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
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)
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.