Kimberly-Clark (KMB) is another example of the dilemma in which income investors find themselves lately. The company is a great cash producer and will continue to increase its cash return to investors for many years on strong products like Huggies and Kleenex. Shares are relatively expensive though as interest rates force bond investors into consumer stocks for yield. The impending spinoff or sale of the healthcare unit could provide a temporary boost to shares but investors may want to be cautious about how much they buy at these levels.
Investment Highlights
• Nearly 80 years of dividends and 39 consecutive years of dividend increases puts Kimberly Clark firmly on income investors’ radar
• Shares are currently fairly valued or slightly overpriced with a slowing growth in dividends due to high debt and sluggish sales
• An impending spinoff or sale of the healthcare segment could help boost shares in the near-term though valuation could still be a problem
Overview
Kimberly Clark is a $41.7 billion manufacturer and retailer of consumer and health products. The company controls a strong share of the personal care market for babies with its Huggies brand. Other brands include Depends, Kleenex, Scott and Cottonelle. The healthcare segment provides surgical and infection prevention products for the operating room under the ON-Q brands.
The personal care segment accounts for nearly half of sales (45%) with the consumer tissue segment posting another third (31%) in 2013. The K-C professional segment accounted for 16% of sales with healthcare posting 8% of the total. Sales in North America accounted for 49% of total revenue with Europe accounting for 14% and Asia, Latin America and other accounting for 37% of revenue.
Kimberly Clark announced in November that it would spinoff its healthcare business but has not yet carried through with the plans. The segment posts over $1.6 billion in sales with 70% in the North American market. With no word yet on the spinoff date, the company may be trying to sell the segment as well and an announcement could mean a strong pop in the shares.
Fundamentals
Sales grew just 0.4% last year, well off of the 2.3% average over the last three years. The company was able to control its operating expenses which fell 0.8% on the year and have grown by an average of 2.2% over the last three years.
Cash on the balance sheet has consistently been around $1.1 billion against an average of $6.0 billion in current liabilities. The company is in no danger of running out of quick cash but another $5.4 billion in long-term debt could limit the amount of cash returned to shareholders over the near-term.
Cash flow from operations fell 7.5% last year to $3.0 billion and is down another 5.6% over the trailing twelve months. The decline is mostly from volatile working capital changes and may only be temporary. The company still posted free cash flow of $2.1 billion last year and will continue to make enough money to cover a sizeable cash return to shareholders.
Dividends and Growth
Shares currently pay a 3.0% yield, below the 3.6% average over the last five years. The company’s payout ratio of 59% has also come down from its average of 62% over the last five years. Dividends per share have grown by 6.9% over the last five years but have slowed to growth of 6.7% over the last three.
Despite some weakness in growth, the company has raised the dividend for 39 consecutive years and has paid cash dividend since 1935. Slowing growth and high debt may limit the cash return in the future but risk-averse investors can still be confident that the shares will return a steady stream of income.
Kimberly Clark has been relatively aggressive in buying back its own shares over the past three years, averaging $1.25 billion in repurchases per year. This is beyond the $1.24 billion the company has returned to shareholders through the dividend over the last four quarters.
Valuation
Shares are trading for 19.8 times earnings for the last four quarters, well above the company’s average multiple of 16.9 times over the last five years but below the industry’s 22.4 times average. This highlights the problem with valuation for investors across the consumer staples sector. It is getting increasingly more difficult to find shares to buy that do not seem overpriced on a price-earnings basis. Long-term investors can find some comfort in the fact that price multiples are not necessarily in bubble territory so there is no reason to expect that stocks would crash anytime soon.
Kimberly Clark uses debt to finance 57.5% of its capital structure and has an A rating from Morningstar. The company’s high use of debt could limit cash return in the future but helps to lower its cost of capital. I have assumed dividend growth of 6.0% over the next ten years and a 3.5% terminal rate for the discounted cash flow analysis below.
While shares of Kimberly Clark look relatively expensive, especially on a price-earnings basis, the spinoff or sale of the healthcare unit could provide upwards of $3.5 billion in cash. This could be used to pay down debt or return to shareholders and would improve the company’s valuation. The company has a solid payout and good brands, making it an acceptable addition to a very risk-averse portfolio.
