By Brian Nelson, CFA
From where we stand, leaders in the consumer staples (VDC) industry cannot successfully price ahead of inflationary headwinds to drive operating profit expansion, and many are experiencing gross margin huge pressure. Not only that, but in many cases we believe branded commodities are experiencing demand (volume) destruction as consumers balk at price increases that still fail to offset the cost environment. increased.
At Kimberly Clark (NYSE: KMB) first-quarter results, released April 22, organic sales rose 10% on the back of a 6% increase in net selling prices, but that was not enough to offset inflationary headwinds. First-quarter adjusted operating income fell to $629 million in 2022 from $804 million in 2021, despite strong revenue performance and price increases. The company’s quarterly diluted earnings per share also fell to $1.35 from $1.80 a year ago, down about 25%.
It is clear that even if consumer staples entities raise their prices, it is not enough to keep operating profit in the right direction, and many investors are increasingly concerned about the type of price increases necessary just to maintain the level of operating profit. lead to a tangible destruction of demand and create a whole series of other problems with regard to volumes. Kimberly-Clark, for example, was “affected by a $470 million increase in input costs, driven by pulp and polymer-based materials, distribution and energy costs” in the first quarter of 2022.
Not only does it appear that inflationary headwinds will dampen Kimberly-Clark’s earnings performance for some time, but the company has net debt of $8.6 billion at the end of March 2022. With shares trading at a high level of 19.6x forecast for 2023 according to Yahoo Finance, downside risks to its stock price increase given these important valuation considerations. Additionally, Kimberly-Clark’s roughly 3.5% dividend yield may not provide enough price support to stem a valuation readjustment, should earnings really start to be hit by utility cost inflation. inputs.
Kimberly Clarkit is Investment Considerations
Kimberly-Clark is best known for its consumer personal care and facial tissue brands (“Personal Care” products account for half of its revenue). The main brands are Huggies, Kleenex, Scott, Kotex, Cottonelle, Depend, Pull-Ups and WypAll. Its products have the #1 or #2 position in ~80 countries. Kimberly-Clark was founded in 1872 and is based in Dallas, Texas.
Kimberly-Clark is a dividend aristocrat who, as of 2022, has increased her annual payout for the past 50 consecutive years. The company is a tremendous generator of free cash flow, even if its net debt is quite large. Share buyback programs are common.
Kimberly-Clark uses acquisitions, brand strength, scale and digital marketing campaigns to increase its presence in developing and emerging markets while maintaining strength in established markets. Inflationary pressures have been significant lately, and Kimberly-Clark is looking to price increases and cost structure improvements to offset these headwinds.
Kimberly-Clark completed its approximately $1.2 billion acquisition of Softex Indonesia, which generated approximately 80% of its revenue from diaper sales under brands such as Sweety and Happy Nappy, in October 2020 through a all-cash deal. The company is looking rather favorably on its growth path in Indonesia.
Kimberly-Clark recently completed its “2018 Global Restructuring Program” which involved exiting some low-margin businesses. Looking ahead, its “Focused On Reducing Costs Everywhere” or FORCE program should improve its cost structure over time.
Analysis of Kimberly-Clark’s economic benefits
The best measure of a company’s ability to create value for its shareholders is expressed by comparing its return on invested capital to its weighted average cost of capital. The gap or difference between ROIC and WACC is called the economic profit gap of the firm. Kimberly-Clark’s 3-year historical return on invested capital (excluding goodwill) is 32.5%, which is higher than its cost of capital estimate of 9%.
As such, we give Kimberly-Clark an EXCELLENT value creation rating. In the chart below, we show the likely trajectory of ROIC in the coming years based on the estimated volatility of the main drivers of the metric. The solid gray line reflects the most likely outcome, in our view, and represents the scenario that results in our estimate of fair value. Although we expect blows at Kimberly-Clark in the short term, we believe it will continue to generate economic benefits for shareholders.
Kimberly-Clark Cash Flow and Valuation Analysis
We think Kimberly-Clark is worth $130 per share with a fair value range of $104 to $156.00. The margin of safety around our estimate of fair value is determined by the company’s LOW ValueRisk rating, which is derived from an assessment of the historical volatility of key valuation factors and a future assessment of these.
Our near-term operating forecasts, including revenue and earnings, do not differ materially from consensus estimates or management guidance. Our model reflects a revenue compound annual growth rate of 3.1% over the next five years, faster than the company’s historical 3-year compound annual growth rate of 1.7%.
Our valuation model reflects a projected 5-year average operating margin of 16.5%, which is above Kimberly-Clark’s 3-year average. Beyond year 5, we assume that free cash flow will grow at an annual rate of 2.9% for the next 15 years and 3% in perpetuity. For Kimberly-Clark, we use a weighted average cost of capital of 9% to discount future free cash flow.
Kimberly-Clark Margin of Safety Analysis
Our discounted cash flow process evaluates each business based on the present value of all future free cash flows. Although we estimate the company’s fair value at approximately $130 per share, each company has a range of likely fair values that is created by the uncertainty of key valuation factors (such as future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn’t see much volatility in the markets because stocks would trade precisely at their known fair values.
Our ValueRisk Rating defines the margin of safety or range of fair value we assign to each stock. In the chart above, we show this likely range of fair values for Kimberly-Clark. We think the company is attractive below $104 per share (the green line), but quite expensive above $156 per share (the red line). Prices that fall along the yellow line, which includes our estimate of fair value, represent a reasonable valuation for the business, in our view.
In light of the company’s outsized net debt, operating profit pressures that may be greater than expected in future years, and the high earnings multiple implied by our fair value estimate, investors can look more specifically down the fair value. estimated value between $104 and $130 for the shares (the company is trading over $130 at the time of this writing). Caution may be in order.
Kimberly-Clark has a strong operating and dividend track record. In business for 150 years and raising its annual dividend for 50 consecutive years, it puts Kimberly-Clark on the coveted list of dividend aristocrats. Its products have the #1 or #2 position in ~80 countries. It recently completed its “2018 Global Restructuring Program” and is focusing on its “FORCE” cost reduction program. The strength of the Kimberly-Clark brand is undeniable with some of its key brands including Kotex, Scott, Depend, Kleenex, Huggies, Pull-Ups, Cottonelle and WypAll. The company is a tremendous generator of free cash flow.
The enormous strength of the Kimberly-Clark brand makes its business resilient, but slowing international population growth due to societal changes in countries like China could, for example, put pressure on sales of diapers (the products of “personal care” accounts for about half of its annual sales). The business is also subject to volatility in currency exchange rates and commodity markets, which can put pressure on earnings at various points in the economic cycle. Competition and inflationary pressures have been intense of late, and we don’t particularly like its net debt position, although we expect Kimberly-Clark to continue to steadily increase its dividend going forward. Still, a 3.5% dividend yield may not provide enough support for Kimberly-Clark’s share price if inflationary pressures weigh further on earnings forecasts over the next two years.
This article or report and any links it contains are for informational purposes only and should not be considered a solicitation to buy or sell any securities. Valuentum is not responsible for any errors or omissions or results obtained from the use of this article and assumes no responsibility for how readers may choose to use the content. Assumptions, opinions and estimates are based on our judgment as of the date of the article and are subject to change without notice.