The strengthening US dollar continues to muddy quarterly results for multinational corporations. Coca-Cola (KO), Kimberly-Clark (KMB), and Procter & Gamble (PG) were no exception in the calendar third quarter. The consumer staples giants demonstrated the strength of their scale and pricing power in the quarter, though reported results could not overcome the significant pressure of foreign-exchange headwinds in economies around the globe with varying growth levels.
Coca-Cola, Kimberly-Clark, and Procter & Gamble hold some of the most well-known consumer staples brands in the world. Coca-Cola, for one, has perhaps the most-recognizable soft-drink portfolio of any company, Kimberly-Clark boasts a wide range of trusted consumer staples brands from Huggies to Kleenex, and Procter & Gamble has one of the most diverse ranges of well-known consumer staple brands worldwide, even as it continues to simplify its portfolio. The recognition of each company’s strong brands offers a significant competitive advantage in the form of customer retention and pricing power, two dynamics that have grown increasingly more important in the face of white-label competition and threats to global economic health.
Maintaining a resilient top line through pricing strength is only part of the story, however. Many consumer staples companies have also benefited from the general reduction in raw materials. Packaging operations, for example, have seen input costs reduced as commodity prices continue to be suppressed. Companies that depend on plastics for packaging are realizing benefits from falling crude prices as their raw materials are often crude derivatives. Falling crude oil and refined products pricing have also benefited the unparalleled distribution operations of these entities which rely on broad scale and significant points of presence to retain brand awareness and strength.
In this piece, let’s take a closer look at the performance of Coca-Cola, Kimberly-Clark, and Procter & Gamble in the third quarter of 2015. The latter is a holding in the Dividend Growth Newsletter portfolio.
Coca-Cola Gains Global Market Share
Coca-Cola reported revenue falling 5% in the third quarter of 2015 from the year-ago period due to currency headwinds. Organic revenue, however, grew 3% on the same comparable basis thanks to improvement in global volumes and a 3% positive impact from price mix. The gain in price mix reflects the success of the beverage giant’s pricing and packaging initiatives across its key markets, and we were generally pleased with the combined 3% jump in unit case volume led by strength in still-beverages demand in the quarter.
The firm’s organic growth was led by its Latin America segment, where revenue increased 14% on an organic, year-over-year basis. Price/mix was the primary driver behind the strength in the region, but we caution not to read too much into such performance given the inflationary dynamics of some countries in the region. The only geographical segment that did not report an organic increase in revenue during the period was the company’s Asia Pacific segment, where sales fell 1% on an organic basis compared to the third quarter of 2014. It’s too early to tell whether weakness in the segment will continue, but economic malaise in China and the greater Asian region won’t help. Despite the many moving parts of its business, Coca-Cola increased its global share of the non-alcoholic ready to drink beverage market.
Coca-Cola’s initiatives helped its bottom line as well. Comparable currency neutral income before taxes (structurally adjusted) outpaced organic revenue growth in the third quarter, thanks to gross margin expansion and productivity initiatives. The general reduction of the cost of raw materials across the globe helped lower its cost of goods sold on an absolute basis. However, we continued to be mindful of reported, unadjusted results, which showed operating income falling 12% in the period and income before taxes dropping 35%. These are large declines to explain away, even if optimists believe Coca-Cola has done so effectively.
Coca-Cola expects its full-year comparable currency neutral earnings per share growth to be ~5%, in line with its original expectations and an indication that it is executing its business plan for the year quite effectively. Also encouraging is the 5% increase in cash from operations year-to-date, to $8.4 billion. Capital spending of $1.67 billion in the period means the company has generated more than $6.7 billion in free cash flow in the nine months ended October 2.
But with all the adjustments to the “very poor” reported numbers in Coca-Cola’s third-quarter results, we’re just not comfortable with such messy performance, even as we say that Coca-Cola’s income growth potential via dividend payments is nearly as strong as it gets. The company has generated $1.39 in earnings per share through the first nine months of the year, on pace for a full-year reported number of $1.85—that’s 23 times current-year earnings.
We like the fundamentals of Coca-Cola quite a bit, and we think its stake in Monster (MNST) may prove to be its biggest growth engine in coming years, but shares aren’t cheap enough for us. Long- and short-term debt stood at $28.6 billion against total cash and marketable securities of $22.8 billion as of October 2.
Organic Growth in Emerging Markets Drives Kimberly-Clark
Kimberly-Clark reported net sales falling 7% in the third quarter of 2015 from the year-ago period, again showing the impact of currency headwinds on reported results. Sales advanced 5% on an organic basis from the year-ago period, driven by a 10% organic increase in emerging and developing markets. The firm’s volumes grew 5% on a year-over-year basis, and price mix had a slightly favorable impact on sales.
Strong demand for Huggies diapers and baby wipes and adult care items in Kimberly-Clark’s Personal Care segment in North America was a source of strength for volume in the quarter (+10%), even as net selling prices in the geographic segment faced pressure (-3%) due to promotional activity. The Personal Care segment benefited from strong volume growth globally (+7%), as did the Consumer Tissue segment (+2%), but pricing weakness (-1%) nearly offset the sales gains from the increased volume in the latter. Responding to weaker currency rates in Eastern Europe and Latin America, Kimberly Clark’s price improvements (+4%) in the Personal Care division in developing and emerging markets were also positives for the segment. The K-C Professional segment, the company’s smallest by revenue, experienced solid organic sales growth in the quarter, driven by gains in both product mix (+3%) and volume (+2%).
Adjusted earnings per share at Kimberly-Clark advanced modestly on a reported basis compared to the third quarter of 2014. Benefits from organic sales growth, cost savings, input cost deflation, and lower share count were almost fully offset by the negative impact of foreign exchange rates and increased marketing, research, and general expenses. Though management noted the quarterly adjusted earnings per share in the quarter amounted to record performance, the pace of growth over last year’s mark was practically nil (a penny per share).
Nevertheless, Kimberly Clark raised the lower bounds of both its full-year organic sales and adjusted earnings per share guidance following the third quarter. The company now expects organic sales growth of 4%-5%, compared to previous guidance of 3%-5%; adjusted earnings per share is now anticipated to be in a range of $5.70-$5.80, up from a previous range of $5.65-$5.80. Though these are rather small guidance adjustments, they indicate the consumer-staples behemoth is executing its strategy in sound fashion in 2015 as its FORCE (Focused On Reducing Costs Everywhere) initiative continues to bear fruit.
We’re keeping a close eye on the company’s free cash flow generation, which has fallen to ~$840 million during the first nine months of 2015 from $1.52 billion in the year-ago period. Sharp declines in reported net income and a huge swing in postretirement benefits has simply punished cash flow from operations during the first nine months of the year. Long- and short-term debt stood at $7.6 billion against a cash balance of ~$600 million as of September 30.
Productivity Savings Boost Procter & Gamble’s Bottom Line
Procter & Gamble’s reported net sales fell 12% in the first quarter of fiscal 2016, ended September 30, weakness that should have been expected as a result of the negative impact from foreign-currency exchange rates and divestitures of lower-return businesses. What wasn’t expected, however, was organic sales falling 1% in the quarter, something we weren’t particularly pleased with, especially in light of consumer-staples peers including Coca-Cola and Kimberly Clark putting up much stronger organic performance. P&G could have done better, and the executive team seems distracted by all the deal-making.
A rather surprising 4 percentage point drop in organic shipment volume worldwide was nearly offset by a 2 percentage point gain in pricing and a 1 percentage point positive impact of product mix, but that may offer little consolation to investors. The company’s Grooming and Fabric Care and Home Care segments were its best performers on an organic sales basis, each segment with flat organic sales growth, the former benefiting from an impressive 5% advance in pricing. That even the best segments couldn’t inch out an organic sales gain speaks of strategic and operational “red flags” in the executive suite, something not to be ignored.
Procter & Gamble expects “organic sales growth to be positive and to further strengthen in the back half” of its fiscal 2016, but we think more patience may be needed by investors. For one, ongoing divestitures should have helped organic growth in the period as weaker businesses are shed, but the fiscal first quarter performance did not speak of this at all. The consumer staples giant plans to “invest to build awareness and trial of its consumer-preferred products and brands,” but something in the quarter just didn’t pass the sniff test with organic growth performance coming in so poorly. Further disappointments may follow.
The positive highlight for Procter & Gamble’s quarter came on its bottom line, however. The firm grew currency-neutral core earnings per share by 12%, compared to the year-ago period. Significant operating profit margin expansion was the main source of the growth, thanks to the benefit of 260 basis points from productivity cost savings. Pricing expansion was prevalent across all of its segments. On a currency-neutral basis, core operating profit margin grew over 3 percentage points in the quarter on a year-over-year basis. A significant reduction in capital expenditures also helped to boost free cash flow in the quarter.
Looking ahead to the rest of fiscal 2016, Procter & Gamble expects organic sales growth to be flat to up low-single digits and “all-in” sales to be down high-single-digits due to minor brand divestitures and the deconsolidation of its Venezuelan subsidiaries. The company noted ”increased volatility in market growth” and continued uncertainty of the impact of foreign exchange rates have made Procter & Gamble’s earnings growth more difficult to forecast. That said, management is sticking with its original guidance of core earnings per share being slightly down to up mid-single digits from fiscal 2015 restated core earnings per share of $3.76.
Continued execution of its productivity cost initiatives–as it did in its fiscal first quarter–will be necessary for the firm to produce results near the upper bounds of its guidance ranges. We’re giving P&G the benefit of the doubt—well, because it’s P&G—but we can’t say that we are pleased with organic top-line trends, and the pace of divestitures in the past several months would be difficult for any investor to get comfortable with. The company remains a holding in the Dividend Growth Newsletter portfolio, but we’d view it as a source of cash should more attractive opportunities present themselves.