming article. Oil prices pulled back significantly from recent highs earlier this year, which helps to moderate inflation throughout the economy. It would be a mistake to assume that this trend will continue. The global oil supply outlook looks grim for the foreseeable future. Natural gas, as well as many other crucial resources, are also seeing a shortfall in the supply/demand balance, globally as well as regionally. Additionally, we still have growing trade and other economic frictions with China, which are also contributing to a deterioration of the global supply chain.
All of this continues to be inflationary, and none of it is likely to change in the foreseeable future, even though some people are betting on slowing economic growth and bringing the commodities market back into balance. Furthermore, inflation is still rising in the eurozone, meaning that consumers in Europe are set to cut back on non-essential spending dramatically, as their wages don't come close to keeping up, and many households will be disproportionally hit by high energy prices.
This all adds up to an environment where producers of goods and services that people are less likely to do without, should outperform companies that produce goods and services that tend to be first on the consumer chopping block. Kimberly-Clark's products may not be seen as vital to survival, same as food, shelter, energy, and so on, but there are a number of products that arguably are non-discretionary, like disposable diapers, both for infants as well as for adults. There are many more products and services that consumers will be willing to cut before they opt for non-disposable alternatives.
Summing it all up KMB stock should no longer be traded as a safe haven asset meant to serve as a shelter within the context of hard times. Hard times are here to stay for the foreseeable future and there are increasingly few risk-free assets out there. KMB is faced with supply chain disruptions just like any other multinational company. There are always prospects of geopolitical flare-ups that can disrupt production, transport, as well as product sales. KMB products are sold in 175 countries and it has production facilities all over the world, and its risk profile needs to be evaluated accordingly.
The risk profile may have worsened as a result of growing global instability, but at the same time, this may no longer be a company that investors should generally discard in search of better returns elsewhere when there will be periods where things will seemingly be looking up. Better returns that beat inflation will be increasingly hard to come by within the current economic environment. Kimberly-Clark should be able to keep up with inflation in terms of sales versus the cost of sales. Its stock price should accordingly keep up with inflation rates.
In addition, it has a solid dividend payment history, which combined with its potential stock price appreciation in nominal terms, could potentially beat inflation rates, as well as perhaps overall average market returns in coming years. In response to the higher risk factors, related to circumstances I discussed in this article, I reduced my position in KMB recently by two-thirds in order to reach my goal of not having many stocks in my portfolio that exceed more than about 3% of the total portfolio's value. In the absence of signs of a major regional market disruption that could potentially disrupt a significant part of its total operations for a prolonged period, I intend to continue holding KMB stock in my portfolio for the foreseeable future.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of KMB either through stock ownership, options, or other derivatives. 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.
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