Kimberly-Clark (NYSE:KMB) is slated to release its results for Q2 2014 Tuesday, July 22. The manufacturer of Kleenex tissues and Huggies diapers registered organic sales growth (excludes the impact of both foreign currency effects and restructuring activities) of 4% in the first quarter of the year, achieving the mid-point of its guidance. Despite the healthy growth in organic sales, the company’s net revenue fell by approximately 1% compared to the year-ago period to $5.3 billion, 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. 
While all the other segments grew organic sales by 3% or more in Q1, Kimberly-Clark’s healthcare organic sales increased by only 1% due to decelerating growth in the U.S. Kimberly-Clark is pursuing a tax-free spin-off of the healthcare division, which is expected to be completed in the current half of the year. We believe that severing the healthcare business is a good move as it will allow Kimberly-Clark to focus on its consumer business. Also, the division has been under-performing relative to the other divisions of the company. Healthcare net sales stood at $1.66 billion in 2011, and have been essentially flat since then owing to the slowing market for healthcare utilization (such as surgical procedures) and infection prevention in the U.S. 
We will update our $110 price estimate for Kimberly-Clark after the upcoming results.
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K-C International Will Continue to be the Most Important Contributor to Overall Growth
The International segment led Kimberly-Clark’s 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. Sales of diapers increased 30% in China, 25% in Russia and 15% in Brazil. This robust growth can be attributed 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.
Cost Savings and Downsizing Actions Will Boost Operating Profit Margins
Kimberly-Clark aims to identify and deliver cost savings in fields where consumers are not much concerned via its FORCE initiative. FORCE delivered $310 million in cost savings in 2013, and another $70 million in Q1 2014, allowing the company to absorb currency translation losses and commodity cost inflation. Kimberly-Clark 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:
- 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 [↩]