Kimberly-Clark (NYSE:KMB) has been facing an uphill battle against commodity prices in the recent past. Volatile prices of raw materials such as paper, pulp and oil – which form the backbone of the company’s production – have caused overall EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) margins to decline from around around 21% in 2006 to 20% in 2011. Of course, there have been slight ups and downs in between, but margins have largely remained stagnant around the 18-20% mark.
This overall downward trend has persisted despite periodic price revisions and efforts by the company to optimize its supply chain. Going forward, however, we expect the trend to take a u-turn, with accruing benefits from previous cost restructuring programs combining well with newer and bolder initiatives to cut costs and increase penetration (and therefore, pricing power) in developing regions. Here’s a list of the key reasons we’re bullish on the company’s long-term outlook.
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1. Pulling out of Western Europe
In October this year, Kimberly-Clark announced its decision to pull out of the diaper business in Western Europe. The company had been present in the market for over 20 years but had been unable to gain any significant foothold. The company’s flagship brand in this segment, ‘Huggies’, had always trailed Procter & Gamble‘s (NYSE:PG) ‘Pampers’ by a fair margin of around 30% in market share. In fact, Huggies’ market share of around 12% in 2012 was even lower than the total share commanded by private labels in the region. This intense competition eroded the company’s profits in the region – a fact compounded by the high cost of manufacturing and raw materials in the strong-currency environment in Western Europe. The exit has allowed Kimberly Clark to cut its production capacity across the region and seek greener pastures in the emerging economies of Asia and Eastern Europe.
2. Relocation of manufacturing to low-cost environments
Kimberly-Clark’s exit from Western Europe has been accompanied by an increasing focus on scaling up manufacturing capacity in emerging economies. In March 2012, the company opened a diaper manufacturing plant in Nanjing, China in order to cater to the increasing demand for baby care products in the region. The company will invest around $100 million in the facility over the next year, and production is expected to start in early 2013. The company also set up a manufacturing plant in Russia in 2010, with additional capacity for scaling up production. These efforts are expected to help it not only meet the growing demand in emerging markets in the Eastern Hemisphere, but will also allow it to reduce supply costs in the form of transport miles and fuel gallons. Cheaper cost of labor and raw materials are also a major factor influencing this decision.
3. Accruing benefits from previous restructuring and cost-saving programs
Kimberly-Clark has had a strong focus on bottom-line optimization since the mid-2000s. 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 USA and Australia, had been sold off by 2011. The benefits from these closures are expected to start accruing in significant numbers going forward, starting with a $75 million dollar target in cost reduction in 2013.
Meanwhile, the company has also implemented wide-sweeping cost reduction program such as FORCE (Focused on Reducing Costs Everywhere) and SCRP (Strategic Cost Reduction Plan), which aim at reducing general expenses in a variety of forms including employee expenses. The costs saved by the twin programs are estimated by the company at around $515 million through 2012, with more benefits expected in the future.
With the above factors in mind, we have projected a slow but steady increase in the company’s margins to about 21% by 2018. However, if the company is able to beat this estimate and achieve an EBITDA margin in the higher range of, say, 27-28%, we could see a 15% upside to our price estimates.
We currently have a price estimate of $86 for Kimberly-Clark, which is in line with the market price.