2023-08-11 14:42:01 ET
Summary
- The current spike in the share price of Kimberly-Clark will be short-lived in the absence of stronger growth.
- Weak fundamentals, high multiples, and market risks undermine bullish reports of increased sales and gross margin.
- Frequent dividend boosts and buybacks inflate the stock price without creating long-term value for shareholders and leave return on net operating assets perpetually flat.
Editor's note: Seeking Alpha is proud to welcome Tuaev Levan as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »
When inflation and interest rates soar, investors often switch to high-quality stocks that pay solid dividends. But even this won't help if the company is losing value - and such dividends won't create long-term value for shareholders. This is true of the Kimberly-Clark Corporation (KMB). Although KMB saw its price increase over the past six months - a marker that received a further boost from an upbeat quarterly report - its long-term value remains flat and its price will likely fall within the year. There are several reasons for this. First, last quarter's results might prove short-lived; second, the company's historically flat return on net operating assets does not justify the growth rate it predicts; third, increased dividend payouts and stock repurchases are soon to become an unaffordable luxury; fourth, the discounted abnormal returns suggest that KMB is currently overpriced; and fifth, inflation and interest rates will affect the cost of sales and the required returns.
Company Overview and Operating Segments
Kimberly-Clark Corporation is a well-known global company operating in the personal care and consumer tissue segments. The company has three main divisions: Personal Care, Consumer Tissue, and K-C Professiona l. KMB completed the acquisition of Thinx Inc (an industry leader in the reusable period and incontinence underwear category) on February 24, 2022.
Although KMB benefited from the pandemic, Yahoo Finance currently gives it a 3.2 or "Hold" rating and a suggested average price of $137.95 per share.
The company's dividend yield might seem to justify its market price, but it would be wise to dig deeper by examining the abnormal return and whether it creates value that corresponds to KMB's current valuation. After this, I will give my stock picks and short-term price target.
Peer analysis and sector performance
We should first compare KMB to its competitors while keeping in mind that the entire sector or market can be overpriced, which would skew the valuation figures. Kimberly-Clark operates in a highly competitive environment and some of its rivals are even larger or more diversified. These are the closest competitors, but clearly not identical.
PG | JNJ | CL | Average | KMB | |
P/E ((FWD)) | 24.53 | 16.1 | 24.26 | 21.63 | 19.95 |
P/S ((FWD)) | 4.33 | 4.49 | 3.29 | 4.04 | 2.11 |
EV/EBIT ((FWD)) | 20.01 | 14.58 | 17.92 | 17.5 | 16.95 |
As you can see from the table above, the KMB figures are close to the average in the sector and its Price to Sales are, as usual, lower than its competitors. Forward KMB Growth Grade from Seeking Alpha Quant rating is C+ in line with peers. And most of them are trading at a forward P/E lower than their average. With a forward P/E of 19.95, KMB is trading a little higher than its 5 years average of 19.92 and sector median of 18.77 indicating that it may have reached the price target.
To gain a more accurate picture, however, we must dig deeper into the company's financial statements to determine its current value and the factors that could drive that value up or down. Comparing KMB with the Benchmark S&P 500 Total Return and Consumer Staples Select Sector ETF returns for the past three years, we find that the company has been performing below projections The fact that KMB has long had high multiples that are close to the industry average but performs poorly compared to the industry brings its valuation into question. The dividends that have been boosting the price are at risk because the payout ratio has been increasing since 2019 and now exceeds the sector median.
Past KMB Financials & Balance Sheets
Year | 2022 | 2021 | 2020 | 2019 | 2018 |
Return on net operating assets (RNOA) | 19.6% | 20.8% | 32.5% | 32.2% | 18.4% |
RNOA from sales | 20.8% | 19.8% | 27.7% | 26.8% | 18.9% |
Core Sales Profit Margin (Core PM) | 9.8% | 9.6% | 12.5% | 11.1% | 7.9% |
Other Operating Income (IO)/Net Operating Assets ((NOA)) | 2.1% | 1.9% | 2.6% | 2.8% | 2.7% |
Unusual Operating Income /Net Operating Assets | -2.7% | 0.1% | 3.8% | 0.1% | -1.6% |
Asset Turnover (Sales/NOA or ATO) | 2.1 | 2.1 | 2.2 | 2.4 | 2.4 |
Net operating assets ((NOA)) growth | -1.1% | 1.4% | 18.2% | 8.2% | -10.0% |
Sales growth | 3.8% | 1.6% | 3.7% | -0.2% | 0.8% |
ROCE drivers (own calculations based on KMB Financial Statements)
This table shows that, in terms of year-to-year changes, the figures influencing valuation remained flat, with the exception of the pandemic period when demand for personal care products rose.
Year | 2022 | 2021 |
?ROCE (Change in Return on Common Equity) | -1.48% | -146.00% |
?RNOA (Change in Return Net Operating Assets) | -1.22% | -11.74% |
?SPREAD (Change in a difference between Return on Net Operating assets and Net Borrowing Cost) | -1.34% | -11.67% |
?FLEV (Change in Financial leverage) | 0.522714 | -1.70405 |
Last year, KMB saw its ROCE (Return On Common Equity) decline due to decreased SPREAD (RNOA-Net Borrowing Cost) and Leverage, while RNOA fell due to Unusual items/NOA (Unusual items/ Net Operating Assets).
ROCE drivers (Author's own calculations)
The company's core return from sales saw a slight uptick but remained flat overall. Because unusual items are exactly that - unusual and, therefore, unsustainable - I prefer to leave them out of the equation.
RNOA drivers (Author's own calculations)
Asset turnover and growing profit margins contributed to a slight increase in RNOA, but as you can see, those figures overall remain flat, excluding the possibility that returns will increase significantly in the coming year.
But did we, perhaps, overlook some increased spending on research or marketing that drove up past costs but also increased the possibility of higher future returns?
Share of costs and gross margin in Operating revenues (Author's own calculations based on KMB Income statements)
This graph shows the share of each item in operating revenue, indicating that those figures remained flat as well. The exception was 2019-2020, when gross margins and advertising costs grew, resulting in higher returns.
Latest Quarterly Results
KMB said the following in its Q2 2023 results announcement :
- Delivered net sales of $5.1 billion, up 1 percent, with organic sales growth of 5 percent.
- Gross margin was 33.7 percent, up 350 basis points; adjusted gross margin was 34.0 percent, up 380 basis points versus the prior year, driven by favorable net revenue realization and productivity, offsetting inflation.
- Diluted earnings per share were $0.30, primarily driven by $1.36 per share in non-cash charges for the impairment of intangible assets; on an adjusted basis, earnings per share were $1.65.
- Raised 2023 outlook for organic growth to 3% - 5%, and for adjusted earnings per share growth of 10% - 14%, with adjusted operating margin up 150 basis points at the midpoint versus last year.
Despite the rosy picture this paints, I was caught by the fact that the share of receivables in net operating assets has grown.
Year | 2023 | 2022 | 2021 | 2020 | 2019 |
Operating assets: | |||||
Cash and cash equivalents | 1% | 1% | 1% | 1% | 1% |
Account receivables, net | 27% | 24% | 23% | 24% | 29% |
Inventories | 24% | 24% | 24% | 20% | 23% |
Other current assets | 8% | 8% | 9% | 8% | 7% |
Property, Plant and equipment | 88% | 84% | 85% | 86% | 94% |
Goodwill | 24% | 22% | 19% | 20% | 19% |
Other Intangible assets | 2% | 9% | 9% | 9% | 0% |
Other assets | 14% | 13% | 13% | 14% | 13% |
Investments in Equity Companies | 3% | 3% | 3% | 3% | 3% |
TOTAL Operating Assets: | 190% | 187% | 186% | 184% | 188% |
This number is increasing for the second consecutive quarter, increasing from 25.8% to almost 27%.
Despite increasing gross margins, core profits from sales remained flat with overall PM decreasing due to asset impairment. A slight increase in ATO continued this year.
2023 | 2022 | 2021 | 2020 | 2019 | |
Core Profit Margin after tax | 10.3% | 9.8% | 9.6% | 12.5% | 11.1% |
Profit Margin | 9.2% | 10.1% | 14.7% | 13.3% | |
Asset Turnover | 2.3 [[1]] [[1]] Forecasted. Based on 6 months results | 2.1 | 2.0 | 2.0 | 2.3 |
Risks
This brings us to possible risks regarding the "improved outlook for 2023". The higher number of receivables might indicate that we cannot rely on these numbers, that KMB might have inflated its sales figures by booking revenues in advance.
The acquisition of Thinx has not produced any quantifiable synergy since last year's accounting, portending a lack of further growth. Although a closer analysis of future cost-saving measures might reveal the potential for continued growth for KMB, current indicators suggest that the company will lose momentum by year's end. PM from sales decreased from the first quarter, suggesting further results to be in line with past years.
High inflation, rising interest rates, and currency fluctuations will continue to have a negative effect. Despite these market risks, KMB does not seem to be taking any meaningful steps to increase its value. Its entire plan seems to consist of continuously increasing dividends and repurchasing its shares in order to boost its per-share price. Not only does this fail to create value for shareholders (it could even reduce share value if they are repurchased at inflated prices), but it could also lower per-share prices in the long run. Moreover, as we noted previously, the payout ratio is already at its highpoint, leaving little room for maneuvering to attract investors. Future quarters should be viewed with caution.
Valuation methodology
My calculations are based on the last 12 years of KMB financial statements. I find the excess return on net operating assets (the difference between the core return on net operating assets and the required return) and then discount it. A stream of forecasted future excess returns is brought to present value. Core RNOA does not include the one-time effect that unusual items have on the income statement. The required return is WACC-calculated and takes into account average historical numbers, current risk parameters, the risk-free rate, market premium, and debt after-tax cost (that is provided in financial statement notes).
Valuation inputs
As we saw from past financial data, KMB provides stable results year-over-year but has limited possibilities for growth. Because I calculate excess return on net operating assets, it is necessary to check how this number changed year-over-year. Over the past five years, the NOA grew by an average rate of 3.33% (including a significant contribution from the pandemic period). Although the long-term rate is close to 0%, I stuck with a 3% growth rate for my calculations. I found no fundamentals indicating that the company's value would either increase or decrease significantly. Moreover, the company in its latest highlights forecasted future growth between 3%-5%.
Interest rates rose, and although this caused the required discount rate to climb as well, KMB still has cheap debt. Taking this into account, along with the company`s cost of equity and debt and an assumption that the Fed will soon stop hiking rates and that market volatility will continue at the same levels, I came to a discount rate of 6.6%. It consists of the cost of equity and the cost of debt. The cost of equity includes : 10 Year Treasury Yield of 4% , a Beta of 0.8, and a market premium of 5.6% . The cost of debt can be found in the financial statement`s notes and I am using the after-tax number. It seems a reasonable required return for KMB matching historically the same market conditions.
Interest rates rose, and although this caused the required discount rate to climb as well, KMB still has cheap debt. Taking this into account, along with the company`s cost of equity and debt and an assumption that the Fed will soon stop hiking rates and that market volatility will continue at the same levels, I came to a discount rate of 6.9% and a growth rate of 3.33%.
Current fair value
In USD Millions except per-share item and discount rate | |||
2022 | 2023E | 2024E | |
Net Operating Assets | 9391 | 9704 | |
Net Financial Obligations ((NFO)) | 8303 | ||
Residual operating income (ReOI) | 1606 | 1659 | |
Discount rate | 1.066 | 1.136 | |
Present Value (PV) of Residual operating income | 1507 | 1460 | |
Continuing value ((CV)) | 52459 | ||
Present Value of Continuing Value | 46164 | ||
Total Present Value of Residual operating income | 2967 | ||
Enterprise Value | 58523 | ||
Value of Common Equity | 42963 | ||
Per-share price ( 337.4 million float ) | 127.3 |
For further calculations, I need to forecast future RNOA, which is simply a PM multiplied by ATO. Despite losing a little bit of momentum from the previous quarter, I will stick with a future ATO of 2.3 and PM from sales of 10.3% (if the company will continue performing the same way). This brings to a RNOA of approx. 23.7%. This number is in line with the company's own overview suggested by the transcript "with adjusted operating margin up 150 basis points at the midpoint versus last year".
To find Residual operating income depicts the difference between RNOA and required return earned on NOA, or stream of future excess returns on NOA. Summing 2023 ReOI with Continuing Value (with the same growth rate) and current NOA, deducting minority interest and options outstanding (calculated using the Black-Scholes formula ), and adding the book value of common stockholders' equity ((CSE)), I came to a price of approximately $127.3 per share (details can be viewed in the table above).
Valuation risk
Because my growth rate is only a five-year average, even a slight change will affect the price. But if the growth rate continues to rise this year, it will result in a higher price target. Due to accounting principles, some of the figures I used in my reformulation might be slightly off, but I tried to minimize their influence. For example, because I was unable to find the share of "Cash and cash equivalents" in operating assets, I used the industry average -- although this had only a minor effect on my calculations.
Conclusion
Kimberly-Clark is a "hold" now, given its risk exposure. However, because it is a stable company that pays consistent dividends, it will be a good investment if its price falls -- and its price might later increase if interest rates stabilize or even fall. Although the company performs below the sector average, it trades at the sector's average multiples, so it is best to find good entry points. To justify its current market price, KMB's growth rate should be higher and/or its volatility lower. None of this is the case at present, however, and high interest rates only compound the problem. The company's latest quarterly results should be viewed with caution and its current market price does not seem opportunistic. What's more, the payout ratio has peaked, making any future increases unlikely. My advice is to wait for a price of approximately $110-$115 before taking a position.
For further details see:
Kimberly-Clark: Wait For A Better Entry Point