Kimberly-Clark (NYSE: KMB) proved in 2013 that one of the company's business risks is, for the present and foreseeable future, a competitive advantage. The company is less diversified than other major conglomerates in its peer group, yet this risk is mitigated to some extent by the way KMB has structured its sales geographically. In fact, lack of diversification relative to peers is providing the company an edge in its attempts to gain market share around the world. Kimberly-Clark's relatively narrow business model, along with lucrative equity investments in affiliated companies, will likely propel the stock to outperformance vis-a-vis its peers in 2014.
A concentrated business
The company operates in four major business segments: personal care (diapers, baby wipes, feminine and incontinence products), consumer tissue (paper towels, facial and bathroom tissues), "K-C professional" (workplace products, including sanitizers, tissues, paper towels, apparel), and health care (operating-room surgical products and infection-prevention products).
As you can see, a majority of KMB's products are paper-based and hygiene-themed. The first two segments, which include well-known brands such as Huggies, Kotex, Kleenex, Scott, and Cottonelle, accounted for 76.6% of company revenue in the first nine months of 2013.
This business structure presents a risk versus larger competitors Procter & Gamble (NYSE: PG) and Unilever (NYSE: UL), whose businesses are diversified over a range of categories as diverse as detergents, snack foods, beverages, pet foods, and beauty products, to name just a few categories.
The company has leavened some of this risk by adjusting the geographic distribution of its products. For example, in late 2012 Kimberly-Clark began to exit its diaper business in Central and Western Europe, a process that is now substantially complete. Meanwhile, it has invested in growing its diaper business in emerging markets such as China, Russia, and Brazil. In the third quarter of 2013, the company grew its diaper business by 45% in China, 35% in Russia, and 20% in Brazil. These three countries alone -- ranked first, ninth, and fifth in world population, respectively -- account for nearly a quarter of the planet's population and exhibit a seemingly built-in demand for infant necessities such diapers and baby wipes.
This narrow focus explains why declining GDP growth rates and more cautious consumers in these three emerging economies did not affect KMB's business, while other conglomerates struggled with growth in BRIC countries in 2013. Additionally, Europe, which is more representative of a mature economy, has since provided the company with opportunities for targeted growth in areas such as pull-ups and bedwetting prevention pants. Concentration can be a virtue given the right conditions. In fact, the company may very well become an even more concentrated enterprise in 2014, as management is exploring the possibility of a tax-free spinoff of the health care segment this year.
As I've discussed in a previous article, larger, more diversified conglomerates will face revenue growth headwinds in 2014 as citizens in developing nations curb their purchasing habits moderately. As lower growth rates and potentially meeker earnings hit its competitors, Kimberly-Clark's stock may benefit from renewed attention as investors comb through the consumer goods sector looking for vigorous organic revenue growth. Kimberly-Clark achieved a 5% organic revenue growth rate in its most recently reported quarter. Investors didn't ignore the company's performance in 2013, which we can see when comparing Kimberly-Clark's total return to P&G and Unilever, as well as peers Clorox (NYSE: CLX) and Colgate-Palmolive.
Equity investments will continue to support the bottom line
Perhaps investors also admire the way KMB invests. The company holds equity investments at near 50% interests in personal care and tissue businesses in India, Mexico, Saudi Arabia, Bahrain, and Colombia. The largest and most significant investment is the company's 47.9% ownership stake in Kimberly-Clark de Mexico (NASDAQOTH: KCDMY). Kimberly-Clark de Mexico has been operating since 1931 and finds itself at present in a burgeoning consumer market: With 118 million inhabitants, Mexico is the world's 11th most populous country, and its $1.2 trillion GDP ranks No. 15 globally.
Kimberly-Clark de Mexico has been a recent boon to KMB, posting a 5.8% annual growth rate over the last three years, which is 1.75 times as fast as Kimberly-Clark's revenue growth rate of 3.3% over the same period. Along with the BRIC countries, economic growth in Mexico has slowed some over the past year. But like its American counterpart, Kimberly-Clark de Mexico's concentration in necessity consumables such as diapers, wipes, and toilet paper provides some insulation from the macro environment.
Kimberly-Clark's Mexican connection paced a 25.6% increase in net income from equity investments in the first nine months of 2013 versus the prior year. Equity investment income now makes up nearly 10% of Kimberly-Clark's net income, and the number is growing, as the increases in this category are outpacing Kimberly-Clark's total net income growth.
At the end of its last reported fiscal year, Kimberly-Clark's $252 million investment in Kimberly-Clark de Mexico's publicly traded shares boasted a market capitalization of $3.8 billion. While this is not equity that directly benefits Kimberly-Clark shareholders (outside from the contributions to KMB's net income that the shares make possible), it gives investors a sense of the success of Kimberly-Clark's equity investments.
You can also look at this success as follows: As of Sept. 30, 2013, the company's total equity investments on its balance sheet equaled $429 million. Year-to-date net income from these investments was recorded at $157 million. This is equal to an annualized rate of return on investment of nearly 49%.
A logical choice if the U.S. market cools down
While KMB is poised for another solid year, and will likely outperform more-diversified competitors, the stock may get an extra push should the U.S. stock markets encounter rough waters. When markets retrace, investors tend to seek defensive stocks with a competitive edge. With its narrow product focus and high return on equity investments, Kimberly-Clark could well rise on long-term investors' priority lists later this year.
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