Kimberly Clark remains one of our favorite names on the short side as a difficult environment is pressuring volume growth, input costs are accelerating, and macroeconomic factors have rendered the stock far less attractive as a source of yield. In addition, the market is still demanding 17x forward earnings (which are likely too high) for the stock. We expect investors to pay up for organic sales-driven growth, not share repurchases and cost savings. The long-term opportunity for the company, particularly in emerging markets, is impressive, but we would wait for 3Q and possibly 4Q earnings to pass before getting behind the stock.
Ahead of 3Q EPS on 10/22: Ahead of earnings, we are highlighting the following factors as most important to us changing our fundamental view from negative to neutral or positive:
- Organic sales growth accelerating
- EBIT growth re-acceleration
- FX impact easing into 4Q
- FCF growth (following a -2.1% decline in 2Q)
- Positive commentary or data points on innovation pipeline
Top-line Concerns: The Company’s growth profile is hampered by difficulties in developed markets such as Korea, Australia, and the U.S. In the U.S., the higher margin personal care business registered negative volume growth despite negative product mix in 2Q, which was a concern for investors.
Cost Savings: The Company has driven a tremendous amount of cost savings - $1.9 billion - out of its business over the past nine years, largely driven by a focus on the supply chain. Two-thirds of the savings have been generated by “lean manufacturing practices” and the remainder has been driven by the company’s global procurement organization. Management is guiding to a $300-350 million annual savings figure (from $250-300 million prior estimate).
At the Barclays Back to School conference, CFO Mark Buthman stated, “the more savings we drive, the more that we find”, as an explanation for the increasing dollars being slashed from the company’s budget. While adding efficiency to a business is good news for shareholders, we do not view cost-cutting as a growth business in and of itself. The company’s organic sales growth is of much greater importance and evidence of an improvement on that front is necessary for us to get comfortable with owning the stock. As the chart below highlights, recent EBIT growth has increasingly been driven by cost savings.
Input Costs Likely Accelerated in 3Q: The acceleration in oil and pulp prices from 2Q to 3Q implies that raw material inflation is likely to be a greater drag on operating income in 3Q than it was during 1H12.
Rates Rising: We have belabored this point, but it is worth emphasizing again. A rise in interest rates from current levels, driven by strong employment data, Federal Reserve commentary, or other market factors, could drive capital further from the consumer staples sector. While correlation is not, nor does it imply, causation, it is interesting to note that during the 2009-2012 period, when quantitative easing measures from the Fed dared investors to chase yield, consumer staples traded at a strong inverse correlation to 10-year Treasury yields. The inverse correlation of KMB to the 10-year yield was, in fact, even stronger during the 2009-2012 period, which may indicate that KMB was even more “bid up” by fundamental-agnostic investors, in pursuit of yield, than the XLP.
Quantitative Levels: KMB is in bearish formation with intermediate-term TREND resistance at $98.23.