Consumer staples company Kimberly-Clark (NYSE:KMB) is having a very good year. It's growing revenue and profits, thanks to its strong brands, which include Kleenex and Huggies. The stock has registered solid gains this year as well. Because of this, it might seem like there's nothing keeping the stock from putting up even better gains over the next several months.
But it's wise to consider the bearish case for any stock. After all, conditions can change rapidly. With that in mind, while we don't know what will happen to any stock, here are three reasons Kimberly-Clark's rise could come to an end.
Input cost inflation
One of the biggest potential headwinds facing consumer products companies is the cost of their raw materials. For Kimberly-Clark, since many of its key brands are paper products, the key issue for the company is pulp. A potential complication arises when inflation hits, because the company has to spend more for its inputs. This erodes the company's margins, and as a result, its profitability.
This is indeed starting to show up in the company's results even though overall Kimberly-Clark grew diluted earnings per share by 5% in the third quarter. Part of the reason the company managed to grow earnings is that it is aggressively cutting costs, which is necessary because cost inflation is rearing its ugly head. Input costs increased $55 million last quarter, due to rising costs for raw materials such as fiber.
The reason this could hurt the stock price is that if input cost inflation keeps rising, the company will reach a limit to how much it can combat this. Its cost savings program is working to boost margins now, but there is only so much Kimberly-Clark can to do cut costs before it either has to raise prices significantly or see its margins suffer. The latter scenario would probably not be received well by investors.
Separately, Kimberly-Clark management recently noted currencies as a potential problem facing its business. Kimberly-Clark is a global company. As such, it does business in many countries across the world. This is normally a very good thing, because international markets, particularly the emerging economies, are growing faster than the United States'. But this also serves as a headwind when the U.S. dollar strengthens in value versus other currencies.
That's because companies that do business overseas see their international sales converted into fewer U.S. dollars when the dollar increases. Kimberly-Clark produced 4% organic sales growth last quarter. Organic revenue is an alternative measure that strips out the effects of currency fluctuations. Overall, net sales grew 3%, meaning currencies reduced sales by a full percentage point. Should the U.S. dollar keep strengthening, Kimberly-Clark will be hard-pressed to keep growing net sales at a satisfactory clip.
Another reason Kimberly-Clark's stock could fall going forward is that it is aggressively valued. Kimberly-Clark holds a valuation that could entice selling, particularly with underlying growth looking modest. Kimberly-Clark trades for about 20 times trailing earnings per share and 18 times forward EPS estimates, according to Thomson Reuters. These are fairly lofty multiples, and Kimberly-Clark is more expensive on a valuation basis than the stock market more broadly.
Kimberly-Clark may not be able to keep up with its expanding valuation, since the company expects only mid-single digit earnings growth this year on a percentage basis. Investors might lose their willingness to pay such a high multiple for the stock.
The Foolish bottom line
Kimberly-Clark is having a good year. Its revenue and profits are up, the stock pays a solid 3% dividend yield, and the company uses billions of dollars of cash flow to buy back its own stock. These are all creating value for shareholders, which explains why the stock has performed well over the past year. Before you make the decision to jump in and buy the stock, however, you should consider the downside scenarios.
Going forward, Kimberly-Clark faces rising cost inflation and a strengthening U.S. dollar. Both of these threaten to take a significant bite out of its sales and profits. If these headwinds stiffen, Kimberly-Clark's growth may slow, which would make its relatively lofty valuation no longer appealing. These three issues should be on investors' radar screens over the next several months.
Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Kimberly Clark. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.