EUR 850.00 For Business Accounts Only

Morningstar | Kimberly-Clark's 2Q Sales and Profit Bolstered by Favorable Macro Backdrop; Shares Not a Bargain

CEO Michael Hsu’s first six months at the helm of narrow-moat Kimberly-Clark have been characterized by accelerating sales and margin gains. In the second quarter, Kimberly posted 5% organic sales growth (an acceleration from 3% in each of the past two quarters, entirely reflecting higher prices), a 120-basis-point increase in adjusted gross margin to 34.6%, and 40 basis points of expansion in adjusted operating margin to 17.2%. While operating margins remain generally in line with the 17%-18% posted in each of the past three years, this is a marked improvement from Kimberly's tepid sales over the same horizon, during which organic sales fell at a low-single-digit clip on average as product innovation failed to win with consumers. However, the firm is still lapping relatively weak comps (with sales nearly flat in the year-ago period), and we don’t expect competitors to sit idly by. As such, we think Kimberly's pursuit of efficiency gains (targeting $500 million-$550 million of cost savings annually by 2021) is a prudent means to free up funds to invest in the long-term health of the business.

Management reduced its expectation for raw material inflation for fiscal 2019 to a $150 million-$200 million headwind from $300 million-$400 million. In light of this more favorable commodity cost outlook and recent performance, management bumped up its forecast for full-year adjusted earnings per share to $6.65-$6.80 from $6.50-$6.70. While we intend to update our near-term assumptions for recent results and management’s revised expectations, we don’t expect to materially alter our $113 fair value estimate or our long-term outlook for 2%-3% average annual sales growth and nearly 18% average operating margins through fiscal 2028 (about 100 basis points above fiscal 2018). With the shares trading at around a 20% premium to our valuation, we think investors should remain on the sidelines.

Despite the recent performance, Hsu’s objectives (elevating brand investments in the core mix, accelerating growth in emerging markets, which account for around one third of sales, and bolstering the use of digital marketing and e-commerce) to stabilize Kimberly's top line have yet to be backed up by details as to how the company intends to ensure this improvement is sustainable. For one, while top-line performance has benefited from the sizable price increases implemented, private label has failed to follow suit, particularly in the consumer tissue aisle, where consumers tend to make purchase decisions based on price rather than brand. This could ultimately hinder volume to a greater extent. Further, if commodity costs remain benign, it is possible that as a means to amass increased share, peers could opt to bolster promotions, potentially constraining volume. In light of these impending headwinds, we view management’s repeated rhetoric surrounding the need to elevate its level of brand spending favorably, and we forecast the firm directing 5.5% of sales annually (about $1.1 billion) behind research and development and marketing in the aggregate, a touch above historical averages on an absolute basis. While we don’t think these investments will insulate Kimberly from competitive pressures, we believe they would support the company's intangible-asset-based narrow moat (and more specifically, its entrenched retail relationships).