The Long and Short
Pandemic darling Kimberly-Clark gets hit by inflation
Meredith Contente | October 29, 2021
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Kimberly-Clark (KMB, A2/A (n)) posted third quarter results which were negatively impacted by significant inflation as well as supply chain disruptions, forcing management to revise full year guidance downward once again. Management increased its input cost inflation estimate for the full year, noting polymer-based materials, pulp, distribution and energy costs were to blame. These pressures are expected to continue in 2022. The company’s rating outlook was recently revised to negative by S&P, which could cause KMB to underperform its consumer staples peers. Bond holders should look to swap out of KMB 2030 bonds, into Estee Lauder Companies (EL – A1/A+) 2030 bonds for both a pick in ratings and g-spread (+7 bp), while taking out over four points of premium.
While we expect the company to take necessary actions to raise prices, there is a lag effect from when prices are raised, to when the benefit is realized at the gross margin level. Margins will likely continue to contract for at least the next three quarters, causing further pressure on KMB’s intermediate curve until it can stem the decline. KMB’s yield curve has largely moved in line with the single-A consumer staples curve, however the 7-year and 10-year part of the curve has held in better than the back end (Exhibit 1). Companies like KMB will need to approach price increases delicately, as to not push customers to find cheaper alternatives (particularly store brands/private label).
Exhibit 1. KMB Curve vs. Single-A Consumer Staples Curve (Now & 1/1/21)
Inflation Running Up Quickly
KMB noted in July of this summer that they had expected commodity prices to ease in the second half of 2021. However, the easing did not materialize and prices for resin and pulp increased meaningfully in the third quarter. They are now expected to stabilize at much higher levels than previously forecast. Key input costs for the year are expected to increase in the $1,400-to-$1,500 million range, up from previous estimates of $1,200-to-$1,300 million. Furthermore, KMB revised downward the cost savings range that it expects to generate from both its FORCE savings program and the global restructuring program initiated in 2018. While the cost savings revision was minimal, as only the high end of the range was reduced, it makes further margin deterioration inevitable. Cost savings were previously expected in the $520-to-$560 million range and are now expected to be in the $520-to-$540 million range. Furthermore, commodity contracts are getting reset at higher levels and the FORCE savings program was constructed under a much lower cost input. That said, the benefit of the FORCE program will be less than what KMB was able to extract this year.
S&P Revises Outlook to Negative
Post the company’s earnings release, S&P revised KMB’s outlook from stable to negative. The agency cited that the outlook change reflected the potential for a lower rating over the next two years, should KMB not be able to strengthen its leverage ratio to the low 2.0x area. We note that KMB’s leverage stood at 2.4x at the end of 3Q and is expected to tick up to the 2.5x area by year-end. The agency noted that KMB has historically maintained leverage in the 1.8x-2.2x range and that while the company may scale back share repurchases to offset further credit deterioration, leverage will remain elevated, especially if macroeconomic conditions worsen. Cost containment efforts and price increases during the quarter were not enough to offset the gross input costs, which were up 1,000bps during the quarter. That said, KMB witnessed an operating margin decline of 230 bp.
KMB surprises with 10-year deal
KMB announced a $600 million new 10-year issue on 10/28/21 with the proceeds for general corporate purposes, which could include debt reduction. Even if all the proceeds are used to reduce debt, it would be a leverage neutral transaction at best. However, we expect the deal to be used for investments as well, which will cause leverage to further creep up. The deal also priced with an approximate +5 bp concession, which we expect will push out the existing 2030 bonds, as accounts look to move out of a tighter issue into the on-the-run bond. Additionally, an account will be about to take out over 8 points doing this swap given that the existing 2030 issue has a higher coupon (3.1% versus 2.0%).