2023-12-10 02:09:20 ET
Summary
- Kimberly-Clark's volume growth should turn positive in the coming quarters.
- A favorable cost environment, cost-saving initiatives, and potential volume recovery should contribute to margin expansion.
- Valuation is lower than the historical average and the dividend yield is attractive.
Investment Thesis
Over the past year, Kimberly-Clark Corporation’s (KMB) volume levels were negatively impacted by price increases that led to consumer trade-down to lower price points from competitors and private labels in an inflationary environment. However, volume decline has already bottomed and volume levels have been improving sequentially thanks to narrowing price gaps with peers. Moving forward, I expect volume levels to turn positive with the help of easy comparisons and reducing price gaps versus peers. This should help the company’s revenue growth. In addition, market share gains and innovations should also help revenue growth in the coming years.
On the margin front, the company should benefit from a favorable cost environment as input cost inflation continues to moderate. In addition, cost-saving initiatives and operating leverage from potential volume recovery should also help in margin expansion. So, the company’s overall fundamentals are positive. Moreover, the stock is trading lower than its historical valuation and offers an attractive dividend yield of 3.94% on a forward basis. Hence, the good growth prospects, lower-than-historical valuation, and attractive dividend yield make me keep a buy rating on the stock.
Revenue Analysis and Outlook
In my previous article , I discussed the company’s revenue growth prospects driven by the carryover impact of price increases, lower price gaps with its peers and private labels, and easing volume comparisons from the prior year’s quarter. The company has reported earnings for its third quarter of 2023 since then and similar dynamics were seen.
In the third quarter of 2023, the company’s sales growth benefited from price increases and a favorable mix. This resulted in a revenue increase of 2% YoY to $5.13 billion. Excluding a 2 percentage point headwind from foreign currency and a 1 percentage point headwind from the divestiture of KMB’s tissue and K-C Professional business in Brazil, organic growth increased by 5% Y/Y. The organic growth reflected a 5 percentage point benefit from price increases and a 1 percentage point benefit from a favorable mix. This helped more than offset a 1 percentage point volume decline.
KMB’s Historical Sales (Company Data, GS Analytics Research)
Looking forward I expect the company’s volumes to turn positive in the coming quarters which should help revenues. While the company’s volume was down 1% Y/Y in Q3 2023, it improved sequentially from down 3% YoY in Q2 2023. The decline in volume can be attributed to the substantial price increases implemented in 2022 and early 2023 to counter the impact of rising raw material and manufacturing costs due to inflation.
These price hikes led some customers to opt for lower-priced products from competitors, including private labels, thereby affecting the company's volumes. However, as the company reaches the anniversary of these significant price increases and the price gaps with competitors narrow (since competitors have also raised prices to offset inflation), we can expect a further sequential improvement in volume. This improvement should eventually result in a positive year-over-year growth in volumes in the upcoming quarters.
The company plans to implement some more price increases but they will be specific to certain inflationary markets and not broad-based and certainly not to the extent we saw in 2022 and early 2023. So, this should not have much impact on volume recovery in the coming quarters.
KMB’s Organic Sales Analysis- Price & Volume Contribution (Company Data, GS Analytics Research)
The company is also doing a good job in terms of innovations like pack size improvements and launching new products which should help it in gaining share. For example, to address the issue of consumer trading down or pulling back their spending by purchasing smaller quantities, management is focused on rightsizing their pack sizes and adjusting the entry price points. In addition to improving price pack offerings, the company is also introducing new performance-enhancing designs and products.
Some of the recent innovations introduced by the company include a new design for Huggies in China, featuring an innovation that efficiently removes both types of baby mess to decrease the occurrence of diaper rash. In North America, the company has introduced new Poise pads, such as the 7-drop ultra absorbency pads and 8-drop overnight pads. These higher-capacity designs offer superior absorbency and protection compared to daytime pads.
These initiatives are helping the company gain market share in its largest markets. According to management, In North America, the company saw sequential improvements in the market share in 6 out of 8 categories. In China, the company is seeing strong market share momentum with Huggies share up nearly 200 bps in the quarter and in the UK the company gained 200 bps yoy market share for Andrex.
In addition to market share wins, new product innovations should also help improve the pricing mix for the company.
Overall, I am optimistic about the company’s revenue growth prospects in the near-to-medium term with the company benefiting from volume recovery and market share improvement.
Margin Analysis and Outlook
In the third quarter of 2023, KMB’s margin growth benefited from price increases and favorable raw materials costs. In addition, cost savings of ~$90 million also contributed to margin growth. This helped the company in more than offsetting higher energy prices, currency headwinds, and higher labor and other manufacturing costs. As a result, the gross margin increased by 530 bps YoY to 35.8% and the adjusted operating margin increased by 210 bps to 15.1%.
KMB’s Historical Adjusted Gross Margin and Adjusted Operating margin (Company Data, GS Analytics Research)
Looking forward, I am optimistic about the company’s margin growth prospects. Inflationary headwinds which have significantly impacted the company’s margins in 2022 and early 2023 continue to moderate with pulp and paper and logistics continuing to trade down this year. Initially, management guided for $100 million to $200 million input cost inflation for the full year which they reduced to $100 million in the second quarter and further reduced to $50 million at the time of the third quarter earnings release. The continued moderation in input costs should help the company’s gross margin.
In addition, the company is also implementing other cost-saving initiatives under “project FORCE” which is expected to deliver $300 mn to $350 million in cost savings for the full year. The company is executing well in this regard and it has increased its operating margin improvement guidance to 170 bps YoY (at midpoint) on the last earnings call (vs 150 bps YoY at the time of July guidance). I believe the company should continue to see margin improvement next year thanks to moderating input costs, cost-saving initiatives, and operating leverage from potential volume recovery.
Valuation and Conclusion
Kimberly-Clark is currently trading at 16.93x FY24 consensus EPS estimate of $7.09, which is at a discount to its historical 5-year average forward P/E of 20.07x. I believe the potential volume recovery in the coming quarters and continued market share improvement should improve investor sentiments towards the stock. This along with good margin expansion prospects thanks to a favorable cost environment and cost-saving initiatives makes the overall outlook encouraging. Moreover, the company also offers an attractive dividend yield of 3.94% on a forward basis. Hence, given the lower-than-historical valuation, volume recovery and margin growth prospects, and attractive dividend yield, I continue to have a buy rating on the stock.
For further details see:
Kimberly-Clark: Improving Fundamentals, Solid Dividend Yield And Low Valuation Make It A Good Buy