Earlier this year, I singled out Kimberly-Clark (NYSE:KMB) as a stock that would likely outperform the S&P 500 index, especially should the broader market decline. I also praised the company's concentrated business model, in which it benefits from a narrower business focus than some of its larger consumer goods peers. KMB's first quarter of 2014, reported this week, seemed a middling result: The company managed to increase net income by 1.3% against a one percent decrease in sales. Organic sales for the period rose 4% versus the prior year. Reviewing a few themes from these earlier two articles in light of the company's first quarter earnings may illuminate Kimberly-Clark's direction for the rest of the year.
Competition still a concern
In a refreshingly open moment during the company's fourth-quarter 2013 earnings conference call back in January, CEO Tom Falk discussed competitors with candor. While he mentioned a number of aggressive peers, from Georgia Pacific to Japanese conglomerate Unicharm, in the intervening months, it appears that mammoth nemesis Procter & Gamble gained the most ground competitively. On Monday's earnings call, Falk noted that one of its most significant brands, Huggies diapers, lost a couple of points of market share to P&G's Luvs diapers during the quarter. Two days later on its earnings call, P&G touted that it had gained two points of market share in its own baby-care business, stating: "This has led to our largest market share in the past 20 years, enabling us to retake market leadership from Kimberly-Clark."
The BRICs buy diapers
One place KMB may look to fight back is in the BRIC countries. Organic sales in diapers increased 15% in Brazil, 25% in Russia, and 30% in China. Kimberly-Clark has shifted around its baby care concentration recently, lessening its exposure in slower-birth countries in Central and Western Europe, and focusing more on high-birth-rate countries in emerging markets. We can wager that next quarter's baby care numbers within the "Personal Care" business segment will also be strong, as KMB wants to wrest market share back from P&G, and because it makes rational business sense to allocate resources where sales are manically outpacing the company's overall growth rate.
Checking in on the "FORCE to Inputs" ratio
"FORCE" is Kimberly-Clark's successful cost-cutting program, an acronym for "Focused on Reducing Costs Everywhere." It's useful to compare FORCE savings to input cost inflation (the increase in price for the raw materials Kimberly-Clark uses to manufacture its products). By doing so we get a thumbnail measure with which we can understand the company's ability to absorb cost increases through trimming operations and productivity improvements.
At the end of 2013, FORCE savings totaled $310 million, versus input cost inflation of $205 million. The ratio of savings to inflation thus stood at a healthy 1.5 times. At the end of the first quarter of 2014, the company realized FORCE savings of $70 million, versus cost inflation of $65 million, bringing the ratio down to 1.08, or almost 1-to-1.
While inflation and cost-cutting produced uncomfortably close effects in the first quarter, management's outlook for the rest of the year is more in line with 2013. The company expects to achieve total FORCE savings of $300 million, and it expects to see cost inflation in the upper half of the $150 to $250 million range. Using a conservative number of $225 million for cost inflation, the FORCE-to-inputs ratio should land somewhere around 1.33, which is not quite as stellar as last year, but still good enough for the company to manage the projected decrease in its raw materials purchasing power.
The Mexican connection
One boost KMB receives every quarter is its return on equity investments. This is led by the company's 48% stake in Kimberly-Clark de Mexico. In the first quarter of last year, income from equity investments was equal to 10.6% of all other net income. This number declined to 8.5% in the first quarter of 2014. The decline is partly attributable to unfavorable currency exchange rates, but CEO Falk also mentioned on Monday's call a slowdown in the general Mexican economy, as well as tougher local competition. While Falk expressed confidence in Kimberly-Clark de Mexico's ability to execute given tough conditions, investors will want to monitor the "share of net income of equity companies" line of the income statement carefully for the next three quarters.
Cash flow loses its edge temporarily
Cash flow in the first three months of the year was substantially lower than the prior year's quarter. KMB generated only $437 million of cash from operations in Q1 2013, versus $607 million in the prior year. The fall-off was due primarily to higher working capital requirements and a $101 million increase in pension contributions. According to management, pension contributions were substantially completed last quarter and thus won't produce the same drag on operating cash, indicating more fluid cash flow in the next three fiscal quarters.
A final theme: the mirror
My thesis from earlier this year, that Kimberly-Clark will shine in a negative market because of its narrower business focus versus larger competitors, still appears to hold, even though the market has so far managed to stay above water after a difficult start to the year. In the first week of February, I noted how symmetrical KMB's chart was versus the S&P 500 Index, implying that the stock was being favored by defensive investors:
While both have recovered since then, even in an upward trending channel, KMB continues to provide a rough mirror image of the broader index. And it's still outpacing the index, albeit by a smaller margin than before:
What's the visual gist here? KMB is it still primed to accumulate the funds of defensive investors should the market buckle. And if the company can show progress on the themes I've outlined here, it will rise in a positive market environment as well.