2023-06-06 20:36:48 ET
Summary
- Kimberly-Clark's dividend consistency is impressive, but the stock is fairly valued with little upside potential.
- The company faces numerous headwinds, including stagnating revenue, shrinking profitability metrics, and a weak balance sheet.
- Risks to consider include adverse changes in commodity prices, fluctuations in foreign exchange rates, and declining birth rates in developed countries.
Investment thesis
Kimberly-Clark ( KMB ) attracted my attention due to its staggering dividend consistency of 50+ consecutive years of dividend increases. However, after diving deeper into the details of the company I decided not to invest. KMB faces numerous secular headwinds, which we can see in stagnating revenue and shrinking profitability metrics. A forward dividend yield of about 3.5% could have been attractive in the zero Federal Funds rates era, but not now. Overall, I assign the stock a neutral rating.
Company information
The company has a vibrant history that traces back to the nineteenth century. Kimberly-Clark manufactures various consumer products, primarily derived from synthetic and natural fibers. The company employs about 44,000 employees across more than 60 countries, according to the latest 10-K report .
The company's fiscal year ends on December 31. The business is organized into three segments: Personal Care, Consumer Tissue, and K-C Professional. Personal Care represented more than half of total sales and about 67% of operating profits in FY 2022.
Financials
Looking at the company's financials over the decade, we can describe it with just one word - "boring". I think so because there was almost no growth over the decade - the topline compounded at a 0.3% CAGR. KMB's profitability peaks are in the rear mirror since revenue stagnated while costs face inflation. For sure, KMB operates under powerful brands and has pricing power, but this pricing power did not allow the business to sustain the profitability metrics it enjoyed ten years ago.
Despite declining profitability metrics, KMB is still a profitability star among its peers. The company has an "A" Seeking Alpha Quant profitability grade, meaning that profitability ratios are substantially higher than the sector median.
Seeking Alpha
Despite stellar profitability, the company's balance sheet looks weak to me. The quick ratio is below 0.5 and the debt-to-equity ratio is massive. Capital allocation looks weird to me since the company's net debt increased almost 66% over the decade and at the same time revenues and margins stagnated. The business is rather capital intensive since the company spent on average a net of one billion dollars on investing activities. It means the company needs to spend $1 billion per year just to sustain its revenue with no growth. If we add this fact to declining operating profitability, we can conclude that at some point in the future, the company will generate cash flows only to sustain its revenue. A massive restructuring is necessary to sustain the business over the long term in my opinion. But massive restructuring is a fifty-fifty game requiring vast capital investments and a clear vision of where the company shall go to flourish. The management is unlikely to take such risky steps because unsuccessful restructuring with substantial CAPEX might make the company out of business.
If we look at recent quarters, we can see that struggles with revenue growth are still in place, though gross and operating margins expanded faster than the topline.
KMB currently faces a very challenging environment. There is not much room to improve pricing to drive revenue growth since consumer demand is declining as a possible recession looms. On the other hand, the company faces inflation from the costs side, which includes both salaries of staff and elevated commodity prices in comparison with the past decade's averages.
Valuation
KMB is a dividend aristocrat with unmatched dividend consistency. Therefore, the dividend discount model [DDM] would be the best option for stock valuation. Valueinvesting.io projects the company's WACC at 7.5%, which I consider fair. FY 2024 dividend consensus estimate is at $4.97 per share. I use 4.3% for dividend growth, which aligns with the company's historical average and forward change in FCF.
Incorporating all the mentioned assumptions into the DDM formula returns me a fair stock value of about $155, indicating a 14% upside potential. The upside potential might look attractive, especially considering other shareholder dividend returns.
Author's calculations
On the other hand, Seeking Alpha Quant suggests that current valuation ratios are higher than 5-year averages. Given rising recession fears and uncertainty regarding Federal Funds rate near-term policy, I consider it reasonable, i.e., investors seek more predictable stock returns in a potentially volatile environment.
Let me also run a discounted cash flow [DCF] simulation to get more evidence. I use an optimistic 3% revenue CAGR over the next decade and expect the FCF margin to expand steadily from 7.5% in FY 2023 to almost 8% in FY 2032. I use the same WACC as I did for DDM. Incorporating these assumptions into the DCF template returns the business's fair value at about $ 41 billion, about 12% lower than the current market cap.
Overall, mixed signals from different valuation approaches suggest the stock is within an acceptable price range with little upside or downside potential.
Risks to consider
KMB faces a significant risk of adverse changes in commodity prices. The company has no power over raw materials prices and we can see it in the steadily declining profitability metrics. KMB's profitability is highly dependent on the price of wood, pulp, and petroleum-based inputs. And, according to Goldman Sachs , the long-term commodity supercycle is expected. It is an unfavorable secular factor for the company.
KMB's products are sold across the world, meaning the company is vulnerable to fluctuations in foreign exchange rates. Trading globally also means elevated risks of potential changes to international trade rules and laws.
Plummeting fertility rate , especially in the developed world, is also a risk for the company. In FY 2022, baby and childcare products represented 35% of KMB's revenue, which is significant. Europe and North America have seen persistently low fertility rates since the 1970s, and the trend continues. The total demand pie is not growing, together with Intensifying competition in the childcare industry means that KMB's market share in this niche is under significant threat.
Bottom line
To conclude, KMB stock is fairly valued with little, if any, upside potential. The dividend consistency of the company is impressive, and the dividend yield looks attractive, especially relative to the remarkable dividend safety. But still, I am not investing because I believe there are more attractive value stocks in the market. I think so because the dividend yield is lower than the current yields of Treasury securities, which are risk-free. Therefore, I assign KMB a "Hold" rating.
For further details see:
Kimberly-Clark: A Boring Dividend Aristocrat