On February, 11th, 2012 our Consumer Staples team added Kimberly-Clark (KMB) to the Hedgeye Best Ideas list and we are officially removing it this morning, June 10th, 2013. The sell-off in KMB from May 28th at a price of $104.28 to Friday’s close of $97.87 - a decline of just over -6.5% - is an opportune time for us to remove KMB as a short. For much of that period, the idea had been solidly against us, but we are now removing it at a price where it underperformed the SP500 during the same period.
Just to rewind from a fundamental perspective, KMB had a very solid Q1, which was reported in mid-April. The key attributes of the quarter included:
- Big beat and flow through on full-year guidance (Q1 EPS of $1.48, well ahead of consensus of $1.33 and guidance for the full year going up $0.10)
- Solid performance against difficult comparisons on revenue and gross margins
- Superb operating leverage with +15.6% EBIT growth on 1.5% sales growth
- Company overcame $35 million of commodity inflation in the quarter
- Well-managed balance sheet as accounts receivables (+1.7% year over year) and inventories (+0.4%) increased in line with sales growth
In hindsight, the quarter was much better than we expected. As noted in the chart below, KMB reported one of the better quarters in the consumer staples sector.
The question, as always, is what to do with the KMB stock from here? Since we are officially removing KMB as a short idea; does that make it a long from here? On the long side, there are some worthy points, including the following:
1) Expectations are low – Even though the company adjusted earnings guidance higher after the Q1 beat, it really only accounted for the beat in the quarter and, as a result, earnings for the remainder of the year appear low. For starters, the current EPS estimate for Q2 2013 is $1.39, which implies 7% y-o-y growth in earnings. Last quarter’s EPS was up 19% y-o-y . . .
2) Commodities have been stable – In its Q4 2012 results presentation, in February 2013, KMB gave its planning assumption of northern bleached pulp at $890 - $910 per metric ton and oil at $90 - $100 per barrel. In total, the Company guided to $150 - $250 million in cost inflation. So far, commodities are in those ranges with WTI oil trading at $95.00 per barrel and northern softwood pulp at $930 in the U.S. and $857 in Europe.
3) Returning capital aggressively – KMB guided to $1.0 - $1.2 billion in share purchases for all of 2013 and repurchased a total of $500 million in Q1 alone. From 2004 – 2012, KMB repurchased more than $10.5 billion in shares. In that period, shares outstanding have declined from 502 shares outstanding to 384.7 million at the end of Q1 2013.
4) Valuation is reasonable – With a dividend yield of 3.3% and P/E of 16.8x on 2013E and 15.8x P/E of 2014E, valuation seems reasonable, especially with a likely upward bias in numbers in the short term. At this valuation, KMB is basically just below its average P/E of the last 2-years.
The biggest issue facing KMB, and Consumer Staples in general, is the potential for a continued shift away from high yielding stocks to those stocks with higher organic growth. In fact, in the year-to-date, based on our Macro team’s factor analysis, low dividend yielding stocks are up +20.9% and high dividend yielding stocks are up +12.0%. In the same vein, utilities have been underperforming the market dramatically this year.
If treasury yields continue to tick higher, this macro headwind is likely to continue for slower growing and higher yielding staples names like KMB. But at 15 -16x earnings with a 3.3% dividend and an aggressive buy-back (oh and an upward bias in numbers), we at the very least wouldn’t be short the name here.
Daryl G. Jones
Director of Research