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.
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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 American operations.
KMB will need to continue investing in marketing campaigns and developing innovative new products to protect and grow its market share and profitability. So far, the company has been successful and recorded low- to mid-single digit organic sales growth in each of the last four years.
Raw material fluctuations pose another risk. Cellulose fiber is the primary raw material for KMB’s tissue products and is a component of diapers and incontinence care products. The company also purchases large amounts of polypropylene and other synthetics and chemicals for manufacturing its diapers, wet wipes, and incontinence pads. We don’t see any supply concerns that would lead to structurally higher raw material costs, but it’s possible for prices to whip around from one year to the next, impacting near-term earnings.
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. KMB’s long-term dividend and fundamental data charts can all be seen by clicking here and support the following analysis.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
KMB recorded an excellent dividend Safety Score of 99, suggesting its current dividend payment is one of the safest you can find in the market. The company’s moderate payout ratios, consistent cash flow generation, recession-proof products, and wide moat support the favorable ranking.
Using consensus earnings estimates for 2016 ($6.20), KMB’s current dividend per share ($3.52) results in a forward EPS payout ratio of 57%. This is a very healthy level for a stable business like KMB’s.
Looking at longer-term trends in payout ratios can also be helpful to see if growth in earnings per share has kept up with dividend growth. As seen below, KMB’s payout ratios have generally remained between 50% and 60%, providing plenty of cushion and room for growth in years ahead.
For dividend companies with enough operating history, it’s always a prudent exercise to observe how their businesses performed during the financial crisis. KMB’s reported sales fell 2% in fiscal year 2009, but its earnings actually grew by 12%. With so many of its products considered necessities, KMB’s strong performance during the recession comes as no surprise. Longer-term, we would expect KMB’s sales to be primarily impacted by population growth, birth rates, and gradually evolving consumer trends.
High quality companies are able to generate free cash flow year in and year out. Rising cash flow is important because it supports continued dividend growth without expanding the payout ratio. As seen below, KMB has generated free cash flow in each of the past 10 years. The mature nature of the industry, KMB’s large manufacturing scale, and the recession-resistant characteristics of many of KMB’s products result in consistent cash generation.
While payout ratios, margins, industry cyclicality, free cash flow generation, and business performance during recessionary conditions help give us a better sense of a dividend’s safety, the balance sheet is an extremely important indicator as well. Companies with high amounts of debt, cyclical business operations, and inconsistent cash flow generation could find themselves in a cash crunch if demand unexpectedly weakens and they have overextended themselves. They will always cut the dividend before missing a debt payment, so monitoring cash and debt levels is important.
As seen below, KMB has about $7.6 billion in debt compared to $643 million in cash on hand. The company’s net debt (total debt less cash) is equal to about 6.1x its earnings before interest and taxes, coming on the high side of what we normally like to see. If KMB was a cyclical company, we would be concerned. However, consumer staples companies like KMB are typically able to maintain higher amounts of debt because their cash flows are so stable.
Altogether, we believe KMB’s dividend is very safe, making the stock appropriate for investors living off dividends in retirement. The company’s payout ratios are healthy (50-60%), the business generates reliable free cash flow in any macro environment, and the industry is mature and slow moving.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
KMB’s Growth Score is 20, meaning its dividend’s growth potential ranks below average. Currency headwinds and higher amounts of debt on the balance sheet could limit near-term dividend growth, but the company’s moderate payout ratios and consistent cash flow generation support a brighter longer-term picture.
After all, KMB is one of the strongest stocks on the list of dividend aristocrats. The company has raised its dividend for 43 straight years and has paid a dividend for more than 80 consecutive years. Over the last 10 years, KMB’s dividend has grown by 9% per year.
KMB has stated that it plans to grow its dividend in line with future earnings growth, which management expects to be in the mid- to high-single digits over the coming years. Currency headwinds are hurting reported earnings growth today, and the company’s increased debt load removes some of the balance sheet’s flexibility. For those reasons, we wouldn’t be surprised to see dividend growth closer to 5% next year.
KMB trades at 20.7x forward earnings and has a dividend yield of 3%. Consumer staples stocks generally trade at an earnings premium for several reasons. Their cash flow stream is generally considered to be more predictable and durable, and their intangible brand equity is also being reflected. All of the marketing and advertising these companies do lowers their earnings because marketing is a GAAP expense, but it builds up brand value over many years to benefit the business.
Not surprisingly, these companies can be tricky to value and almost always look expensive.
From 2004 through 2014, KMB grew its adjusted earnings per share by 6% per year. Going forward, KMB targets a similar growth rate in the mid- to high-single digits. Earnings growth is expected to be driven by 3-5% sales growth and moderate improvements in return on invested capital.
Using a basic total return analysis, KMB’s 3% dividend yield plus its expected earnings growth rate would generate an 8% to 11% annual return going forward. The stock doesn’t appear to be a bargain today, but these types of businesses rarely ever do.
KMB is a quality blue chip dividend stock that should continue generating loads of free cash flow for years to come. The dividend payment appears to be extremely safe with room to continue growing at a mid-single digit rate. Like other multinationals, KMB is challenged by the strengthening U.S. dollar, but underlying growth remains solid.
We would be more excited about KMB if we had greater confidence in its profitable growth opportunities in emerging markets. While we don’t doubt KMB will continue to be a large player in these regions, we are less certain about the long-term margins the company can achieve as the competitive environment and consumer preferences continue evolving.
Given the stock’s current total return potential and fewer opportunities for growth in North America (its largest and most profitable region), we will continue to watch the stock for now.