Kimberly-Clark (NYSE:KMB), the manufacturer of the widely popular Huggies diapers, registered a 4% year-on-year increase in first quarter organic sales (excludes the impact of changes in foreign currency exchange rates and lost sales as a result of restructuring activities). All the segments posted organic sales growth of 3% or more, except health care where sales increased only by 1% due to decelerating growth in the U.S. —the largest market for disposable medical devices in the world.  Kimberly-Clark is pursuing a spin-off of the health care division (expected to complete by the end of this year) due to its lower than company-average organic sales growth and operating profit growth. It has assembled the leadership team for the new entity ahead of the spin-off. 
Despite the healthy growth in organic sales, Kimberly-Clark’s net revenue fell by approximately 1% compared to the year-ago period to $5.3 billion. This was due to the negative impact of currency translation losses and lost sales as a result of restructuring activities that reduced net revenue by 3% and 2%, respectively. However, operating profit increased 2% to $797 million as $80 million in cost savings from the company’s FORCE (Focused On Reducing Costs Everywhere) program and pulp and tissue restructuring actions more than offset the decline in revenue. 
We are in the process of updating our $112 price estimate for Kimberly-Clark’s stock based on the recently announced results.
K-C International Will Continue To Lead From The Front
Like previous quarters, Kimberly-Clark’s international segment led the growth in Q1 with a 12% increase in organic sales. The segment registered high single-digit to double-digit organic sales growth in categories such as adult care, baby diapers and feminine care. Growth was particularly strong in diapers, as indicated by diaper organic sales, which increased 30% in China, 25% in Russia and 15% in Brazil. This robust growth is attributable to the company’s expansion into newer cities in these countries and the launch of new products and innovation. 
The penetration of baby care products is increasing at a fast rate in countries such as Brazil and China owing to a large population, an increase in purchasing power, persistent product innovation and greater brand awareness among consumers. Kimberly-Clark has increased its focus on these markets following its exit from the saturated Western and Central European diaper market in Q2 2013. The company has identified China as a key growth market and will expand into more Chinese cities by the end of the year. It will launch new diaper innovations in Brazil, China and Russia, and also support these by increasing its advertising spend. We think that these factors put the company on track to deliver strong growth in international baby care this year. 
Kimberly-Clark’s international portfolio is more inclined towards diapers and feminine care. Its diapers and feminine care products have greater reach in international markets than its baby wipes and adult care products. This offers it the opportunity to expand its presence in the latter two categories as well.
Operating Margins Will Expand Due To Cost Savings And Downsizing Actions
The FORCE program is aimed at containing costs and keeping the company on track for sustainable growth. FORCE delivered $310 million in cost savings in 2013, and another $70 million in Q1 2014, allowing Kimberly-Clark to absorb currency translation losses and commodity cost inflation. The company expects significant currency headwinds and higher commodity costs this year. However, it also expects to save at least $300 million from the FORCE program which should help it sail past these headwinds and post margin expansion. 
We think that Kimberly-Clark’s recent efforts to enhance the selling price per unit for tissues and diapers will also provide an upward momentum to the margins. In mid-2013, the company carried out a de-sheeting exercise across its Kleenex and Cottonelle line of tissue products, reducing the number of tissues per box by 13% without changing the price of the box.  The effective rise in price per sheet boosted operating profits for consumer tissue (accounts for 31% of company net sales) by 17% year-on-year in Q4 2013, the highest for any business segment of the company. Kimberly-Clark conducted a similar exercise across its Huggies diapers range and began shipping the new packages in February. We believe this will help the company to post margin expansion in baby care as well. Baby care products contribute about 25% to company net sales.Notes:
- Q1 2014 Results and 2014 Outlook, Kimberly-Clark Earnings Presentation, April 21, 2014 [↩]
- Kimberly-Clark’s CEO Discusses Q1 2014 Results – Earnings Call Transcript, Seeking Alpha, April 21, 2014 [↩] [↩]
- Kimberly-Clark Announces First Quarter 2014 Results, Kimberly-Clark Earnings Release, April 21, 2014 [↩]
- Kimberly-Clark’s CEO Discusses Q4 2013 Results – Earnings Call Transcript, Seeking Alpha, January 24, 2014 [↩] [↩]
- Toilet-Tissue ‘Desheeting’ Shrinks Rolls, Plumps Margins, The Wall Street Journal, July 2013 [↩]