The Long and Short

Inflation continues to squeeze margins at KMB

Meredith Contente | January 28, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Despite beating consensus estimates on both the top line and EPS, inflation and supply chain issues continue to hammer Kimberly-Clark Corporation’s (KMB) margins, with no relief expected until the back half of the year. While management is committed to returning margins to pre-pandemic levels, they noted that they will get there over time, which means pre-pandemic margins may not return until 2023 or 2024. While in some parts of the curve KMB now trades wide to peer Estee Lauder (EL A1/A+), there are still some instances in the intermediate part of the curve where the trading relationship is reversed. Investors can trade out of KMB 3.1% 2030 bonds into EL 2.6% 2030 bonds for a pick of 5 bp (g-spread) while taking out nearly 4 points and improving one notch in ratings at both Moody’s and S&P.

Exhibit 1. KMB vs. EL Curves

Source: Bloomberg TRACE; APS

The deterioration of KMB’s margins since the start of the pandemic is highlighted in Exhibit 2. Margins are at their lowest levels now and we could see a further deterioration in the first half of 2022. That said, KMB still looks like a weaker value than Estee Lauder, an idea highlighted in our 2022 Outlook.

Exhibit 2. KMB Margin Profile (4Q19-4Q21)

Source: Company reports; APS

Consumer Tissue Witnessing the Biggest Decline

KMB’s second largest business unit continues to experience the largest rate of margin decline, with operating margins down 40% in the fourth quarter and 39% for the full year. Margin deterioration in the segment was a result of lower organic sales coupled with higher input costs. Consumer Tissue witnessed a 9% organic decline in the quarter which was largely driven by a 7% decrease in volumes due to de-stocking. Management noted on the earnings call that input cost increases experienced in 2021 were double the previous all-time high. Furthermore, the supply chain is actually more volatile now than during the lockdowns at the start of the pandemic, as COVID variants continue to increase absentee rates. Management is forecasting that costs are expected to rise in the $750 million-$900 million range this year. KMB noted that they expect costs for most inputs including raw materials, distribution and energy to increase for the year. As such, KMB is gearing to increase prices this year in the mid-to-high single digit range to offset inflation. While volume declines in 2021 were largely due to de-stocking, further price hikes could continue to pressure volumes in 2022, if the consumer trades down to private label brands in an effort to save money.

Guidance Falls Short of Consensus

KMB’s full year 2022 guidance fell short of consensus estimates on both the top line and EPS. KMB expects net sales to increase in the 1%-2% range, which is below street estimates of 3%. Organic growth is forecasted to be in the 3%-4% area, which is below estimates of 5.4%. KMB guided to EPS in the $5.60-$6.00 range, which is below street forecasts of $6.31. Management also noted that they expect operating profit to be down in the low-to-mid single digit area, which translates to further margin contraction given the increase expected in the top line. Additionally, KMB will look to increase investments in the business on both the marketing and research side which could put even more pressure on the operating margin.

Leverage Creeps Higher

Given the margin contraction, leverage for the year increased from 2020 despite a decline in total debt levels. KMB ended the year with total leverage of 2.6x which we note is 4 ticks higher than where KMB’s leverage was at year-end 2020. We note that this is higher than the 2.0x threshold that the rating agencies expect for the current ratings. While management made no mention of targeted debt levels on the earnings call, they did note that they remain committed to the single-A rating. While share repurchases have long been a part of management’s capital allocation policies, they did note that given the margin contraction and pressure on free cash flow, they are currently not in a position to execute share buybacks within the current mid-single A ratings profile. Once margins and free cash flow improves, KMB plans to resume repurchases. We believe that management’s decision to pause repurchases has bought them some time with the agencies to get leverage back to levels more commensurate with the ratings.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.