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Kimberly-Clark Corporation (KMB)

Kimberly-Clark (KMB) was founded in 1872 (incorporated in 1928) and has grown into one of the largest global manufacturers of various tissue and hygiene products, selling its products in more than 175 countries. The company's products have such a wide reach that they are used by one-quarter of the world's population.

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

Kimberly-Clark's products are sold under a number of strong global brands, including five billion-dollar brands: Huggies, Kleenex, Cottonelle, Scott, and Kotex. Products are primarily sold to supermarkets, mass merchandisers (Walmart is a 10+% customer), drugstores, and other retail outlets.
Source: Kimberly-Clark Investor Presentation

By segment, Personal Care (diapers, training pants, wipes, feminine and incontinence care) accounts for 50% of the company's sales and operating profits. 

Consumer Tissue (facial tissue, bathroom tissue, paper towels) contributes another 32% of Kimberly-Clark's mix, and K-C Professional (facial tissue, bathroom tissue, paper towels for away-from-home use, safety products) generates the remaining 18%.

Kimberly-Clark's Personal Care segment has been its most successful growth engine since this is where most of its mega-brands are located. As a result, Personal Care has grown from 39% in revenue in 2003 to 50% most recently. 

By geography, 51% of sales and 69% of segment operating profit come from North America. It's worth noting that Kimberly-Clark’s business has gradually shifted more manufacturing overseas, where faster growth is available and costs are lower. In fact, developing and emerging markets account for approximately 30% of the company's overall sales today, up from 14% in 2003. 

And since developed market organic sales are actually shrinking in recent years (3% decline in fiscal 2017) versus 3% growth in non-North American markets and 6% in emerging markets, Kimberly-Clark's future sales and earnings are going to continue to become more diversified. 

With 46 consecutive years of dividend growth, Kimberly-Clark is a dividend aristocrat and becomes a dividend king in 2022.

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 difficult to disrupt.

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

The company routinely spends more than $600 million annually on advertising, 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 want brands that will sell quickly and at healthy margins.

Simply put, retailers have little incentive to do business with new suppliers 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. The company can outspend them, redirect its R&D investments (which routinely exceed $300 million each year), and leverage its well-known brands and distribution channels to eliminate most threats in due time.

As a result, the company enjoys #1 or #2 market share positions in 80 countries. Kimberly-Clark also claims to have created 5 of the 8 major product categories in which it competes, underscoring its strong history of innovation and the returns it has reaped from its consistent investments in research, development, and advertising. In total, the company's R&D and advertising budget amounts to about 5% of annual revenue.

The mature nature of the tissue and hygiene markets only adds to the challenges new entrants face. For example, 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). Furthermore, in categories like diapers, customers want products that are reliable and trustworthy, making them less likely to switch brands.

The industry's slow pace of change also reduces the number of opportunities other players have to capitalize on trends Kimberly-Clark might not have recognized. Consumption patterns are pretty stable as well and tend to track population growth, further limiting the potential for rapid 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 have historically provided incumbents with numerous competitive advantages and favorable pricing power in many markets.

Kimberly-Clark has consistently enjoyed a high and stable return on invested capital over the past decade, often a sign of a business with durable competitive advantages. The company's continuous efforts to cut costs and improve production efficiencies should help it maintain its strong profitability.

Specifically, 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 (compared to annual sales of about $18 billion).

The program has delivered $3.8 billion in cost savings between 2003 and 2017, focusing on improving manufacturing productivity, optimizing product cost design, and negotiating raw material price savings.

On January 23, 2018, Kimberly-Clark announced a new global restructuring program, its largest in more than 15 years. The 2018 Global Restructuring Program will reduce the company's structural cost base by streamlining and simplifying its manufacturing supply chain and overhead organization.

The plan calls for closing or selling 10 manufacturing facilities, reducing the firm's global workforce by about 13%, divesting lower-margin businesses that generate approximately 1% of its sales.

The company estimates that total cash costs of the four-year plan (runs through 2021) will be $1.6 billion. The annual cost savings of this program are expected to be $525 million, most of which will be reinvested in higher R&D and marketing spending to fuel Kimberly-Clark's long-term growth.

The new cost-saving plan continues the companies strong track record of lowering its overhead costs (what it calls "between the line" or BTL) as a percentage of revenue.
Source: Kimberly-Clark Investor Presentation

Thanks to its productivity initiatives, Kimberly-Clark has demonstrated an impressive ability to hold or improve its margins throughout many different economic and competitive environments, providing a steadier stream of cash flow from which to pay reliable dividends.

For example, since its 2014 cost initiatives went into effect, the firm's operating margin has hovered near 18%, its highest level in the more than a decade. That's allowed Kimberly-Clark to reward shareholders with over $16 billion in buybacks (30% share count reduction) and $15 billion in dividends over the past 14 years.

Many of Kimberly-Clark’s products also play in the higher quality, higher price tier of the market. This segment can be susceptible to private label and import competition if name brands underinvest, 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 and appropriate marketing campaigns and packaging.

From a growth perspective, long-term demand should be supported by the rising population of baby boomers and infants, especially in developing markets. 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.

Similarly, other emerging markets around the world have higher total birth rates than in the U.S., meaning a far larger current and future potential market for one of Kimberly-Clark's main business lines.
Source: Kimberly-Clark Investor Presentation

However, market penetration rates for Kimberly-Clark’s key products are already quite high across most developed markets. Therefore, 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. In fact, by 2022 China's middle class is expected to hit 600 million in size, or nearly double the entire population of the U.S.

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 strong moat that should allow it to continue generating healthy cash flows and paying safe, growing dividends for years to come.

A large marketing budget, leading market share in consolidated markets, strong brands, global scale, and continued new product innovation will likely continue keeping new competitors at a safe distance.

When combined with the company's A credit rating, which management has publicly committed to maintaining, Kimberly-Clark appears to be a company that is built to last.

Going forward, management targets organic sales growth and earnings per share growth of 3% to 5% and mid- to high-single digits, respectively. The firm's dividend is expected to grow in line with earnings.

Those targets are all part of the company's "Global Business Plan" (GBP) which launched in 2003 and has managed to deliver great results for investors.
Source: Kimberly-Clark Investor Presentation

If management can achieve its long-term growth goals, then Kimberly-Clark should be able to grow cash flow and dividends at roughly its long-term (20-year average) rate of 7%, which would continue to make it a solid defensive income growth investment.

That being said, there are a number of challenges the company is facing that could cause it to miss its financial targets.

Key Risks
Despite the company’s strengths, there are a number of risks to understand. Kimberly-Clark’s markets are highly competitive, and fluctuations in currency exchange rates can add to the 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 decade to help reduce currency risk and be better positioned to serve higher-growth emerging markets. However, in the short term a rising U.S. dollar can hurt reported foreign sales and earnings growth rates.

More importantly for the company's long-term outlook, some of Kimberly-Clark's business lines have struggled competing against the industry's giants.

For example, in the U.S. Kimberly-Clark's Huggies diapers have fallen to second place (35% share, down from 38% in 2011) while Procter & Gamble has taken over the top spot (45% share, up from under 38% in 2011) according to Euromonitor.

In adult diapers as well, Kimberly-Clark, though still commanding over 50% market share in the U.S. with its Depends brand, has noted it's been losing market share to P&G in recent years.

As a result, since 2012 the company has been unable to post better than 1% company-level revenue growth. While much of that weak growth is attributable to selling off commoditized and slower growing business lines, it highlights the fact that Kimberly-Clark's growth struggles are not a new occurrence and may very well represent "the new normal."

After all, while the emerging markets growth story is attractive, the company still generates over half of its income in North America, where low-cost Chinese imports, private label products, and a declining birth rate (people getting married later and having fewer children) have resulted in intensified competition, threatening the company's ability to hit its long-term financial targets.

Investors have grown increasingly skeptical of Kimberly-Clark's ability to meet its goals as revenue has stagnated in recent years and pricing power has remained muted despite rising input costs, an unusual combination that suggests the market's dynamics may have structurally changed for the worse.

That may be due to increased private label competition. 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 as smartphone-wielding consumers become savvier shoppers.

Private label (generic) products also pose a threat because these are typically in-house brands for major retailers like Walmart, which accounts for 14% of Kimberly-Clark's sales.

Because the U.S. retail landscape has become more competitive (due to the rise of e-commerce), private label brands offered by Walmart and Target gives them more leverage when negotiating annual price hikes.

In other words, Kimberly-Clark could be increasingly challenged to pass on rising input costs. For example, before the major price hikes in the third quarter of 2018, the company was able to achieve just 1% price increases year-over-year, which is historically low for Kimberly (price increases averaged 2% to 3% historically).

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. The company does manufacture private label products for a number of retailers across several categories, but this area represents less than 5% of overall sales.

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. It might take Kimberly-Clark many years to build up a similar logistics and distribution base as it has in the U.S. to achieve similar levels of profitability.

Unfortunately, in recent years (2016 and 2017) the company's emerging market organic growth rates averaged just 5%, compared to their earlier long-term rates of 8%. This indicates that Kimberly-Clark's success in such large and fast-growing markets is far from guaranteed, especially if it bungles new product launches or invests in ineffective advertising campaigns that could cost it market share in those regions.

Raw material fluctuations pose another risk, at least in the short term. 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 (plastic and oil) for manufacturing its diapers, wet wipes, and incontinence pads.

While structurally higher raw material costs seem unlikely, it’s not unusual for prices to whip around from one year to the next, impacting near-term earnings (especially if pricing gains are harder to come by going forward).

Closing Thoughts on Kimberly-Clark
Kimberly-Clark is a quality blue-chip dividend stock. The company has paid dividends for more than 80 years (including 46 consecutive annual increases), and its payout appears to remain very safe today with room to continue growing at a low- to mid-single digit rate over time, assuming management delivers on its long-term growth goals. 

The biggest uncertainty facing the company is whether or not it can return to meeting its financial targets while maintaining its strong profitability. Currency challenges, raw material cost headwinds, a declining birth rate in America, and intensified competition have all worked against the business in recent years. 
 
While there is risk that some of these challenges turn out to be structural rather than transitory issues, Kimberly-Clark continues to possess a number of strengths that make it look like a reasonably appealing holding for a defensive income portfolio. 

With that said, due to the uncertainty surrounding the firm's future growth rates, conservative investors looking to buy Kimberly-Clark will want to make sure they do so when its yield is above its historical norm (representing a high margin of safety).

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