"Unexciting" is the word that comes to mind when I look at Kimberly-Clark's (NYSE:KMB) fourth-quarter performance. Actually, that holds true for the company's entire 2005 showing. But looking at the numbers on the surface doesn't tell the whole story. Beneath the boredom is a company that's actually working quite hard to keep up with increasing costs -- and doing so fairly well.
Behind the numbers
Kimberly-Clark showed mild sales growth in its fourth quarter -- about 4% in constant currency. Earnings and operating profits before "unusual items" (more on that in a moment) were up about 3% and down 1%, respectively.
What those numbers don't show is that Kimberly-Clark is fighting an uphill battle against inflationary costs as energy prices remain high. Costs rose by a full $110 million in the quarter. Of that amount, $45 million went to pay higher raw-materials costs (a lot of polymer resins, which are a byproduct of oil production, go into Huggies diapers), $30 million went toward paying for energy (it takes a good deal of power to convert polymer resins and pulp into those cute little Huggies), and another $30 million covered higher distribution costs (the trucks that deliver those Huggies don't run on water).
The company is fighting back by cutting other costs left and right. It slashed $60 million in the fourth quarter alone and in 2006 plans to cut another $250 million -- a figure that includes $80 million to $100 million in what it terms a "reduction of sales, general, and administrative expenses" (code for "layoffs") in Europe.
Management is doing all the right things. It is spending more money on research and development to design new products and improve existing ones. Investing in new SAP software should make the company more efficient in the future, too. And cutting costs through factory closures and consolidations, however painful, will help as well.
That last step is where the "unusual items" come in. Factory closures and layoffs, after all, cost money. However, the majority of charges were counted as accelerated depreciation. As a non-cash charge, accelerated depreciation reduces net income but has no impact on operating cash flows.
The "unusual" charges won't be all that unusual in 2006, as Kimberly-Clark expects to keep closing factories. What's more, it plans to keep doing so through 2009. In the process, the company expects to incur cumulative charges of $900 million to $1.1 billion that should result in pretax annual savings of $300 million to $350 million by 2009 -- a very good return on investment.
Investors should also note that the company's spinoff of Neenah Paper (NYSE:NP) distorts comparisons with 2004 numbers somewhat.
Outlook
Kimberly-Clark is not a high-growth company. It is a slow-growth cash cow, and it's managed that way. It pays about 45% of its income out in dividends and constantly buys back stock. In fact, in 2005, it bought back 24.3 million of its shares at a cost of $1.5 billion. Buying back stock at today's price makes sense, since the stock is not expensive and doing so helps earnings and dividend growth.
However, the stock's future performance to a large degree is tied to oil prices. If they keep rising, 2006 will give the company a serious case of deja vu. But if oil prices stabilize at about $60, the company's margins should show a modest improvement. Kimberly-Clark is leveraged to do well in a declining-oil-price environment. Its earnings should, of course, increase when inflationary costs begin to decrease, and the company's shrewd cost-cutting measures now would just be the icing on the cake.
Kimberly-Clark is a good company: It has well-known brands, a strong balance sheet, great return on assets, and very stable, predictable free cash flows. The company is well poised to deliver about 5%-9% earnings-per-share growth (in a normal commodity environment) through a combination of 3%-5% sales growth, a 2%-3% share buyback, and a slight expansion in margins. Add a 3% dividend (which is soon to be raised), and we're talking about a respectable return of 9%-12% without taking a lot of risk.
Foolish bottom line
At about 15 times 2006 earnings estimates, this is an OK stock. It appears to be fairly priced, though with a small margin of safety. Investors wanting exposure to this sector may want take a closer look at the company. It will not be a home run, but on the other hand, it does not have a lot of risk.
Oil prices do create a bit of uncertainty for the immediate future. But unless Goldman Sachs' prediction comes to fruition and oil prices rise to $100 per barrel, the stock should at least do better than a savings account would. However, if one believes that oil prices are more likely to decline than to rise, Kimberly-Clark is a good way to play on that hunch.
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Vitaliy Katsenelson is a vice president and portfolio manager with Investment Management Associates, and he teaches practical equity analysis and portfolio management at the University of Colorado at Denver's Graduate School of Business. He owns shares of Kimberly-Clark, as does Investment Management Associates. The Motley Fool has a disclosure policy.
