Kimberly-Clark: Pricing Benefit Unlikely To Be Present In FY24 (NYSE:KMB)

Summary

In my coverage of Kimberly-Clark Corporation (NYSE:KMB), I recommended a hold rating as I believe the valuation was not attractive back then. This post is to provide an update on my thoughts on the business and stock. I reiterate my old rating, as I do not expect KMB to enjoy the same pricing power it did over the past few quarters. Excluding pricing growth, organic sales have been weak, and I think this weakness will become obvious in the coming results, which will continue to pressure the stock and valuation.

Investment thesis

KMB posted 3Q23 organic sales growth of 5%, driven mainly by price (contributed 5%) as product mix impact and volume decline offset each other. The organic sales growth rate was 7% in North America, 0% in developed markets, and 5% in other developing and emerging markets. China is worth highlighting because both its organic sales and volume increased by double digits compared to the previous year. Personal care saw an organic sales increase of 7%, consumer tissue saw an increase of 2%, and KCP saw an increase of 4%. With favorable input costs and efficient overhead, the company was able to achieve healthy gross margins of 35.8%. However, the improvement in gross margin was partially offset by the larger increase in SG&A spending (18% growth), resulting in an 18% increase in EBIT.

The primary factor behind my previous decision to assign a hold rating was the valuation, which appeared to have incorporated the anticipated short-term growth potential of the stock, as indicated by its forward PE ratio of 19x. Given the downward re-rating of the stock to a forward PE ratio of 17x, it is possible that certain investors may adopt a more optimistic stance. However, I remain cautious in this regard, as I hold the belief that the growth of earnings in the immediate future could potentially be hindered. Specifically, despite the consecutive improvements in volumes and margins, I maintain a cautious stance regarding KMB’s capacity to achieve the necessary volume growth to sustain its upward revenue trajectory, particularly as pricing reaches a saturation point. It is important to note that the entirety of the organic growth observed during this quarter was primarily attributed to pricing strategies. Based on my analysis, taking away the price increase initiatives, KMB’s organic sales growth would have been almost negative throughout the past 11 quarters. Pricing growth over the past 7 quarters has been >5% and my opinion is that it is unlikely to be a strong driver in the coming quarters (unless management is willing to give up on volume, which hurts growth).

You know, we’re not ready to call ’24 yet, but, you know, I think volume, you know, we’ve cycled most of our big pricing actions from last year.

But overall, you know, I think we’re, you know, we’ve taken pricing. We’ve probably moved faster on pricing than other brands. And so, I’d say, you know, to me, our normal price gaps have begun to normalize. 3Q23 earnings results call

It could be contended that the rise in prices was implemented as a means to counterbalance the escalation in the cost of raw materials. This argument is valid; however, it implies that as the price of commodities decreases, KMB must adjust its prices downward in order to maintain competitiveness. During the 3Q23 call, management effectively conveyed the information that commodity prices are indeed experiencing a decline. It is worth noting that the management explicitly stated that they do not anticipate significant deflation that would necessitate a reduction in pricing. Nevertheless, it should be noted that management has also stated that they reduced pricing in the Professional segment in Europe due to the decrease in energy prices, while also making price adjustments in certain markets. This observation has prompted me to posit that there exists potential for a price reduction. The indication by management that they are receptive to implementing additional price modifications introduces an additional layer of uncertainty.

We have rolled back some pricing because, notably, in Professional in Europe, you know, we had energy costs that, you know, really shot up and then came back down.

And so we have adjusted some pricing in some markets, and we’ll do that, you know, where it makes sense. 3Q23 earnings results call

To sum it up, my analysis of KMB’s performance in the third quarter of 2023 indicates that pricing is anticipated to have a reduced influence on the overall results. However, if KMB’s management cannot maintain the robust consumption and market share improvements seen in their primary markets, there is a noteworthy risk of KMB losing its growth momentum. This risk becomes particularly significant if KMB needs to start being aggressive in promotion to compete against competitors that decide to lower prices to capture share.

Valuation

I believe the fair value for KMB based on my model is $123.63. My model assumptions are that KMB will not be enjoying the same pricing tailwind it did in FY24, as they have already raised prices by a fair bit over the past few quarters. With commodity prices easing, there is a likelihood that KMB might need to roll back prices on certain products. Post FY25, the business should revert to normalcy, where it grows at low single digits. The main difference between my updated model and my previous model is that I originally expected FY24 to experience 2% growth as well, but that expectation is now off the table as I don’t expect the same pricing power to continue into FY24. Consequently, I see near-term earnings growth being impaired due to the absence of pricing growth. While KMB is now valued at 17x forward PE, the low end of its historical trading range, I expect this valuation to stay for the near term until the market gains further clarity on potential revenue and earnings growth.

Risk

The risk to my hold rating is that KMB might be able to pull through another few price increases in the near term, which is likely to reignite the positive sentiment around the stock, driving the price to go up. Furthermore, with valuation at the low end of the trading range, any re-rating back to the historical average of 19x forward PE will certainly boost returns.

Conclusion

In conclusion, my analysis of KMB reveals a challenging outlook for the upcoming fiscal year (FY24). While the company delivered strong 3Q23 organic sales growth driven primarily by price increases, the sustainability of this pricing power is uncertain. KMB’s organic sales growth has been largely reliant on pricing strategies, with minimal volume growth. Looking ahead, I anticipate a diminished impact of pricing on KMB’s overall performance, as the company may struggle to continue raising prices. There is a risk of KMB losing its growth momentum, especially if it needs to resort to increased promotional activities to compete with rivals lowering prices.