Kimberly-Clark (KMB): A Quality Dividend Aristocrat for Long-term Income and Growth

Kimberly-Clark has provided investors with reliable income increases for decades.

 

In fact, the company is one of the 51 dividend aristocrats, which can all be seen here.

 

Kimberly-Clark pays one of the safest dividends in the market, yields close to 3%, offers mid-single digit payout growth, and sells recession-resistant products.

 

All of these investment qualities are appealing for retired investors living on dividends.

 

However, like many other large consumer brand multinationals, Kimberly-Clark is battling foreign currency headwinds, slower growth in developed markets, and an evolving competitive landscape.

 

Let’s take a closer look at Kimberly-Clark to see why it deserves to be a core position in our Top 20 Dividend Stocks portfolio.

 

Business Overview

Kimberly-Clark has been in business since 1928 and has grown into one of the largest global manufacturers of various tissue and hygiene products.

 

Some of the company’s key products are disposable diapers, training pants, baby wipes, incontinence care products, tissues, toilet paper, paper towels, napkins, and more.

 

Kimberly-Clark’s major brands include Huggies, Pull-Ups, Kleenex, Cottonelle, Kotex, Scott, and Depend. Products are primarily sold to supermarkets, mass merchandisers (Wal-Mart is a 14% customer), drugstores, and other retail outlets.

 

By segment, Personal Care accounted for 50% of sales and 52% of segment operating profit in 2016. Consumer Tissue accounted for 33% of sales and 31% of operating profit, and K-C Professional generated 17% of sales and 17% of operating profit.

 

By geography, about 52% of sales and 65% of segment operating profit came from North America in 2016. Asia / Latin America generated 37% of sales and 28% of operating profit, and Europe accounted for 12% of sales and 7% of operating profit.

 

Kimberly-Clark’s business has gradually shifted more manufacturing overseas, where more growth is available and costs are lower.

 

Business Analysis

Few businesses have survived for as long as Kimberly-Clark has. The company’s size, financial strength, and presence in mature, slow-changing markets make it very difficult to disrupt.

 

Kimberly-Clark’s scale allows it to manufacture its products on a very cost-effective basis. However, the company’s marketing campaigns and brand equity are arguably its strongest advantages.

 

The company spent $665 million on advertising in 2016, and retailers have few reasons to change the products they choose to promote. There is only so much shelf space for the types of products Kimberly-Clark sells, and retailers only want brands that will sell quickly and at healthy margins.

 

Simply put, retailers have little incentive to do business with new supplier if their current mix is generating strong results and supported by the massive marketing budgets of companies like Kimberly-Clark.

 

Not surprisingly, it is challenging for potential new entrants to break into the distribution channels that Kimberly-Clark enjoys.

 

Kimberly-Clark’s marketing budget also allows it to respond aggressively to smaller players’ efforts to compete on price or release an innovative new product.

 

Kimberly-Clark can outspend them, redirect its R&D investments (which totaled nearly $330 million last year), and leverage its well-known brands to eliminate most threats. The mature nature of the tissue and hygiene markets only adds to the challenges new entrants face.

 

Product use cases in these markets hardly change over time (e.g. diapers will continue doing the same job with only incremental technology improvements, such as better sealing), reducing the number of opportunities other players have to capitalize on trends Kimberly-Clark might not have recognized.

 

Consumption patterns are also pretty stable, further limiting the potential for disruption.

 

All of these factors have combined to help consolidate many of the markets Kimberly-Clark operates in. For example, Kimberly-Clark has roughly half of the U.S. disposable diaper market, with Procter & Gamble being the other major player.

 

Brand loyalty, large marketing budgets, continuous product innovation, and proven sales success across many retail customers provides incumbents with numerous competitive advantages and favorable pricing power in many markets.

 

As seen below, Kimberly-Clark has consistently enjoyed a high and stable return on invested capital over the past decade, a sign of a business with durable competitive advantages:

 

 

Continued efforts to cut costs and improve production efficiencies will help maintain high returns as well.

 

Kimberly-Clark’s FORCE (Focused on Reducing Costs Everywhere) program has instilled a cost reduction mindset in the company’s culture and resulted in several hundred million dollars of cost savings in each of the last five years.

 

Most recently, in October 2014, Kimberly-Clark initiated an organizational restructuring program to offset stranded costs resulting from the spin-off of its health care business.

 

Restructuring concluded at the end of 2016, resulting in annualized savings of $140 million, which was at the high end of Kimberly-Clark’s initial guidance ($120 million to $140 million).

 

I expect Kimberly-Clark to continue holding or improving margins as a result of its ongoing productivity initiatives.

 

Many of Kimberly-Clark’s products play in the higher quality, higher price tier of the market. This segment can be susceptible to private label and import competition if brands are underinvested in, the economy weakens, or consumer preferences change.

 

For these reasons, it is essential that Kimberly-Clark continues advancing its product quality and brand loyalty through new product innovations improving characteristics such as absorbency and comfort and through appropriate marketing campaigns and packaging.

 

From a growth perspective, demand should be supported by the rising population of baby boomers and infants. China, one of Kimberly-Clark’s important diaper markets, recently ended its one child policy and should help drive diaper consumption over the coming decade, for example.

 

However, market penetration rates for Kimberly-Clark’s key products are already quite high across most developed markets.

 

For this reason, Kimberly-Clark and other consumer giants have increasingly targeted emerging markets for future growth. These regions should see rising consumer wealth over time, increasing the allure of Kimberly-Clark’s products for the growing middle class.

 

Finally, it seems reasonable that Kimberly-Clark will continue to expand into adjacent product categories that take advantage of its branding abilities, distribution network, and product innovation.

 

Overall, Kimberly-Clark’s business has a very strong moat that should allow it to continue generating healthy cash flows for years to come.

 

A large marketing budget, consolidated markets, secure shelf space, and continued new product innovation will likely continue keeping new competitors at a safe distance.

 

Key Risks

Despite the company’s strengths, there are a number of risks to understand.

 

Kimberly-Clark’s markets are very competitive, and the strong U.S. dollar only adds to challenges faced by domestic manufacturers who export some of their products.

 

Kimberly-Clark has been shifting more of its production outside of the U.S. over the last 5-10 years to help reduce this risk and be better positioned to serve higher-growth emerging markets.

 

However, the company still generates over half of its income in North America, where low-cost Chinese imports and private label products pose a risk to future growth and profitability.

 

In fact, consumers could save more than $40 billion annually by purchasing store brand products over national brands, according to the National Bureau of Economic Research.

 

U.S. private label goods have increased their dollar market share from 16.5% in 2009 to nearly 18%, according to Nielsen. This market share figure varies significantly between product categories, but it highlights the general trend.

 

Within the North American tissue market, private labels have continued closing the gap in market share, increasing their share by 9% over the last decade to reach 27% of the overall pie.

 

Store brands have continued to see growth across most channels in recent years, too. Kimberly-Clark will need to rely on effective marketing spending and product innovation to keep consumers coming back for its higher-priced products.

 

 

Competitive developments in emerging markets such as China are another risk factor to monitor.

 

The bulk of future sales and earnings growth is expected to come from these regions (they have higher birth rates than developed markets and rising consumer wealth), so it’s important for Kimberly-Clark to establish a large and profitable market share. Today, these regions are much less profitable for the company than its North American operations.

 

Kimberly-Clark will need to continue investing in marketing campaigns and developing innovative new products to protect and grow its market share and profitability. So far, the company has been successful and recorded low- to mid-single digit organic sales growth in each of the last four years.

 

However, the company’s growth was largely disappointing in 2016, with organic sales increasing just 2% compared to management’s initial forecast calling for 3-5% growth. A similar pace of organic growth is expected in 2017.

 

Raw material fluctuations pose another risk. Cellulose fiber is the primary raw material for Kimberly-Clark’s tissue products and is a component of diapers and incontinence care products.

 

The company also purchases large amounts of polypropylene and other synthetics and chemicals for manufacturing its diapers, wet wipes, and incontinence pads. We don’t see any supply concerns that would lead to structurally higher raw material costs, but it’s possible for prices to whip around from one year to the next, impacting near-term earnings.

 

Kimberly-Clark’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Kimberly-Clark recorded an excellent dividend Safety Score of 99, suggesting its current dividend payment is one of the safest you can find in the market. The company’s moderate payout ratios, consistent cash flow generation, recession-proof products, and wide moat support its favorable ranking.

 

Kimberly-Clark’s free cash flow payout ratio over the last 12 months sits at 54%, which is a very healthy level for a stable business like Kimberly-Clark’s.

 

Looking at longer-term trends in payout ratios can also be helpful to see if growth in earnings per share has kept up with dividend growth.

 

As seen below, Kimberly-Clark’s payout ratios have generally remained between 50% and 60%, providing plenty of cushion and room for growth in years ahead.

 

 

For dividend companies with enough operating history, it’s always a prudent exercise to observe how their businesses performed during the financial crisis.

 

Kimberly-Clark’s reported sales fell 2% in fiscal year 2009, but its earnings actually grew by 12%.

 

With so many of its products considered necessities, Kimberly-Clark’s strong performance during the recession comes as no surprise.

 

Longer-term, we would expect Kimberly-Clark’s sales to be primarily impacted by population growth, birth rates, and gradually evolving consumer trends.

 

 

High quality companies are able to generate free cash flow year in and year out. Rising cash flow is important because it supports continued dividend growth without expanding the payout ratio.

 

As seen below, Kimberly-Clark has generated free cash flow in each of the past 10 years. The mature nature of the industry, Kimberly-Clark’s large manufacturing scale, and the recession-resistant characteristics of many of Kimberly-Clark’s products result in consistent cash generation.

 

 

While payout ratios, margins, industry cyclicality, free cash flow generation, and business performance during recessionary conditions help give us a better sense of a dividend’s safety, the balance sheet is an extremely important indicator as well.

 

Companies with high amounts of debt, cyclical business operations, and inconsistent cash flow generation could find themselves in a cash crunch if demand unexpectedly weakens and they have overextended themselves. They will always cut the dividend before missing a debt payment, so monitoring cash and debt levels is important.

 

As seen below, Kimberly-Clark has about $7.6 billion in debt compared to $923 million in cash on hand. The company’s net debt (total debt less cash) is equal to about 2.0x its earnings before interest and taxes (EBIT), which is a very reasonable coverage level.

 

S&P also gives the company an “A” credit rating, suggesting that Kimberly-Clark should have no problem continuing to tap debt markets thanks in part to its very stable cash flows.

 

 

Altogether, we believe Kimberly-Clark’s dividend is very safe. The company’s payout ratios are healthy (50-60%), the business generates reliable free cash flow in any macro environment, and the industry is mature and slow moving.

 

Kimberly-Clark’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Kimberly-Clark’s Growth Score is 69, which suggests its dividend has potential to grow at an above average rate over time (the S&P 500’s average annual dividend growth rate is about 6%).

 

Currency headwinds and higher amounts of debt on the balance sheet could limit near-term dividend growth, but the company’s moderate payout ratios, consistent cash flow generation, and strongholds in faster-growing emerging markets support a brighter longer-term picture.

 

Kimberly-Clark raised its dividend by 5.4% in early 2017, marking its 45^th consecutive annual dividend increase. The company has paid dividends for more than 80 consecutive years and increased its dividend by 6.5% over the last decade.

 

 

Kimberly-Clark has stated that it plans to grow its dividend in line with future earnings growth, which management expects to be in the mid- to high-single digits over the coming years.

 

Valuation

Kimberly-Clark trades at 21.2x forward earnings and has a dividend yield of 2.9%, which is slightly below its five-year average dividend yield of 3.1%.

 

Consumer staples stocks generally trade at an earnings premium for several reasons. Their cash flow stream is generally considered to be more predictable and durable, and their intangible brand equity is also being reflected.

 

All of the marketing and advertising these companies do lowers their earnings because marketing is a GAAP expense, but it builds up brand value over many years to benefit the business.

 

Not surprisingly, these companies can be tricky to value and almost always look expensive using basic valuation multiples.

 

Over the last decade, Kimberly-Clark has grown its adjusted earnings per share by about 6% per year. Going forward, Kimberly-Clark targets a similar growth rate in the mid- to high-single digits. Earnings growth is expected to be driven by 3-5% sales growth and moderate improvements in return on invested capital.

 

Using a basic total return analysis, Kimberly-Clark’s 2.9% dividend yield plus its expected earnings growth rate (5% to 8%) would generate an 8% to 11% annual return going forward.

 

The stock doesn’t appear to be a bargain today, but Kimberly-Clark seems like a reasonable hold for long-term shareholders.

 

Conclusion

Kimberly-Clark is a quality blue chip dividend stock that should continue generating loads of free cash flow for years to come.

 

The dividend payment appears to be extremely safe with room to continue growing at a mid-single digit rate.

 

Like other multinationals, Kimberly-Clark is challenged by the strengthening U.S. dollar, but underlying sales and earnings continue to grow.

 

Given the stock’s current total return potential and competitive strengths, we view it as a quality long-term holding for income and moderate growth.