As far as recession-proof products go, tissue paper and toilet rolls seem as recession-proof as they come. The global consumption of use-at-home tissues rose unabated through the recent period of global economic downturn, increasing steadily from around 21 million tonnes in 2009 to 24 million tonnes in 2011. Away-from-home tissues may have marked up a slower growth rate, but this segment too did not show any signs of decline in demand, increasing from around 5.7 million tonnes in 2009 to around 5.8 million tonnes in 2011. Why is it, then, that Kimberly-Clark (NYSE:KMB) – one of the world’s largest suppliers of paper-based consumer products in the world – saw revenues from its tissues division decline from around $6.7 billion in 2008 to $6.3 billion in 2009 and $6.5 billion in 2010?
The answer to the question is competition, primarily in the form of private labels which sell at prices significantly lower than that of bigger labels such as Kimberly-Clark. Global sales of tissue papers continue to be dominated by the developed economies of North America and Europe – the regions hit hardest by the recession. With decreased purchasing power, consumers in these geographies wasted little time in switching to more economic variants of consumer products.
The switch in consumer preference from costlier, big-name brands to cheaper, private labels can be observed not just in Kimberly-Clark’s top-line. Key competitors such as Procter & Gamble‘s (NYSE:PG) and Georgia Pacific also experienced a major slowdown in sales of paper-based products placed at the higher end of the market. In a way, the 2009-11 period showed what consumers get from bigger labels doesn’t always justify the cost difference – especially in financially challenging times.
With Kimberly-Clark now looking towards emerging economies to drive future sales, the 2009-11 episode will serve the company as a good learning lesson in product pricing. This is particularly true for countries such as China and India, where the recent boom in demand for paper-based consumer products has created a highly fragmented market, full of small labels competing at very low margins.
The question now is, do lower prices to keep out the competition and expansion into low-price environments necessarily mean that Kimberly-Clark will also have to sacrifice on some of its margins in the long run?
The company has made significant gains on its bottom-line in the last few years, despite the top-line pressure. The company’s EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) margins have increased steadily from around 15% in 2008 to around 18% in 2011. We believe the company can sustain itself at the current margin levels, and here are the factors to support this view:
1. Exiting integrated pulp manufacturing activities: In 2011, Kimberly-Clark announced its decision to completely exit its pulp manufacturing and production operations, and focus on third party sources for all its raw materials. The outsourcing of its materials requirement should protect the company from the volatility in costs of raw materials such as oil and paper pulp and allow it to focus on core activities such as distribution and promotion. The company expects the decision to save at least $75 million in 2013 and $100 million by 2014. This should help offset weaker pricing in the short term.
2. Accruing benefits from historical restructuring efforts: In 2004, the company launched its ‘supply chain of the future’ program, which primarily focused on redesigning its supply chain to remove redundancies such as too many distribution centers and manufacturing plants. The move allowed the company to sell off many facilities around the world that were adding to its cost structure. Around six production facilities, operating in high-cost regions such as the US and Australia, had been sold off by 2011. The benefits from these closures are expected to start accruing in significant numbers going forward, allowing the company to maintain a downward revision in prices while maintaining margins.
3. Sourcing from ecologically sustainable sources: In 2012, Kimberley Clark committed to sourcing around 50% of its paper pulp from non-wood, recyclable sources such as bamboo by 2025. This decision is geared more towards the long term, during which a stable source of paper should help protect it from price volatility while recyclable raw materials drive down input costs. In the short term, this should also provide the company with marketing leverage and help differentiate itself from private labels.
We currently have a price estimate of $86 for Kimberly-Clark, which is in-line with the market price.