KMB is one of 52 dividend aristocrats that has provided reliable income increases for decades. In this article, we analyze KMB’s dividend, evaluate the company’s competitive advantages, and review some of the key challenges facing the business.
We believe that KMB has one of the safest dividend payments you can find, but we would like to see a better price to add the stock to our Top 20 Dividend Stocks list or our Conservative Retirees dividend portfolio.
Like many other large consumer brand multinationals, KMB is battling foreign currency headwinds, slower growth in developed markets, and an evolving competitive landscape in higher-growth emerging markets.
KMB has been in business since 1928 and has grown into one of the largest global manufacturers of various tissue and hygiene products. Some of the company’s key products are disposable diapers, training pants, baby wipes, incontinence care products, tissues, toilet paper, paper towels, napkins, and more. KMB’s major brands include Huggies, Pull-Ups, Kleenex, Cottonelle, Kotex, Scott, and Depend. Products are primarily sold to supermarkets, mass merchandisers (Walmart is a 13% customer), drugstores, and other retail outlets.
By segment, Personal Care accounted for 49% of sales and 52% of segment operating profit in 2014. Consumer Tissue accounted for 34% of sales and 31% of operating profit, and K-C Professional generated 17% of sales and 17% of operating profit.
By geography, about 47% of sales and 58% of segment operating profit came from North America in 2014. Asia / Latin America generated 39% of sales and 34% of operating profit, and Europe accounted for 14% of sales and 8% of operating profit. KMB’s business has gradually shifted more manufacturing overseas, where more growth is available and costs are lower.
Few businesses have survived for as long as KMB has. The company’s size, financial strength, and presence in mature, slow-changing markets make it very difficult to disrupt.
KMB’s scale allows it to manufacture its products on a very cost-effective basis. However, the company’s marketing campaigns and brand equity are arguably its strongest advantages.
The company spent $767 million on advertising last year, and retailers have few reasons to change the products they choose to promote. There is only so much shelf space for the types of products KMB sells, and retailers only want brands that will sell quickly. They have little incentive to do business with new entrants if their current mix is generating strong results and supported by the massive marketing budgets of companies like KMB. Not surprisingly, it is very challenging for potential new entrants to break into the distribution channels that KMB enjoys.
KMB’s marketing budget also allows it to respond aggressively to smaller players’ efforts to compete on price or release an innovative new product. KMB can outspend them and quickly redirect its R&D to eliminate most threats. The mature nature of the tissue and hygiene markets only adds to the challenges new entrants face.
Product use cases in these markets hardly change over time (e.g. diapers will continue doing the same job with only incremental technology improvements, such as better sealing), reducing the number of opportunities other players have to capitalize on trends KMB might not have recognized. Consumption patterns are also pretty stable, further limiting the potential for disruption.
All of these factors have combined to help consolidate many of the markets KMB operates in. For example, KMB has roughly half of the U.S. disposable diaper market, with Procter & Gamble being the other major player. Brand loyalty, large marketing budgets, continuous product innovation, and proven sales success across many retail customers provides incumbents with numerous competitive advantages and historically favorable pricing power in many markets. As seen below, KMB has enjoyed a high and stable return on invested capital over the past decade:
Continued efforts to cut costs and improve production efficiencies will help maintain high margins as well. KMB’s FORCE (Focused on Reducing Costs Everywhere) program has instilled a cost reduction mindset in the company’s culture and resulted in several hundred million dollars of cost savings in each of the last five years.
Most recently, in October 2014, KMB initiated a restructuring program to offset stranded costs resulting from the spin-off of its health care business. Restructuring is expected to conclude by the end of 2016 at a pretax cost of $190 to $230 million and result in total pretax savings of $120 to $140 million by the end of 2017. As of the third quarter of 2015, KMB had spent $169 million and generated $55 million in savings. We expect KMB to continue holding or improving margins as a result of its ongoing productivity initiatives.
Many of KMB’s products play in the higher quality, higher price tier of the market. This segment can be susceptible to private label and import competition if brands are underinvested in, the economy weakens, or consumer preferences change. For these reasons, it is essential that KMB continues advancing its product quality and brand loyalty through new product innovations improving characteristics such as absorbency and comfort and through appropriate marketing campaigns and packaging.
From a growth perspective, demand should be supported by the rising population of baby boomers and infants. China, one of KMB’s important diaper markets, recently ended its one child policy and should help drive diaper consumption over the coming decade.
Market penetration rates for KMB’s key products are already quite high across most developed markets. For this reason, KMB and other consumer giants have increasingly targeted emerging markets for future growth. These regions should see rising consumer wealth over time, increasing the allure of KMB’s products for the growing middle class.
Finally, it seems reasonable that KMB will continue to expand into adjacent product categories that take advantage of its branding abilities, distribution network, and product innovation.
Overall, KMB’s business has a very strong moat that should allow it to continue generating healthy cash flows for years to come. Large marketing budgets, consolidated markets, secure shelf space, and continued new product innovation will likely continue to keep new competitors at a safe distance.
KMB’s markets are very competitive, and the strong U.S. dollar only adds to challenges faced by domestic manufacturers who export some of their products. KMB has been shifting more of its production outside of the U.S. over the last 5-10 years to help reduce this risk and be better positioned to serve higher-growth emerging markets.
However, the company still generates about half of its income in North America, where Chinese imports and private label products pose a real risk. As seen below, courtesy of Nielsen, private label goods have increased their market share in the U.S. from 16.1% in 2009 to 17.5% halfway through 2014. Of course this market share figure varies significantly between product categories, but it highlights the general trend.
Competitive developments in emerging markets such as China are another risk factor to monitor. The bulk of future sales and earnings growth is expected to come from these regions (they have higher birth rates than developed markets and rising consumer wealth), so it’s important for KMB to establish a large and profitable market share. Today, these regions are much less profitable for the company than its North