Kimberly-Clark Needs Fatter Margins to Drive Fair Value Higher

Kimberly-Clark’s (NYSE:KMB) personal care division generates lower sales than the consumer and professional tissues segment, but it contributes a higher value for the company owing to its higher margins. The high-cost environment of 2011, was particularly harsh for the personal care segment whose margins suffered a sudden four-percentage point decline last year after five continuous years of stable EBITDA margin. If commodity inflation eases over the new few years, we believe the division could generate more than half of the value for the company. Kimberly-Clark competes with Procter & Gamble (NYSE:PG) and Unilever (NYSE:UL).

See Our Full Analysis for Kimberly-Clark’s Stock

Kimberly Clark’s personal care division (that includes Baby Care, Feminine Care and Adult Incontinence products) contributes to more than 48% of Kimberly-Clark’s value, compared to 43% corresponding to consumer & professional tissues segment (Kleenex and Scott brands), even though the latter generates 10% higher revenues.

The difference in valuation comes from the significant difference in the margins generated by the two. For example, in 2010, the tissue segment generated 10% more revenues than the personal care segment, but reported 20% lower EBITDA than the latter. The tissues segment reported an EBITDA margin of 18%, compared to a 24% EBITDA margin for the personal care division.

However, the difference narrowed in 2011 as higher input inflation in the personal care category brought down margins to 19.7% (down from the 24% average EBITDA over the last four years), while the tissues division maintained margin at around 18-19%.

We currently expect input costs to ease and the personal care division to recover some of its margins going forward. However, there could be a 10-15% upside to the Trefis price estimate if margin’s improved to the 2009-2010 levels of 24-25% by 2018. If the personal care division pulls out a turnaround and regains its historical EBITDA margins, it would contribute more than 52% of Kimberly-Clark’s stock price, compared to 40% by the consumer & professional tissues segment.

Input Inflation And Pressure On Margins

The company-wide EBITDA margin’s for Kimberly-Clark fell from 20.6% in 2010 to 19% in 2011, despite a 2-3% increase in selling prices and $265 million in cost savings. This was due to high input commodity inflation which increased input costs by $580 million. Nonetheless, input costs moderated over the second half of 2011 which helped second half gross margins improve by 1 percentage point compared to the first half of the year, helped by higher prices. We expect the a moderation in input costs to continue which should ease the pressure on the company’s bottom-line, particularly the personal care segment.

Increased Marketing Budget

According to the company management, the firm’s strategic marketing spending is planned to increase faster than sales, primarily supporting product innovations, targeted growth initiatives and overall brand equity. Research and development and selling expenses are also expected to rise faster than sales to support growth initiatives and to further improve capabilities. This could eat up some up the margins improvement.

We have a $76.54 Trefis price estimate for Kimberly-Clark, 5% ahead of the current market price.

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