2023-07-28 12:37:12 ET
Summary
- Kimberly-Clark's revenue growth is expected to benefit from easing comparisons and closing price gaps versus peers.
- The company reported better-than-expected Q2 2023 earnings, with revenue increasing by 5% organically and adjusted EPS growing by 23.1% YoY.
- Reasonable valuation after recent underperformance and improving revenue outlook warrant an upgrade to a buy rating.
Investment Thesis
Kimberly-Clark Corporation's (KMB) revenue growth is expected to benefit from easing comparisons and closing price gaps versus peers. On the margin front, KMB should benefit from the carryover impact of price increases, and moderating inflation. Additionally, the company is trading lower than its historical averages based on the FY24 EPS estimate and has a good dividend yield of 3.62%. In my earlier article on the company, I preferred being on the sidelines given the company's mixed revenue outlook and high valuation. However, after recent underperformance, valuations have become reasonable and the revenue outlook is also improving. Hence, I am upgrading my rating to buy.
Q2 2023 Earnings
Earlier this week, Kimberly-Clark reported better-than-expected results for the second quarter of 2023. The company's revenue increased by 5% organically or by 1% Y/Y on a reported basis to $5.13 billion, which exceeded the consensus estimate by $30 million. Adjusted EPS grew by 23.1% YoY to $1.65 and beat the consensus EPS estimate by $0.17. The adjusted gross margin increased by 380 bps YoY to 34% and the adjusted operating margin increased by 190 bps YoY to 14.2%. The revenue growth was driven by price increases which more than offset the volume decline. Adjusted EPS and margins increased due to price increases, and productivity and cost-saving initiatives.
Revenue Analysis and Outlook
In my previous article on Kimberly-Clark, I discussed near-term headwinds on the company's volume growth from tight consumer spending in an inflationary environment and consumer trade-down to lower price points or to the private labels given KMB's significant price increases. I also preferred to stay on the sidelines due to the company's high valuation and the stock has underperformed since then, validating my stance.
In the second quarter of 2023, the company's market share continued to suffer due to price gaps as compared to peers and private labels, resulting in a volume decline. However, the volume decline was more than offset by price increases resulting in a revenue increase of 1% YoY to $5.13 billion. Excluding a 4% headwind from foreign currency, organic growth increased by 5% YoY, reflecting an 8% benefit from price increases and a 3% volume decline. One positive thing was a sequential improvement in the YoY volume decline. The volume decline of 3% YoY in Q2 was better than the 5% YoY decline seen in Q1.
KMB's Historical Revenue (Company Data, GS Analytics Research)
Looking forward, while headwinds from tight consumer spending and trade downs to lower price points or private labels still persist in an inflationary environment, I believe the company's volume should start recovering in a couple of quarters. The company should see volume recovery as the price gap with peers decreases and it sees easing volume comparisons.
To give a quick recap on KMB's organic sales performance, the company increased its price in order to protect its margins from inflationary costs, just like the rest of the industry. However, the company took price increases pretty early as compared to its peers. This created price gaps between KMB's products and its peers and private labels. In times of inflation, when consumers face financial constraints, they tend to seek lower-priced products, even in essential categories. This leads to consumers trading down to lower price points or purchasing smaller quantities in order to manage their budgets effectively. So, due to significant pricing early as compared to peers, the company started to lose market share, which pressured sales volume, and sales growth was solely contributed by price increases.
KMB's Historical YoY Price Increases and Volume growth/decline (Company Data, GS Analytics Research)
The company's price increases were heavily weighted in 2022 and the last price increase was in the first quarter of 2023. Looking forward, management mentions that they are seeing inflation moving in the right direction. So I expect the company to pause further price increases in the near term. This should help lessen price gaps with peers as they catch up. Moreover, volume comparisons are also starting to ease in the back half of 2023. This should give room for volume to recover moving into the second half of 2023 and further into 2024. I expect volume growth to turn positive over the coming quarter and the market share to improve, alleviating some investor concerns.
Margin Analysis and Outlook
In the second quarter of 2023, price increases and cost savings of ~$80 million more than offset the impact of input cost inflation of ~$30 million. This resulted in a 380 bps YoY expansion in gross margin to 34% and a 190 bps increase in adjusted operating margin to 14.2%. The benefits of cost savings and price increases realized on the adjusted operating margin were offset by planned marketing and research expenses along with a $100 million headwind from foreign currency.
KMB's Historical Adjusted Gross Margin and Adjusted Operating margin (Company Data, GS Analytics Research)
Looking forward, I expect KMB to continue recovering its margins to pre-pandemic levels (KMB had ~35% gross margin and ~17.8% operating margin for FY 2019). The company should benefit from moderating inflation. Sequentially, inflationary costs are becoming less of a headwind for margin growth. Previously, management guided for $100 to $200 million of input cost inflation for the full year. However, due to earlier than expected moderation of pulp and paper cost, and logistics costs, management is now expecting inflationary input costs to be ~$100 million of a headwind. This implies that inflation should further moderate as we move forward in the second half of 2023. Moreover, the impact of carryover price increases should be able to fully offset inflation. So, margins should continue to recover on a sequential as well as on a year-over-year basis.
Valuation and Conclusion
KMB is currently trading at 20.22x FY23 consensus EPS estimate of $6.44 and 18.46x FY24 consensus EPS estimate of $7.06. The company's margins have started recovering, and volume should also start recovering over the next couple of quarters thanks to easing comparisons and normalization of price gaps with peers.
I believe recovering volume growth and the company regaining some of the lost market shares should help investor sentiment moving forward. If we look at the valuation on the basis of the FY24 consensus EPS estimate, the company is trading lower than its historical 5-year average forward P/E of 19.91x. Moreover, the company also has a good dividend yield of 3.62% on a forward basis. So, given improving fundamentals, reasonable valuation, and good dividend yield, I am upgrading my rating to a buy.
For further details see:
Kimberly-Clark: Improving Growth Prospects And A Reasonable Valuation (Rating Upgrade)