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Morningstar | Kimberly Strings Together Another Quarter of Increased Sales, but Pressures Persist; Shares Heated

We don’t expect to alter our $113 fair value estimate for narrow-moat Kimberly-Clark following first-quarter results that included 3% organic sales growth (5% benefit from higher prices and favorable mix was offset by a 2% volume downdraft) and 17.4% adjusted operating margins (flat with the year ago period). This was the second quarter in a row the firm chalked up 3% organic top-line gains, after posting a string of more muted top-line performance the past few years. However, we don’t yet posit this signals the firm has steadied its footing. Rather, we expect Kimberly’s near-term sales trajectory hinges on the receptivity of retailers and consumers to the higher prices it and its peers are bringing to market to offset lingering inflationary pressures (as it relates to transportation and logistics as well as commodities) and the ensuing volume impact. As has been the case historically, we surmise consumers are likely to balk at higher prices at the shelf at first (evidenced by the retreat in volumes in the quarter), but if these actions are accompanied by value-added innovation, we don’t expect the hit will prove lasting. Our 10-year explicit forecast calls for 2%-3% average sales growth, roughly split between higher prices and increased volume.

Long term, because competitive pressures abound, we surmise Kimberly’s ability to withstand these headwinds partially rests on the extent to which it reinvests behind its brands (in R&D and marketing) as a means to ensure its fare stands out at the shelf. In this vein, we perceive the firm’s strategic intent to extract efficiencies (to the tune of $500 million-$550 million annually by 2021) by rightsizing its employee base and manufacturing footprint favorably. We forecast it will direct a mid-single-digit percent of sales toward these efforts (in line with historic levels). While shares popped at a mid-single-digit clip on the news, we believe the stock looks inflated, trading at a 15% premium to our valuation.

From a segment perspective, personal care sales (around half of its consolidated basis) shot up 5%. However, its performance was not as robust across all markets and geographies. More specifically, beyond its home turf, Kimberly continues to succumb to an intensely promotional environment in the mid-tier Chinese diaper market (around half of its regional diaper business), but boasted increased sales in the premium segment (both of which management qualitatively alluded to). In our view, competitive pressures and stagnant birthrates will continue to hinder its category sales in China. However, we think the firm is poised to benefit from greater diaper usage in many emerging markets as income levels rise, allowing greater consumption per child (from the one diaper used per day on average, which pales relative to the five consumed by developed market consumers daily) and ultimately an expansion of the category. And outside of child care, we think Kimberly is also positioned to benefit from an aging global population base (and the potential for increased demand for its adult incontinence fare, a category where Kimberly already controls more than half the share on its home turf). As such, we aren’t wavering on our expectations for a modest acceleration in segment sales to around 3% growth annually longer term.

After just three months at the helm, we continue to posit CEO Michael Hsu’s top priority remains on sustainably reigniting the firm’s lackluster sales performance. From our vantage point, over the last several years, we posit that Kimberly was caught flat-footed as it relates to product innovation and has subsequently ceded share across its mix to lower-priced private-label offerings, other branded operators, and local peers (as organic sales have fallen nearly a point on average since fiscal 2016). While the firm’s stated objectives on its path to improvement center on elevating brand investments within its core mix, accelerating growth in emerging markets (around one third of sales), and bolstering its use of digital marketing and e-commerce (the premise of which strikes us as sound), we’ve been underwhelmed by the lack of details as to how the firm intends to achieve these objectives. We will look for more context surrounding the specific means by which it will achieve these aims over the next few quarters.