KMB reported Q4 EPS of $1.37 versus consensus of $1.36 and provided 2013 guidance - $5.50 to $5.65 versus consensus of $5.59. Ho-hum, enough with the Old Wall earnings recap.
The good – constant currency organic sales growth was +5.0%, against a +3.0% in the lapping quarter. The sales result was at the high end of the 3-6% range we saw in the prior three quarters.
The deterioration in earnings quality that we highlighted earlier in the week continues to manifest - $39 million of EBIT growth year over year, provided courtesy of $80 million of cost savings and a $15 million commodity tailwind (this with the benefit of 5% top line growth). The commodity benefit is a decline from Q3 ($55 million) and Q2 ($30 million) reflecting the fact that core commodities have begun to creep up again.
What’s the Bull Case?
We get that sales were solid this quarter, and that the KCI International business continues to be an opportunity. Also, Q4 was a robust FCF quarter ($2.01 per share in Q4, $5.54 per share for the full-year) and that the company continues to deploy its FCF to the benefit of shareholders via dividends and share repurchases. That sort of profile certainly has an appeal to a certain group of investors.
To those investors, we ask a couple of questions:
- What’s the right multiple for cost savings, recognizing that all of KMB’s EBIT growth is from restructuring savings? (4-6x earnings is what we are thinking). We recognize that there is a stability and consistency to that EBIT growth, but there is also a limited duration that should be reflected in a far lower multiple relative to EBIT growth derived from operations.
- What happens if sales weaken? When things are going well at a consumer products company, sales growth should drop to the bottom line in substantial fashion. That is clearly not the case with KMB. If sales weaken, declining core EBIT should overwhelm the level of cost savings.
- Are the company’s increases in strategic marketing really strategic? We have seen investments in strategic marketing decline sequentially throughout 2012 – is the company using that investment tactically to manage earnings, or is it truly viewed as long-term in nature? We consider the former to be a distinct possibility.
With commodities moving against the company and the multiple at 15.5x 2013, we continue to believe that people should not be paying up for 3-4% top line growth and EBIT growth that is largely derived from restructuring savings. Our bias remains to be short.
Call with questions.
HEDGEYE RISK MANAGEMENT, LLC