2023-04-30 05:15:20 ET
Summary
- Kimberly-Clark's 1Q23 earnings were strong, with a 5% increase in organic sales due to higher net price realization.
- Inflation may also strain consumers' ability to spend, prompting a shift toward cheaper private label alternatives.
- KMB stock is currently trading at an all-time high of 22x forward earnings, which is above its average of 18x and a reversion to the mean could result in 20% downside.
Overview
Kimberly-Clark Corporation ( KMB ) produces and distributes a wide variety of household goods. Diapers, tissues, paper towels, etc., are just a few examples. Recently, KMB announced its results for the 1Q23 , and they were surprisingly strong, leading to a beat and rise. Things look good for the time being, but growth could be weaker than expected this year. While the current inflationary environment has been beneficial for KMB pricing growth strategy, it will eventually put a strain on consumers' ability to spend, prompting a shift toward cheaper private label alternatives. While FY23 numbers are likely to be achievable, I believe the valuation has already factored in the optimistic outlook this year, and so I am recommending a hold rating. The current valuation of 22x is also at its 10 year high, which means we would eventually see a reversion to mean of 18x - which is around 20% downside to the stock.
1Q23 earnings
KMB's organic sales increased by 5% in 1Q23, with price growth offsetting some of the volume declines. Significantly higher price realization was the primary factor in the better-than-expected outcomes. Consumer Tissue has significantly outperformed its other divisions in terms of net price realization. There was expansion in the Personal Care and KCP categories across all significant regions, with the highest rates of growth in North America and other developed markets. The increase in gross margin, to 33.2%, was due to higher net price realization, which more than made up for input cost inflation.
Growth outlook
My primary concern with KMB growth is that it is being driven primarily by price increases while volume declines. A drop in sales volume is indicative of waning consumer demand as the trade-down effect of rising prices is felt more keenly. KMB was one of the first to raise prices early last year, but it will be up against a tough comp starting 2H23, so the benefits it has seen from its price increases so far will likely diminish. As KMB begins to comp again against a higher base from last year and faces headwinds from FX, I anticipate a slowdown in growth moving forward. This seems to support management's growth guidance of 2-4%. The good news is that the revenue growth program was effective, driving the growth in pricing rather than simple price increases. This indicates that management could possibly raise prices further again (one last push) in order to meet its FY23 guidance. However, once the pricing effect begins to wane, a return to growth in volume would convince me that the situation is better than I had anticipated.
Margin
Strong top-line growth, driven primarily by pricing, and COGS-level cost savings combined to increase gross margin by more than 300 basis points. As a result of the growth in gross profit and the decrease in operating expenses, adjusted operating margin increased by nearly 300 basis points. Given the recent trend in oil prices, which has led to an increase in the cost of many other raw materials, the increase in gross margin came as something of a surprise. I am not well-versed in commodities, so I cannot give a reliable forecast for the future of raw materials prices. However, I would compare it to the fact that KMB costs are still significantly higher than 2019 levels (based on management commentary). So, I think the raw material costs can still go down, which will help the company's gross margin. According to the company's historical gross margin data, KMB is currently operating at a margin that is below its average. This appears consistent with management's expectations as well, as they anticipate input costs to moderate in 2H23, resulting in its forecast of continued gross margin growth for the rest of the year. But as I mentioned up top, KMB will begin lapsing previous pricing actions in 2H, meaning the expected gross margin expansion won't be as large in absolute terms as it has been in recent quarters.
Valuation
KMB is currently trading at an all-time high of 22x forward earnings, which is 4x higher than its average of 18x. I'd also like to remind readers that KMB stock typically trades at a 1x ratio to the S&P, and it is currently at 1.2x. According to consensus estimates, EPS will increase by around 27% to $7.51 in FY25. If we assume that multiples will have re-rate to a normalized level of 18x by then, the total return excluding dividends will be 7%. With a 3% dividend yield, the total return over three years would be 15%, or 5% per year. In today's market, where the three-year treasury yield is 3.7%, I believe this return profile is not appealing enough.
Conclusion
KMB 1Q23 earnings results were strong, with organic sales increasing by 5% primarily due to higher net price realization. However, the growth outlook for the company is a concern as it is being driven primarily by price increases while sales volume declines, indicating waning consumer demand. Additionally, the current inflationary environment may eventually strain consumers' ability to spend, prompting a shift toward cheaper private label alternatives. While the company's FY23 numbers are likely to be achievable, the current valuation already factors in the optimistic outlook for this year, and it is at its 10-year high. Therefore, I recommend a hold rating.
For further details see:
Kimberly-Clark: Expectations As Well As The Valuation Are High