It's pretty easy to understand why investors are disappointed in Kimberly-Clark
For the quarter and for fiscal 2005, sales increased by 2.8% and 5.4%, respectively, but cost of goods sold increased even more, by 5.3% and 8.1% over the same periods. The company has been trying to pass on some of its increased production costs to consumers through retail-price increases, but over the past two quarters, it hasn't been clear that the strategy is allowing the company to increase its prices to match its costs.
A raft of unusual items makes Kimberly-Clark's earnings a bit difficult to to interpret this quarter. The way the company tells it, earnings before unusual items were up 3%, from $0.92 last year to $0.95 this year. However, it appears the gain was due entirely to a 4% increase in earnings from repurchases; without the repurchases, the company would have delivered negative earnings growth. The company also states that the unusual charges are "related to competitive improvement initiatives for streamlining the company's operations, incremental tax expense for repatriating earnings of certain foreign subsidiaries, and the cumulative effect of an accounting change related to asset retirement obligations."
Breaking those three items down into bite-size chunks, we get a $0.09-per-share charge for competitive improvements, a $0.04 charge for income taxes on "American Jobs Creation Act" dividends, and a $0.03 charge for the accounting change. I'm willing to cut the company some slack on the taxes and the accounting changes as "unusual" items, but the competitive-improvement item strikes me as an operational item related to increasing cost pressures on the company. Accounting rules may allow the company to classify "competitive improvements" as an unusual item, but I'm looking forward to seeing the company's 10-Q to better understand exactly what these charges are for.
Including all of the "unusual" items, the company's quaterly earnings declined 14% to $0.79, which is a disappointing performance. More disappointing, though, is the $764 million in reported free cash flow, just a little more than half of last year's $1.42 billion. About $175 million of the decline in FCF was caused by increased capital spending, most of which was used for expansion. That helps the company become more efficient, but investors will want to pay close attention to this line item.
Next year, the company expects to grow sales in the 3%-5% range, operating earnings (again, before "unusual items") in the 3%-6% range, and to earnings per share in the $3.85-$3.95 range. The midpoint of that earnings range would be a 3.2% improvement over this year's adjusted $3.78.
Most investors aren't turned on by 3% growth, and I have to admit I'm not either. Kimberly-Clark's shares do currently carry a 3% yield, and the company's press release announced a dividend increase in the "high-single, low-double-digit percentage range" starting this April. Based on today's price of $58.65, that would bring the yield up to about 3.3% and the stock's total return into the 6%-7% range. Not bad, but I'd like to see more out of a consumer-products investment.
I would wait for Kimberly-Clark shares to trade at a lower valuation, or simply pick up more of Income Investor selection Unilever
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