Summary
- Kimberly-Clark's stock has enjoyed a brief period of at-par performance with the rest of the equity market.
- Some of the tailwinds that made this rally possible are dissipating and are unlikely to provide a sustainable tailwind for shareholders.
- The long-term picture remains grim and could soon require some drastic changes to the current strategy.
In recent years, it has been next to impossible to conceive a long investment thesis for Kimberly-Clark (KMB). Even after all the pandemic related tailwinds and massive increase of both the S&P 500 and the consumer staples sector, the company's share price lost more than 10% since June of 2020 when I first warned of all the risks associated with investing in KMB.
Nevertheless, that does not mean that there aren't short periods of time when swings in investor sentiment could result in Kimberly-Clark's share price becoming too depressed. This was the case in October of last year after KMB fell nearly 20% in a matter of weeks. Although I reinstated my bearish thesis back then, I clearly illustrated why sentiment was on the wrong side again (at least in the short run).
Since then, KMB has delivered nearly double-digit returns and at one point was trading with a very wide gap to the broader equity market.
Unfortunately, however, the share price is now quickly catching-up with reality and KMB is on track to once again deliver very disappointing performance in 2023.
On one hand, we had the expectation that the worst in terms of cost inflation is already behind us which spurred a wave of optimism across the sector.
Overall, the fiber market prices have plateaued in Q3, and they actually began to turn slightly in Q4.
Source: Kimberly-Clark Q4 2022 Earnings Transcript
On the other hand, KMB also capitalized on significant price increases, which were implemented across the sector.
One of its major peers - Procter & Gamble ( PG ), for example, has recently announced that pricing contributed roughly 8% within its Baby, Feminine and Family Care segment during its latest quarter, while volumes declined by 6%.
This highlights the relatively low pricing power within this product segment and shows the unattractive positioning of Kimberly-Clark as a pure player in consumer tissue products.
That is why, KMB now expects a mere 2% to 4% organic revenue growth for 2023 and a similar increase in earnings per share.
The Problem For Long-Term Shareholders
As the company continues to muddle through with low organic revenue growth and stable to declining margins, its total free cash flow has not shown a material increase for the past 20 years or so.
The management, however, is bragging about a 5% annual increase in the company's dividend per share since 2012 which is supposed to make KMB attractive for dividend investors.
Usually, this might be enough of a reason to own a slow-growth large consumer staple business as such stocks offer low risk and predictability. The major problem in this case, however, is that the consistently growing dividend payment is now squeezing the company's flat free cash flow, thus leaving little to no room for more dividend hikes in the future.
Kimberly-Clark's dividend per share also benefited from the decreasing total number of shares outstanding.
The rate of decline, however, has slowed down in recent years as KMB's low free cash flow has made it harder and harder for the company to continue to repurchase shares at such high rates.
The situation is even worse when we consider the amount of capital expenditure within the free cash flow estimate. Total amount of Capex has now declined near the 2016-17 lows and is barely enough to cover the annual depreciation and amortization expense of around $750m.
As a percentage of sales, annual capital expenditure is now at one of its lowest levels ever at barely above 4%.
All that creates significant difficulties for a company that is expected to continue to deliver consistent dividend increases and share repurchases in order to compensate for low topline growth. It also creates a significant moral hazard problem for management, which is likely to consider riskier movements in its efforts to reinvigorate growth. In this case, an aggressive M&A strategy or a large acquisition in a new product area is a highly likely scenario and one that rarely delivers shareholder value.
That is why, even when investing in low-growth consumer staple businesses, investors should consider the long-term strategy of a business and how it positions it to be competitive. This process often requires unpopular decisions to be made in the short run, in order to secure competitive advantages in the future. It is what I call 'the roundabout route' and is an area of focus across all of my high conviction ideas posted in The Roundabout Investor .
Conclusion
After a few months of respite for Kimberly-Clark shareholders, the share price is once again turning south. Although good news could be expected in the near term, these would likely be limited to a broader decline in raw material prices or slightly better than expected volume declines. In the meantime, medium to long-term shareholders are still faced with all the risks associated with flat free cash flow and the need for higher shareholder distributions.
For further details see:
Kimberly-Clark: Short-Term Tailwinds Dissipate