• It's Coming...

    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

Kimberly-Clark reported 2Q EPS of $1.41 versus consensus $1.39 despite a miss on the top line. Management reaffirmed FY13 EPS guidance of $5.60-5.75. Per management, the impact of lower predicted sales growth is expected to be offset by higher cost savings and share repurchases. We remain bearish on the name.

Conclusion

We believe the stock traded off today, despite the earnings beat, because of soft volumes in the U.S. and a looming miss or guide down in the back half of 2013. Management’s reiterated FY13 EPS guidance seems much, much less stable than it was three months ago; higher cost savings and share repurchases are set to fill the void being left by slower-than expected sales growth. With inflation sequentially accelerating and FX rates acting as a top-line headwind, we see downside risk to the company’s FY13 EPS estimates and would advise clients to continue to look elsewhere for exposure to consumer staples on the short side. We do not expect the market to pay 17x for earnings increasingly driven by cost savings and share repurchases. Below are the positives and negatives we took away from the quarter.

What we liked:

  • Emerging markets have sustained strong volume growth
  • The company is finding incremental cost savings (raised annual target by $50m to $250-350m) to drive EBIT growth
  • Operating margin expanded by 90 bps to year-over-year to 15.5% despite no sales growth and commodity inflation
  • KCI produced broad-based top line growth and operating margin expansion

What we didn’t like:

  • Organic sales growth was dragged lower by negative volume growth in developed markets, particularly the U.S., Australia, South Korea
  • U.S. personal care volumes declined despite negative product mix
  • Management highlighted increasingly volatile macroeconomic environment, FX, and oil prices
  • Big K-C I markets like Australia and South Korea experienced a slowdown in 2Q
  • Negative 2Q FCF growth (-2.1%) with EBIT growth slowing to 5.8% from 15.6% in 1Q13 and 8.1% in 2Q12 (mgmt says cash flow to improve in 2H13)
  • Valuation is rich – now important with increasing risk to the downside (or limited upside, at least) in earnings estimates
  • Oil prices holding above $100 per barrel could push cost inflation above mid-point of company expectations ($150-250 million)
  • FX rates holding current levels will likely result in EPS below mid-point of guided range

Rory Green

Senior Analyst