2023-04-29 03:52:17 ET
Summary
- Trade-down risk remains a near-term concern for volume growth in an inflationary environment.
- Margins should continue to benefit from price increases and moderating inflation.
- Valuation is above historical averages.
Investment Thesis
Kimberly-Clark Corporation's (KMB) revenue outlook is mixed with volume decline offsetting the impact of price increases on revenue. In the short term, there are concerns about volume decline due to the risk of consumers switching to cheaper private-label alternatives in an inflationary environment. On the margin front, KMB has made good progress so far. In the coming quarters, it is likely to benefit from price increases and moderating inflation. The company is currently trading at a premium to its historical average P/E valuation and I prefer to be on the sidelines given the mixed revenue outlook and high valuation.
Q1FY23 Earnings
Kimberly-Clark recently announced Q1 2023 results that exceeded expectations. The company's revenue rose by 2% year-over-year on a reported basis, reaching ~$5.19 billion, which surpassed the consensus estimate of ~$5.02 billion. Adjusted EPS grew by 24% year-over-year to $1.67, surpassing the consensus EPS estimate of $1.32. The gross margin increased by 340 basis points year-over-year to 33.3%, and the adjusted operating margin rose by 280 basis points year-over-year to 15.1%. The revenue growth was fueled by price increases that more than offset a decline in volume. Adjusted EPS and margins increased due to price hikes, as well as improvements in productivity and cost-saving initiatives.
Revenue Analysis and Outlook
As I had predicted in my earlier coverage in January, KMB's volume growth has suffered due to the high price increases implemented over the past year. In Q1 2023, KMB benefited 10 percentage points year-over-year from pricing gains, but this came at the cost of a 5 percentage point decline in volume as consumers traded down to less pricey options. Among the company's segments, the Personal Care segment, which makes up approximately 52% of total revenue, experienced a greater decline in market share and lower revenue growth than the Consumer Tissue and K-C Professional segments, due to the somewhat discretionary nature of the purchase and more exposure towards developing and emerging markets.
KMB's Historical Revenue (Company Data, GS Analytics Research)
Looking ahead, although KMB has managed to achieve positive organic growth through price increases, I believe the risk of consumers trading down to cheaper alternatives should continue to hinder volume growth in the next few quarters.
KMB implemented further price increases in Q1 and intends to continue doing so for the remainder of the year. However, these price hikes amplify the risk of consumers switching to private-label products in an inflationary environment. There is a high likelihood of an economic recession in the second half of the year due to rising interest rates and historically high inflation.
The pressure on price-sensitive consumers during a potential recessionary environment places them in a difficult position even when purchasing essential items like bathroom tissue, leading them to seek more affordable options. Consequently, KMB's high product prices during a recessionary environment increase the likelihood of trade-downs to private label brands, which are relatively cheaper. This could result in market share losses and negatively impact volume growth in the coming quarters. Thus, the risk of negative volume growth in the near term should still be a concern.
Therefore, I believe the revenue outlook is somewhat mixed over the coming quarter with volume decline offsetting the impact of price increases on revenues.
Margin Analysis and Outlook
Since my previous article much has changed on the margins front and management's efforts to recover margins have yielded results earlier than expected. The aggressive pricing strategy adopted by management over the last year has paid off as far as margins are concerned, as the company has demonstrated sequential as well as year-over-year margin growth for the last couple of quarters.
In the first quarter of 2023, price increases and cost savings of around $105 million more than offset the impact of input cost inflation of around $160 million, resulting in a 340 basis point year-over-year growth in gross margin to 33.3% and a 280 basis point increase in adjusted operating margin to 15.1%. This has narrowed the gap between current and pre-pandemic margin levels (35% gross margin and 17.8% operating margin for FY 2019) to approximately 200 basis points.
KMB's Historical Adjusted Gross Margin and Adjusted Operating margin (Company Data, GS Analytics Research)
Looking forward, while commodity costs especially pulp and paper (KMB's major raw material) are expected to remain elevated year-over-year, Q1 had the toughest Y/Y comparisons and this headwind should decrease sequentially as the year progresses. Further transportation costs are also declining. So a more favorable costs environment as we progress forward in the year should help KMB in recovering margins. In addition, the carryover impact of price increases and additional price increases should continue to support margin growth and recovery toward the pre-pandemic levels over the next couple of years. So, I am optimistic about the company's margin improvement prospects.
Valuation and Conclusion
KMB is currently trading at a forward P/E of 23.66x FY23 consensus EPS estimate of $6.19 and 21.27x FY24 consensus EPS estimate of $6.88, which is higher than its historical 5-year average forward P/E of 19.56x. While I like the company's execution on margins, it seems to be priced in with the stock trading above its historical average P/E valuations even on FY24 earnings. Further, with the mixed revenue outlook and the risk of trade-down persisting in the near term, I prefer to remain on the sidelines and wait for convincing signs of positive volume growth before becoming more optimistic about KMB's long-term growth. Thus, I am maintaining my neutral rating.
For further details see:
Kimberly-Clark: High Valuation And A Mixed Revenue Outlook